Sustainable Innovation as an Antidote to Corporate Short-Termism



In the late 1960s, Stanford Professor Walter Mischel conducted a series of experiments with children involving rewards in form of sweets. Children were given the option of either a small immediate reward or a larger reward if they waited for a defined period of ca. 15 minutes. Follow up studies showed that children who waited for the larger rewards tended to have better overall life outcomes as grownups. Whilst these ‘Stanford Marshmallow Experiments’ are now famous and often associated with videos of cute children struggling to exert self-control, the underlying issue of short-term thinking is a phenomenon that is neither limited to children nor to marshmallows.


Short term thinking, or short-termism, describes the tendency of humans and institutions to value short-term gains disproportionally higher than long term benefits and is increasingly recognized as one of the most fundamental challenges to human progress. Short-termism hinders our ability to think, plan and act for the long run and it can lead to irrational and counterproductive decisions. Examples include the failure of corporate executives to sufficiently invest in R&D or preempt environmental regulation, of governments to effectively act on climate change and of individuals to save for their retirement.


Short-termism undermines corporate performance, economic growth and prosperity [1]–[3], contributes to the accelerated destruction of our ecosystem, adds to intergenerational injustices [4], [5], inhibits effective governance [4] and negatively affects human wellbeing [6]. And while short-termism is not new, it is getting worse, especially in the financial [3] and corporate [7] world, where the phenomenon is sometimes referred to as quarterly capitalism.


Why do we fail to act for the long-run, why is short-termism such a problem, and what can we do about it?

Short-termism is a problem of intertemporal choice

Many important economic, environmental, political and personal decisions require the decision maker to carefully balance short-term results with long term outcomes. The decision maker cannot only consider the now, but must also consider the future. To do this effectively, he must solve what is known as an “intertemporal choice problem”. An example of an intertemporal choice problem in the corporate setting could be a company that must decide between the exploitation of a current product line or investment in a new technology. Exploiting the current product line leads to greater profits in the short-term, investing in new technology provides greater profits in the long term. Unfortunately, finding the right balance is challenging.


Take the famous example of Kodak, a company that did not manage to strike the right balance between exploiting its photography line of current products (short term benefits) and investing into innovative digital photography (long term benefits). Digital photography required a sustained initial investment with negative net return for Kodak compared to high positive net return for photographic film based products (Figure 1). But after a certain point in time t, the net return of digital photography would have greatly surpassed that of the now declining photographic film business. The executive board of Kodak failed to transform Kodak’s value proposition fast enough, and in 2012 the pioneer of photography had to file for bankruptcy. Students of innovation will of course notice the Kodak example of an intertemporal choice problem is in fact also an example of the innovator’s dilemma [8].


Figure 1: An Intertemporal Choice Problem

Another example of an inadequately solved intertemporal choice problem (and of the tragedy of the commons) was the promotion of unsustainable private investment in cod fishing in Canada during 1980s, which nearly drove the cod fish population to extinction and resulted in the loss of 40.000 jobs. Had the private companies taken a long-term approach, they would have generated significantly higher returns over a quasi-indefinite period.

Short-termism is a major reason for the failure of corporations to take sustainability seriously

Although the past decades showed some progress in the area of corporate sustainability (CSR), far too often the classic CSR approach fails to capture the many business opportunities that a truly long-term oriented approach to corporate sustainability management could yield. After all, many factors should encourage businesses to adopt sustainable technological innovations, such as tightening regulations, consumer demand and rising and more volatile commodity prices. Crucially, the business upsides of sustainable innovation in product-, business model and process development are becoming increasingly obvious. Optimising energy and resource usage results in lower production and operational costs. Green product lines have a positive impact on sales. Companies actively pursuing sustainable business practices attract and retain the best employees. By adhering to high environmental standards, companies pre-empt future regulations, reduce their risks and improve their speed to market.


Despite these obvious advantages, most companies fail to take the long-term view on the topic of sustainable business practices and opt for expedient short cuts, as recently demonstrated in the diesel scandal in the automotive industry or the slow speed with which innovative sustainable business models such as the product as a service model are adopted, with markedly negative consequences on company performance [7]. In large part, this is because corporate decision makers still view sustainability as an unnecessary investment with unclear long-term outcomes, and instead prefer to pursue secure short-term benefits.

Optimal intertemporal choice requires a balance of our two selves

The basis for the human ability to think and act for the long run, in other words to be patient and exert self-control, is of a neurological nature. This has recently been indicated by using brain imaging technology, suggesting that the brain’s pre-frontal cortex is the home for the human ability of self-control [9].


The human neo-cortex is the most developed in the animal kingdom and uniquely enables us to think and plan for the long-term. This ability was the prerequisite for many important human evolutionary developments e.g. of our current social, economic and political systems. For example, long-term thinking (or patience) is the requirement for savings by households which in turn finances investments into the economy, and savings by firms are financing R&D and drive future output [10].


Sadly, the human brain has not evolved fast enough to allow humans to continually make optimized intertemporal choices in the complex and rapidly evolving modern era, and we often fail to adequately consider long term consequences of our actions. Why is that?


Using the System 1 and System 2 thinking terminology proposed by Kahneman [6], we can partially explain our short-term thinking tendencies by understanding that effective long term decision making is predominantly based on System 2 thinking, i.e. logical, deliberative decision making [5]. System 2 thinking is more resource intensive for humans than fast, instinctive System 1 thinking and therefore often avoided, which makes it so hard to think for the long-run.


The two selves model, which proposes that all people have both patient (long-term thinking) and impatient (short-term thinking) components [11], is well suited to illustrate this dilemma. Optimal intertemporal choice represents a balance between our two selves: the patient planner and the impatient doer (Figure 2), and is very hard to achieve.


Figure 2: A balance that is hard to achieve

Even when employing System 2 decision making, we are subjected to a wide range of cognitive biases. Some of these biases negatively influence our ability to think and act for the long term. For example, the hyperbolic discounting bias, or our tendency to devalue future benefits much more than it would be rational [12], contributes significantly to the lack of urgency with which important issues, such as environmental degradation, are addressed. Other biases, such as loss aversion [13], status quo bias, and confirmation bias similarly reinforce our short-term tendencies (Figure 3).


Figure 3: Some of the cognitive biases contributing to short-term thinking

Asymmetries between costs and benefits invite biases against long-term actions

A further barrier to long-term decision making and action relates to a common asymmetry in the cost benefit analysis of many long-term decisions.


Long-term thinking often requires resource intense action in the short term, for example in the form of a significant amount of investment capital for sustainable innovation initiative. This represents a practical hurdle to many initiatives aimed at the long-run.

At the same time, long-term decision making requires the decision maker to predict the future result of a present action or decision, for example in 5 or 10 years after an R&D project has been started. This is very difficult and often impossible, especially in complex, interconnected systems, such as the economy.


The resource insensitivity of long term decisions and actions, the uncertain and delayed nature of the desired outcomes, and powerful behavioral biases against this asymmetry make long-term decision making very difficult and are the reason that short-termism is systemic in our society and entrenched in its institutions and their organizational processes (Figure 4).


Figure 4: Principal barriers to long-term thinking

Solutions to corporate short-termism

Due to the systemic nature of the barriers to long-term thinking and action, no one-size-fits-all solution will be sufficient. Instead, a multidisciplinary approach consisting of information, advocacy, regulatory and institutional reform as well as the development of tailored decision making tools based on e.g. behavioral- and decision science for all stakeholders is required.


Luckily, with the increasing awareness of this challenge, the issue of short-termism is starting to gain attention from initiatives by organizations including the Aspen Institute [14], the Forum for the Future [15] and the McKinsey Global Institute [1]. The first corporations are also beginning to tackle the issue through corporate reform. Unilever, for example, has stopped giving quarterly earning guides under its CEO Polman, and increased its focus on a corporate strategy for the long term [16].


However, the fight against short-termism represents a challenge of such enormous proportions that we not only require continuing investment into ongoing initiatives, but also additional and innovative approaches to tackling the problem. After all, the re-orientation of our corporations to a long-term focus requires a fundamental shift in the way corporate decision makers think about and make decisions.


One way to facilitate this shift in the corporate world is to incentivise businesses to design products and business models that take into account long-term consequences of their adoption and use. A possibility to contribute to this goal lies in the promotion of tailored methods for sustainable product- and business model innovation and corporate sustainability management.

An extended version of this article as originally been published with the Long Run Institute

References

  1. D. Barton, “Measuring the Economic Impact of Short Termism,” McKinsey Quarterly, 2017.

  2. G. Davies, “Short-termism in business: the long and the short of it.” Bareclays Bank, 2013.

  3. A. G. Haldane and R. Davies, “The Short Long,” 29th Société Universitaire Européene de Recherches Financières Colloquium. 2011.

  4. R. Veld and L. Meuleman, “Sustainable development and the Governance of Long-term Decisions.” EEAC Working Group Governance, 2009.

  5. E. U. Weber and H. Kunreuther, “Aiding decision-making to reduce the impacts of climate change,” 2014.

  6. D. Kahneman, Thinking, Fast and Slow. Penguin UK, 2011.

  7. D. Barton, “Rising to the challenge of Short Termism,” McKinsey Quarterly, 2016.

  8. C. M. Christensen, The Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail. Harvard Business School Press, 1997.

  9. B. Figner, D. Knoch, E. J. Johnson, A. R. Krosch, S. H. Lisanby, E. Fehr, and E. U. Weber, “Lateral prefrontal cortex and self-control in intertemporal choice,” Nat Neurosci, vol. 13, no. 5, pp. 538–539, May 2010.

  10. A. G. Haldane, G. Coppins, R. Davies, S. Ladha, P. Lowe, and G. Murphy, “Patience and Finance,” no. September. Oxford China Business Forum, Beijing, 2010.

  11. R. H. Thaler and H. Shefrin, “An economic theory of self-control,” Journal of Political Economy, vol. 89, no. 2. pp. 392–406, 1981.

  12. S. Frederick, G. Loewenstein, and T. O’Donoghue, “Time Discounting and Preference : A Critical Review,” Journal of Economic Literature, vol. 40, no. 2. pp. 351–401, 2002.

  13. A. Tversky and D. Kahneman, “Loss Aversion in Riskless Choice: A Reference-Dependent Model,” Q. J. Econ., vol. 106, no. 4, pp. 1039–1061, 1991.

  14. B. Budinger, “American Prosperity Project,” 2016.

  15. R. Curran and A. Chapple, “Overcoming the Barriers to Long-term Thinking in Financial Markets,” 2011.

  16. A. Semuels, “How to Stop Short-Term Thinking at America’s Companies,” The Atlantic, 2016.

#Shorttermism #longtermthinking #Intertemporalchoice #quarterlycapitalism

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