"Capitalism for the Long Term," Dominic Barton

This piece in the Harvard Business Review calls for rethinking corporate strategy, reorienting it from short-term thinking to what Barton calls long-term thinking. His emphasis on a five-year horizon isn't what I'd call long-term, but at least he's advocating looking beyond the quarterly results that preoccupy shareholders today.

What does obsession with the short term do to companies?

If CEOs miss their quarterly earnings targets, some big investors agitate for their removal. As a result, CEOs and their top teams work overtime to meet those targets. The unintended upshot is that they manage for only a small portion of their firm’s value. When [Barton's firm] McKinsey [& Company]’s finance experts deconstruct the value expectations embedded in share prices, we typically find that 70% to 90% of a company’s value is related to cash flows expected three or more years out. If the vast majority of most firms’ value depends on results more than three years from now, but management is preoccupied with what’s reportable three months from now, then capitalism has a problem.

So, how do we end this fixation on the short term? Barton says it must start with the big institutional investors.

Taken together, pension funds, insurance companies, mutual funds, and sovereign wealth funds hold $65 trillion, or roughly 35% of the world’s financial assets. If these players focus too much attention on the short term, capitalism as a whole will, too.

Why do they focus on the short term, considering they're managing assets for the long haul?

Fund trustees, often advised by investment consultants, assess their money managers’ performance relative to benchmark indices and offer only short-term contracts. Those managers’ compensation is linked to the amount of assets they manage, which typically rises when short-term performance is strong. Not surprisingly, then, money managers focus on such performance—and pass this emphasis along to the companies in which they invest. And so it goes, on down the line.

In short, there's a cascade effect that punishes anybody downstream, like money managers, who might try to do the right thing. The only way to fix this is to change the attitudes of fund trustees as to what they should expect.

To get these big investors to refocus, we need to reassess what is actually good for shareholders. Specifically, we need to understand that the interests of stakeholders -- "employees, suppliers, customers, creditors, communities, and the environment" -- are actually aligned with the interests of shareholders, if you look beyond a single quarter and consider the company's future over several years.

I regret that I don't find Barton to be persuasive on this point. He doesn't cite specific ways in which stakeholders' interests line up with shareholders', and absent such evidence shareholders large and small aren't going to be eager to adopt his mindset. I believe he's right, but that's not going to convince anyone.

Finally, Barton calls for much more effective corporate governance. To achieve that, we need more involved and knowledgeable boards of directors, a pay structure for management that encourages them "to act like owners" (stock options haven't had that effect for reasons Barton explains in the article), and what Barton calls "redefined shareholder 'democracy.'" By that he means that there must be a way to distinguish between the votes of long-term shareholders and those traders who may own a company's stock only for hours or minutes (or even seconds). The latter cannot be allowed undue influence over a company's strategic planning.

I agree with most of what Barton says, but I'm skeptical that he's going to convince anyone to follow his advice.

(Thanks to The Browser for the link.)