4 Ways Directors Can Fend Off Short-Termism

short-termismIf you think the pressures of short-termism cause headaches now, just wait until the economy slows.

Over the next five years, America’s economy will likely grow at an annual pace of between 2 and 2.5 percent – not terrible, though well below historical averages. The danger in a slowing economy is succumbing to the temptation to skimp on both time and resource investments to boost short-term results.

Do CEOs recognize this dilemma? New data suggests many of them do.

In a recent survey from The Conference Board, over 40 percent of the U.S. CEOs who participated ranked balancing short-term vision with long-term performance as their most critical hallmark of future operational success.

But the CEO alone can only do so much in positioning his or her company for the long-term. All parts of the company must do their part, including the board. Here are four steps directors can take:

#1 – Communicate quarterly earnings in the context of the company’s long-term plans

For the past decade, there has been a movement by many respected business leaders and organizations to do away with quarterly earnings guidance and embrace more non-financial indicators of company value. One of the main arguments for stopping such guidance is that it motivates management to meet previously-issued guidance even if it would require cutting capital expenditures or R&D. (It also makes stock buybacks more tempting for management.) At the same time, such earnings guidance attracts investors with short-term horizons and so-called “analyst herding,” where analysts release forecasts similar to other forecasts previously released by other analysts.

Since quarterly earnings guidance doesn’t seem to be going away anytime soon, directors can help communicate that guidance with a long-term focus: First, they can clearly articulate a narrative of the company’s long-term strategy that consistently flows through all investor disclosures, including earnings releases, annual reports, and proxy statements. Moreover, they can communicate guidance that focuses on metrics pertaining to long-term value creation, such as 10-year economic value added, R&D efficiency, patent pipelines, and multi-year return on capital investments to help take some of the focus off quarterly earnings per share. And to help guide strategy, they should use a balanced scorecard that includes both nonfinancial and financial metrics.

#2 – Foster long-term relationships with investors

Get to know your shareholders, especially key individuals. Doing so requires fostering long-term relationships by listening to what they have to say about corporate purpose and culture. That starts with regular, routine communications – don’t wait until a crisis is at hand. Instead, use channels including transparent disclosure and year-round dialogues to facilitate conversation.

Key shareholders, such as BlackRock and State Street Global Advisors (SSGA), focus on their portfolio companies’ purpose and corporate culture as a way to measure their ability to create value. Purpose is a company’s fundamental reason for being; it is not the sole pursuit of profits but the “animating force for achieving them,” according to BlackRock CEO Larry Fink. When aligned with long-term strategy, it can enable organizations to achieve their goals and differentiate them from competitors.

#3 – Adopt capital allocation policies that ensure long-term interests

Directors need to pay attention to growing concerns about both excessive stock buybacks and timing such purchases to enhance capital efficiency. Law-makers from both parties have identified this as a talking point that resonates with their constituents and fits into larger societal narratives about trust in business and income inequality.

To illustrate, one recent proposal coming out of Washington aims to prevent companies from buying back their own shares unless they first pay workers $15 an hour and offer paid time off and health benefits. Boards and business leaders need to think about how to address both the social and business concerns about whether companies buying back their stock are doing so at the expense of investment in innovation, technology, and their employees.

#4 – Ensure executive compensation plans foster long-termism

As the saying goes, people will do what you pay them to do. This is why many investors scrutinize executive compensation: not to craft populist critiques, but to see what the board cares most about when setting goals for the executive.

Directors should look at the metrics with which their companies measure executive performance with an eye toward how “long-term” his or her incentive plan really is. If the bulk of the pay is tied to hitting one-year total shareholder return goals, investors will see that the individual’s biggest priority is short-term stock performance – and so will other leaders at the company.

Looking ahead, global competition will only intensify. And for that reason, companies that relegate long-term investments and growth strategies to the backburner will have an even harder time maintaining and gaining an edge than they do today. Operating with an eye toward the short-term, however, becomes more tempting in a slower economy – something that looks increasingly likely in the coming years. Fortunately, directors can play a critical role in staving off this temptation.

Read more: Will Trump’s Six-Month SEC Checkup Reduce Short-Termism

Douglas Chia and Gary Larkin
Doug Chia is the executive director of The Conference Board Governance Center. Previously, he had served as board chair of the Society for Corporate Governance and corporate secretary of Johnson & Johnson. Gary Larkin is a research associate for The Conference Board focusing on corporate governance. He has been a governance thought leader for more than 13 years, having worked in the governance practices for KPMG and PwC.