Today’s executives are still being driven to make decisions that address
short-term financial performance at the expense of the long-term
best interests of the company. When will it end?
With the global economy still working its way through a seemingly interminable series of financial crises and yo-yoing oil prices, companies are struggling to manage all the repercussions. Airline business models surely weren’t built with high oil prices factored in. Banks didn’t foresee the credit crisis on the horizon. Auto makers didn’t anticipate interest in SUVs crashing. Why aren’t these companies able to see these things happening with more notice? Wall Street and its investors—which means almost all of us who have savings or pension plans—may well have a lot to do with it, along with incomes based on hitting the quarterly targets Wall Street demands.
Most investors seek the best and quickest possible return on their investments, so companies often make decisions based solely on the short-term impact on bottom-line results. Investors see quick returns and reward companies by continuing to invest in their shares.
However, this short-term financial focus often comes at the expense of companies making longer-term, more strategic, decisions that might not have as good a short-term financial effect. Unlike Warren Buffet, who has been quoted saying “our favorite holding period is forever,” most investors do not have a very long-term focus. Since they’re paying the piper, they call the tune leaders must dance to.
You get what you reward
In nearly every company, people burn the midnight oil in the last days of a quarter to ensure that they bring in each and every last dime of sales, in the hopes of squeezing everything possible into the current quarter. Aggressive bargaining is followed by last minute deals. Everyone breathes a collective sigh of relief when the quarter-ending bell tolls and the targets have been made—by whatever means.
Why do they do this? Because their pay, bonuses and stock options depend on these quarterly results; as does their organization’s ability to attract future investment.
However, since all mangers know the game, many game the system, thereby leading to less than ideal outcomes. This is not to say that short-term performance should be ignored. Still, it is the long-term strategic focus that will keep the company ahead of its competitors and viable for years to come, with all the benefits that come along with that attitude: local job creation and tax revenues, product and service innovation, and continued financial success for executives, employees and shareholders.
Perhaps it’s time to change the rules.
To be realistic, such a change must be driven by those with the capital, since “he who has the gold, makes the rules.”
Let’s hope the capital markets make the time soon to reflect on the causes and implications of the mess they are currently in and the reasons for the global economic downturn. I suspect that, if they do, they will realize the ‘first-mover’ advantage they could reap by being the one that changes first. If my thinking is right, they ought to see that their overall returns will ultimately be higher by looking further out than 90 days into the future.
While keeping a steady eye toward the basics of financial performance, successful leaders make sure to pay close attention to the appropriate time frame. They don’t take short-term gains at the expense of long-term value, since long-term viability is a far greater accomplishment than a short-term boom followed by a long-term fizzle into recession and losses.
Until everyone learns this, we’ll continue to lurch from boom to bust.
Technorati Tags: long-term thinking, boom and bust, judging performance, investment criteria
September 16th, 2008 at 6:19 am
The true issue here is that companies are under pressure to turn a buck for investors and the stock market rather than think in long term measures. It is my belief that some of these ‘get-rich-quick’ schemes that are being pushed by outside pressures should be avoided without proper scrutiny.
It is my belief that many of these companies refuesed to say “No” because the short term profits were so lucrative at the time at the costs of future and long term profits. This is much like the Andersen Consulting case that brought us SOX.
I am sure that there are financial institutions who steered away for the “what’s hot today” pressures that are sound due to their ethics and practices.
September 16th, 2008 at 6:38 am
Scott,
I am sure you are right and that there are companies who focused on short-term profits at the expense of longer-term benefits. However, I truly believe that there are those companies that focus on the long-term and forgo some short-term opportunities so as to ensure the viability of the company vs. risk it for short-term gain, as we are seeing with so many in the financial industry today. These companies, many of them long-standing companies, swung for the fences in hopes of tremendous short-term gains, only to be burned badly, along with their investors and employees, when the markets turned against them. Now, perhaps, we will see companies take cautionary steps away from short-term “get rich quick” schemes/investments and get back to the fundamentals of business - long-term business.
September 16th, 2008 at 7:20 am
Nina
Who in their right mind wouldn’t agree with you? The fundamenatal problem, as your post implies, is not just that the markets look to maximise the short term gains in everything, but the companies that play the same game every quarter in the ultimately vain quest to maximise earnings in order to maximise shareholder value.
The crux of the problem is that the professional managers, historically employed to look after the longer-term, and thus counter-balance any tendency on the part of the investor to take the short-term gain and move on, have been compromised by the reward system which makes them shareholders with the same interests, and/or wealthy as a result of bonuses tied into the same fundamental measures. With the checks and balances thus out of kilter, the pursuit of unending growth inevitably leads to a calamatous fallout like the one we are currently seeing in the US financial markets.
Thus the only people left who truly have a long term perspective are the employees who work there and whose livelihoods are ruined when the business collapses. And even for them it is as much fate as anything that has them in a particular organisation when it collapses, because the old values of employee loyalty have been corroded - as much by the example from above and the poor leadership as anything!
So what is the solution? Conceptually it is quite simple: to clip management’s incentive earnings and to make them more long-term focused aligned more closely to the workers’ vested interests and to find a way of making more effective use of these vested interests and enhancing that long-term stake to ensure that they have a greater stake in the business and are able to resist the short-term pressures.
I am actually in the formative stages of formulating a proposition that I think may ultimately achieve this, but it is very much Phase 2 of my current business proposition.
Bay
September 16th, 2008 at 7:21 am
Exactly my thinking!!!! I am sure that new laws will come of this just as it did regarding Enron, Worldcom, etc. with the passing of SOX. I also hope that they cut the cords on those executive golden parachutes!
It appears to me that many a company has lost their moral compass at the cost of the stakeholders. This is the reason that we need a powerful leader - and not just in government but in business as well. I am tired of these execs who are in office for a short time and come out smelling like a rose when they bail while the company they headed is down the cr@per! THAT is not leadership!
September 16th, 2008 at 8:57 am
Bay,
I agree with you that the checks & balances that ought to be in place are no longer serving this critical role. Whereas management uses a board of directors who are ultimately accountable to shareholders to maintain checks and balances, in many instances, these board members are either members of the management team or appointed by them; thereby clouding the judgment and fiduciary authority of these board members.
What inevitably happens, as you point out, is that incentives are aligned in favor or management and/or the overseers and against the long-term interests of the shareholders. I agree with you that employees’ interests are those most aligned with shareholders, but reckon that it is these two constituencies that have the least control over the direction and ultimate fate of the company.
The solution is to shore up the oversight function, disaggregate the incentives of management and overseers and align the incentives of all relevant stakeholders to ensure a common goal and vision is sought after. While there can surely be short-term performance goals, without doubt, it is the longer-term viability of an organization that ought to be in everyone’s best interests. We must also eliminate golden parachutes and overblown severance agreements for management members.
I hate to say it, but some form of regulatory oversight might just be warranted as well; at least until management can properly demonstrate its adherence to policies that don’t fly in the face of shareholders [let us not forget the fact that 'shareholder' = 'owner']. Management must be compensated in part for ‘performance’, which must be redefined to mean ‘in the best collective interests of stakeholders’.
I look forward to learning more about your proposition as you advance it from the formative stages.
September 16th, 2008 at 9:06 am
Scott,
I agree with you that new laws [i.e. regulation] will be upon us soon enough. Read my reply to Bay and you will see that I agree with you on the golden parachutes too!
The moral compass you speak of interests me from this perspective: is it a company that has a moral compass or the management team members? A company is merely a legal entity unto itself, but it is managed and led by individuals who ought to have a better calibrated moral compass of their own which collectively amounts to the company’s moral compass. We must hold these individuals accountable when appropriate and demonstrate that we, as a society, will not tolerate such digressions from the morally appropriate path and objectives that management ought to adhere to. That said, mistakes happens, bets aren’t always won, and losses can occur. Not all such negatives are to be blamed on management. Sometimes, as they say, bad things happen to good people. I just want to do all that can be done to ensure that we have the ‘good people’ at the helm.
Tremendous leadership qualities are needed to get us through these rocky times. The qualities that I speak of don’t mean short-term performance gains. More to my point, they mean honesty, accountability, alignment of incentives and a willingness to act/live in a shareholder’s shoes. At the collective level, shareholders can make the necessary decisions to ensure long-term stability and performance. Management, like government, should be of the people, by the people, for the people.
September 16th, 2008 at 1:45 pm
The short term results are important as to the immediate health of the company while the long term prospective is the life line. Ideally one have to keep the eye in front of the car as well as on the road to drive successfully. The short term result must integrate with the long term prospective. These can not be independent of each other as we need the people inside to work on immediate plans and the stake holders to stay with the company to go through the present and meet the future. I don’t think laws can help the process.
September 18th, 2008 at 9:41 am
Sambit,
I agree with you, but it is unfortunate that many have been incentivized to focus on the short-term at the expense of the long-term and don’t mind doing so since they don’t foresee a long-term at their current employer. This is a very different time than in the past where people thought of themselves as “lifers” at the company where they worked. Today, average tenures are dramatically shorter and maximizing short-term gains seems like the right thing to do.
While laws may not address some of these fundamental issues, there may just be some regulatory opportunities available to mitigate these divergent issues - short-term gains vs. long-term viability. I’m not prescribing any particulars myself, but pondering the possibilities of such things happening.