Stop Panicking About Corporate Short-Termism (Harvard Business Review)
Jones Day Partner Lizanne Thomas, leader of the Firm's Corporate Governance team, debunks the conventional wisdom that corporates are strategically myopic and instead offers her own measured reforms for the marketplace.
Contrary to some claims in popular culture, boards and c-suites are not intrinsically heartless and societally myopic. While the rules of the capitalist road surely could do with some updates, almost all of the corporate decision makers my firm has dealt with are responsible, not reckless.
This is particularly true when it comes to the question of how well public companies balance the precepts of long-term value with those of short-term performance. As a practical matter, at most organizations most of the time, the notion that these tenets are in opposition constitutes a false dichotomy. Yes, legitimate concerns exist that some enterprises fail to find the proper equilibrium. But empirical data support the notion that the requirements that come with being publicly listed have not, in fact, impeded capital allocations oriented towards enhancing long-term performance.
Recent analysis indicates that listed companies are measurably more inclined toward the long term than has been surmised by proponents of the so-called “myopia hypothesis.” Last year, economists connected to the Federal Reserve Board published a study of IRS data from 2004 to 2015 that indicated publicly traded companies actually invested 48.1% more on R&D than their privately held counterparts (when adjusted for size and sector.) Beyond that, the Fed researchers reported that when private companies went public their ratio of R&D to physical assets spiked by 34.5%. (What’s more, on average the allocations go in the opposite direction when a public company goes private.)
"It is not simply that public firms invest more relative to their asset base and thus out-invest private firms,” the researchers conclude, “they also direct a greater share of their investment portfolios to long-term assets."
The regulatory environment largely encourages these dispositions. In the U.S., corporate laws mandate that boards act for shareholders with care and loyalty (and without conflicting interests). Federal securities laws meanwhile, mandate that company leaders tell the truth and that they not take advantage of inside knowledge. More broadly, the marketplace rewards companies that devote themselves simultaneously to long-term value creation and short-term performance. And corporate leaders avoid this twin imperative at their peril.
To the extent that some actors are short-sighted, proposals to scuttle, say, quarterly reporting or earnings guidance, while admirable, would have scant effect. Why? Because analysts will still publish their own expectations, and corporate leaders will still want to beat those expectations. (The one difference such a change might make is that corporate leaders would be less likely to engage in the self-inflicted injury of over-promising and under-delivering.)
In other words, although the underlying goal is laudable, those reforms would result in marginal change, at best. In fact, their attendant opacity might even create more volatility.
So let’s accept that the obligations imposed by corporate and securities laws, in the main, reward good conduct and deter bad. That has created an environment that invites investment and innovation. Capital is already largely accountable.
And yet, while the majority of corporate leaders whom we deal with set strategies for the long term and do their best to stick with them, more can be done to encourage all stakeholders to prioritize long term corporate health. Here are a few suggestions.
Deactivate activists. Shareholder activists are often potent contributors to short-termism. But regulators can take a stronger hand on this front. We urge U.S. regulators to consider adopting something akin to the U.K.’s proposed Stewardship Code for fund managers and institutional investors. Here, though, such adoption should be yoked to activism reforms from the Securities and Exchange Commission, such as requiring greater transparency for those accumulating ownership as a precursor to activism.
Reward long-term investors. Legislators could tier capital gains tax rates to reward truly long-term shareholders. The current system too often rewards “trading securities,” rather than “owning companies.” In parallel, let’s persuade asset managers to support revivification or preservation of staggered boards to increase the continuity of leadership that can too easily be dislodged. These tweaks would promote a “Goldilocks” incentive structure—not too short, not too long, just right—when it comes to monitoring operational clocks and strategic calendars.
Align compensation to the long term. Investors should support executive compensation that is linked to the types of targets referenced above—development of strategic plans, articulation of those plans to stakeholders, and establishment of goals based on long-term performance and value creation. Likewise on that front, equity should be generally slow to vest. And it is worth discussing whether executives should be required to hold their shares for a period of time following share buybacks.
Finally, it’s important to keep stakeholders informed of all this in order to dispel the misperception about executive priorities. Companies can create standing liaison committees, populated by employees, customers, and relevant community members. These groups can identify externalities—safety concerns, say, or employee satisfaction—that might not show up on the P&L statement. To be effective, such arrangements must be ongoing and iterative, with Investor Relations (and, again, the CFO) directly involved. In parallel, companies are well served by reserving time during earnings calls to share those long-term strategies, as well as overarching corporate purpose and governance arrangements.
Solutions in search of problems aren’t the answer. Transparency is.
Reprinted with permission from the June 28, 2019 issue of Harvard Business Review. Further duplication without permission is prohibited. All rights reserved.
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