Myth of the Long-Term Investor

A concerned, perhaps nervous, director might speak up after an earnings shortfall. To peers during a board meeting, such a director might venture: "I think like an investor, and from experience I know the short-term bettors are right a lot of the time. They're voting 'no' on our new announced strategy and the stock price reflects this, it doesn't make me feel very patient either."

When this happens, how should the board and management react? Should they stick with a strategic redirection agreed to months earlier? Or sound the alarm for a different, more market-friendly, initiative? In this hypothetical scenario, we see the reaction of a director when the market shows mistrust in a strategy.

Many CEOs and directors adhere to the legitimacy of long-term strategic value creation. It is no mere piety: Corporate reinvention, turnarounds, and strategic revisions are almost a steady state in today's business climate. Each situation turns on a strategic plan that, by definition, is anticipated to yield optimal payoff in the long run, while allowing for some level of risk in the short run. Of course, management's strategic long-term view comes up for renewed scrutiny by investors, while the law of intended consequences and the unforeseen surely take their toll. Even supportive investors who accept a firm's long-term view—and there are still many of them—hope, if not expect, to see quarterly performance as forecast (i.e., the long term is fine, but see if you can manage the short term while you are at).

Judging by the fact that NYSE shares are held for an average of just seven months, the reality is that most investors are short term. They are enforcers of the market discipline that is characteristic of our time, meaning their patience is limited when early performance against a strategy is unexpectedly modest.

The directors' dilemma is balancing long-term implications of a strategic plan with the short-term demands of its owners. Assuming the director accepts management's strategy and has done all the necessary due diligence, there is a requirement for the director and other board members to have made a highly realistic assessment not only of the strategy, but the market impact. They should then be able to referee between business managers who wish to create longterm value for themselves and their companies, and investment managers demanding a range of criteria to their assessment of performance.

Knowing your investor is another consideration when assessing how hard to push against the market. Directors' counsel should be keen students of investor diversity: Momentum investors (a large part of the market) will primarily watch the market's near-term confidence in an investment and ignore strategic intent. Growth investors, however, are most likely to interpret surprise underperformance as a defect in the strategy and a cause for reduced expectations. Value investors may tolerate fluctuations, but they truly need directors' focus and stabilizing effect lest they largely forego their low entry points only to see new investors enjoy a strategic payoff.

While there may be few simple answers, there are assumptions that can be drawn: Long-term strategy is essential, long-term performance modeling is meaningful, and short-term performance is the first of many steps on the strategic road.

Investors will operate from diverse principals, and the perspective of each investor type will be somewhat limited. In light of this, directors must remember to counsel an anxious executive team that stock price is nothing more than what willing buyers agree to pay sellers at that moment in time. Stock price is not a measure of intrinsic value. When faced with exciting, but possibly risky, strategic initiatives, directors should be prepared to vote confidently in management's vision. Then their only responsibility is to communicate to investors both the strategic longterm expectation and detailed and transparent insight into the short term.