The challenges of balancing short-term and long-term factors for public boards
With every new public scandal since the financial crisis of 2008, investors have become more anxious about the potential for losing money over the long term. The result, for most corporations, is that the pendulum is swinging too far in the direction of short-term action to the detriment of long-term growth. The market is proving that the heavy focus on short-term profits is creating pressure to perform that will be impossible to sustain over the long term. While many corporations and investors are seeing the light about the need to re-shift their focus toward longer-term strategies, they haven't quite figured out just how to generate that thinking across their shareholder constituencies. As new theories of corporate models come forth, board directors and investors are evaluating how they can balance short- and long-term growth.
A Quick Look at Long-Term Strategies
'Long term' has different definitions based on its context. As it relates to the stock market, most corporations consider a long-term strategy as one that is five years or longer. Usually, anything worthwhile takes time, and strategic planning is no exception.
Changes over the long term are transformational. Because of that, changes tend to be longer-lasting than changes that result from short-term planning. Long-lasting, transformative changes benefit all stakeholders, including the board, shareholders, managers, employees, customers and communities.
What some people see as a negative for long-term investments is that they take a longer time to pay off. Shareholders usually see much up and down activity before they realize an increase in profits. The volatility of the market makes them nervous whenever there is a downturn in trading.
Another problem is how to quantify the effects of long-range planning. Not knowing the products and services that research teams will create, or how successful those products and services will be, creates uncertainty about long-range planning.
A Quick Look at Short-Term Strategies
It is far easier to see the benefits of short-term strategic plans than speculative long-term plans. When times are good, annual performance measures look great, and shareholders get quick returns on their investments.
The downside for shareholders is that short-term strategies don't provide them with the benefit of funding research for future endeavors, launching new products and growing existing businesses. Short-term strategies transfer value to shareholders without creating value for the future.
Short-term goals also have a few advantages and disadvantages for board directors. Short-term plans give board directors the ability to react quickly when the market necessitates a change or when a crisis is looming. Boards that focus too heavily on the short-term face problems like CEO turnover, low investment activity overall and negative effects on human capital.
Shareholder Activism Prompts Exploration of Corporate Theories
To some degree, shareholders have lost faith in board directors to represent their best interests. As a result, shareholders are attempting to use pressure to influence boards. One way they are doing that is by promoting the agency theory as a model for governance, but there are some distinct problems with this theory.
Shareholders generally like the agency theory because it suggests that they own the corporation by virtue of their status as owners. From their perspective, ownership gives them the ultimate authority over the business, and they feel that it gives them the right to make certain demands. The agency theory mentality places pressure on managers to deliver positive short-term financial results and suggests that boards should think like activists.
While the agency theory is popular with shareholders, many corporate people believe that it weakens companies and the broader economy because it changes authority without changing responsibility equally.
As shareholders push to have more say in voting and strategic planning, they aren't legally bound to protect or serve anyone but themselves. They aren't responsible for the corporation, employees, shareholders or society at large. Unlike board directors, who can be held legally liable for their decisions, limited liability protects shareholders from the corporation's debts, misdeeds, errors and omissions.
Under the current processes, shareholders can buy and sell shares at almost any time with little restriction. Their ability to sell out may mean that they won't stay invested for the long term, which is adverse to the practice of good corporate governance. This practice makes them owners without the rights and responsibilities of owners, which sets things up for them to act in their own interest, as opposed to the interests of all shareholders.
Also, because shareholders may be physically and psychologically distant from the companies they invest in, they are not always vested in the process for the long term.
A Company-Centered Model May Be the Answer
There are rumblings on Wall Street about moving toward a company-centered model of corporate governance. This model strives to build a bridge between investors that focus on short-term results and boards that focus on long-range strategic planning. A corporation's overall financial health leads the company-centered model.
The company-centered model suggests that corporations are independent bodies that are legally responsible and that have the potential for indefinite life. Ethical standards guide the board and shareholders in decision-making, rather than greed or personal gain. Corporations need to learn, adapt and transform themselves according to never-ending changes in the landscape of the marketplace.
Talented board directors have the expertise to develop performance measures that uniquely serve their corporations rather than model performance after another corporation's or industry's standards.
Managers who are skilled and professional have the necessary expertise to carry out the board's strategic plans to meet the company's goals and expectations. The success of their roles benefits customers, employees, suppliers and communities, as well as the shareholders. The central idea behind a company-centered model is that it takes socioeconomic systems into account when evaluating risks and opportunities.
Many believe that a company-centered model of governance may help the culture of the marketplace return toward the goal of long-term investing. Corporations that grasp this philosophy will likely attract investors who share the same thinking. A company-centered model may also prompt some new regulations that create some degree of accountability for shareholders.
Recommendations to Divert 'Short-Termism'
The Global Network of Director Institutes (GNDI) agrees that it's a prime time to revert to corporations balancing short- and long-term strategic planning. In a 2014 perspectives report, GNDI highlighted three major recommendations for corporations to strive for:
- A long-term outlook and culture, with greater emphasis on research and development
- Engagement, communication and reporting practices that favor long-term strategical focus
- Executive remuneration and rewards based on long-term performance
The notion of accepting the ups and downs of the stock market with the goal of a gradual upwards trend is not so far in the past that we can't rely on it once again. The idea of moving to a contemporary governance model that includes balancing short- and long-term planning will be a good thing once the financial sector moves past the emotional reactivity of the crises in recent decades.
