Short Term Thinking III

Here comes the rain again
Falling on my head like a memory
Falling on my head like a new emotion
--Eurythmics

Last time we considered the relationship between leverage and time horizon for decisions. The formal proposition was:

Proposition 1: The greater the leverage, the shorter the decision-making time horizon.

While there appears to be conceptual and empirical support for the influence of leverage, other factors are likely to shrink time horizon as well.

The 'obvious' one is environmental uncertainty. As present and future conditions become more unpredictable, then decision makers are likely to focus on the here and now. From a fundamental investment standpoint, if future cash flows cannot be confidently forecast, then it makes little sense to make long term capital commitments. A proxy for uncertainty is volatility or variation. Higher volatility is likely to motivate increased response to cope with changing conditions, which kicks more behavior into present time periods. Stated formally,

Proposition 2: The greater the uncertainty, the shorter the decision-making time horizon. 

One contributor to uncertainty is the political arena. For example, the spectre of government interference in economic activity is likely to give managers pause about committing to long horizon projects (see this missive for a nice elaboration here). In such situations, managers are more likely to choke up on the risk bat and swing for average that is more likely to accrue from shorter term decisions that can assessed with clarity.

To use one industry example, the energy sector is often regarded as one that has lacked 'foresight' in its decisions. Domestically we lack exploration and production capacity as well as refining capacity for fossil fuels. Alternative energy sources, such as batteries, nuclear, solar, wind, etc seem underdeveloped as well. Why so short term of an orientation? One thing that would be paralyzing me is the regulatory environment. I have little idea what energy industry regulation is going to look like down the road, other than a sense that it will be more restrictive.

The other thing that would give me pause is government's habit of picking winners and losers in the energy sector, and tossing out incentives and disincentives accordingly. If I'm an ALT E entrepreneur, not sure I'd want to be making big capital commitments if government might take that risk for me, or at least spot me a few $million. If I'm and oil and gas operator, I might to be less likely to invest in a $10 billion refinery project if government is going to throw its weight behind, say, nuclear or batteries.

Although potential for government interference is really one form of uncertainty specified in Proposition 2 above, its capacity attracting decision-maker attention seems to merit singular theoretical focus here. Therefore,

Proposition 3: The greater the prospect of government intervention, the shorter the decision-making time horizon.

Evidence suggests that all of these factors are in force today--and growing in intensity. That time horizons for decisions has been shrinking accordingly should be no surprise.

no positions