Perhaps the most concerning distortion though is the obsession with “growth.” So deeply ingrained is it in our thinking today that one could be forgiven for thinking it has always been thus. But it is actually quite new. Increasingly, we see it as a part of the widespread though subtle inflation of expectations.
As can be seen, this growth fetish also seems to have developed during the credit inflation. Note also the relation to inflated time preferences. The fixation on growth can encourage behavior which may seem beneficial in the short term but is detrimental to the long term. The debt-overhung world we live in today is a very good macro-level example of the long-run damage this growth obsession can cause. But the corporate world is strewn with them. Most companies even tie executive compensation to implied or explicit EPS growth targets. These, not to mention the primacy of expected growth in the broader financial community, create a pressure on management to behave in a manner they otherwise might not. It also encourages executives to focus more on their stock price than on their business, which can be quite devastating.
For example, a survey of 169 CFOs polled for a recent study into earnings quality found that 20% “manage their earnings to misrepresent economic performance” in any given period. In their book Financial Shenanigans, Howard M. Schilit and Jeremy Perler write that “investors are beginning to harbor a troubling suspicion about corporate financial reporting: that management now plays tricks... Sadly, these suspicions are well founded.” Indeed, the bulk of the frauds analyzed in their book turn out to be perpetrated by executives fearful of disappointing the growth expectations they had previously fostered among their shareholders.
Don’t misunderstand us, there is nothing wrong with growth. We like growth and we like the companies we have ownership stakes in to grow. But we like growth as the outcome of an outstanding business process. An enterprise which is better at solving its customers’ problems than its competitors will soon find itself with more customers. Such a business will inevitably grow and this is a natural and good thing.
But a company pursuing growth for the sake of it, or because Wall Street demands it, or because remuneration has been structured around it, is less likely to be concerned with the long-term health of the business. The pressure on them to engage in the financial shenanigans that Schilit and Perler document in their book will be greater, all else equal. So it is no longer necessary to merely keep a weather eye on the manner in which companies report their numbers. Today, stewards of capital must also make sure executives haven’t succumbed to the growth disease.
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