No Shortcuts to Long-Term Thinking

In 1901, George Westinghouse sent a letter to his shareholders explaining that Westinghouse Electric hadn’t issued financial reports for the prior four years because it wasn’t in “the interests of all.” The company didn’t bother with another annual report until 1906.

Companies today can only dream about investors willing to give them such latitude. Instead, many often feel hostage to Wall Street’s drumbeat for ever-higher quarterly earnings. The debate over long-term managerial focus and what companies should report to their shareholders has welled up again in recent years, after the meltdown of many companies prompted widespread reaction to what many see as excessive pressure on executives to deliver consistent results, even at the expense of longer-term performance.

The concerns have produced a growing outcry for change. Initially, the calls came from pension funds and other institutional investors that invest heavily in index funds. More recently, business groups have joined the debate, with recent statements against short-termism coming from the U.S. Chamber of Commerce and the Business Roundtable Institute for Corporate Ethics, among others.

The Aspen Principles

The most ambitious campaign has been mounted by the Aspen Institute, an independent leadership think tank. Last summer, a four-year effort culminated in the so-called Aspen Principles, a document titled “Long-term Value Creation: Guiding Principles for Corporations and Investors.” One reason the paper took so long to draw up is that the principles represent a consensus view of groups from both of these camps, including the Business Roundtable, Office Depot, PepsiCo, Pfizer, and Xerox on the company side, and investors such as the AFLCIO, the California Public Employees’ Retirement System (CalPERS), and the Council of Institutional Investors (CII).

The principles represent a remarkable achievement, given how these groups square off against each other on issues ranging from proxy access to executive compensation. Despite the meeting of the minds, the Aspen Principles remain a work in progress. They call on companies and investors to use long-term metrics on a range of behavior, from corporate operations to executive pay. But while the group came out clearly against the much-criticized practice of quarterly earnings guidance, it didn’t give a clear and detailed description of what the alternative metrics should look like. It’s now taking up that task, as well as searching for ways to draw in more companies, says Judith Samuelson, executive director of the Aspen Institute’s Business and Society Program. The group started the follow-up effort in December.

A key hurdle is defining exactly what the problem is, which can be difficult to pin down even after all these years of complaints. There does seem to be some convincing evidence that a short-term perspective can drive inferior corporate performance. For example, a recent study by REL consultants of Atlanta found that the 1,000 largest U.S. companies employed a variety of short-term tactics to boost their collective working capital by $100 billion in the last quarter of 2006— only to see all those gains erased when working capital plunged by a total of $122 billion in the first quarter of 2007. REL found similar patterns in 2004 and 2005. The study identified five common practices companies used to pump up their year-end numbers, including product discounting, delaying payment to suppliers, accelerating the collection of bills due, halting inventory purchases, and running at full capacity to reduce overheads.

Since executive compensation typically is tied to corporate performance in various ways, critics argue that such manipulation stems from misaligned pay incentives that prompt widespread earnings manipulation. “It is clear that year-end gamesmanship is akin to binge dieting, where an unreal and unsustainable illusion of beauty is created for the purpose of meeting the expectations of others,” REL’s report concludes.

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The Aspen Principles 

• Companies stop providing quarterly earnings guidance to analysts
• Corporate boards communicate with long-term oriented investors on senior executive compensation
• Senior executives hold stock rewards beyond their tenure
• Senior executives are banned from hedging the risk of long-term oriented stock options
• "Clawbacks" are used to recoup comp later proven undeserved