Chief executives like to think they aim high. “Go big or go home” and similar slogans gained currency late in the last century and still capture the imagination today.
Yet many US corporate chiefs have actually prioritised the opposite approach for much of that time: they put more emphasis on hitting near-term earnings targets at the expense of spending on long-term success.
That is almost certainly a mistake. Studies by McKinsey, the CFA Institute and others consistently show that companies that invest less in long-term growth relative to their peers end up underperforming over the medium or long haul. The bonus is largest for companies that continue to invest during difficult periods like the one we are in now.
So who is to blame for this short-sighted short-termism? Corporate executives finger sellside analysts and greedy investors. The former, who dominate on earnings calls and at conferences, ask for quarterly targets for use in their models and punish those who fall short. Activist investors are accused of seeking to profit from short-term moves in a company’s share price and demanding that earnings be spent on dividends and share buy-backs.
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While there is some truth to these complaints, corporate leaders and chief financial officers in particular also need to take a hard look in the mirror. Last year, investment time horizons for the world’s biggest public companies fell to five years, the shortest since the think-tank FCLTGlobal began crunching data in 2009 on what companies do with their earnings.
At the same time, investor time horizons rose slightly to 5.45 years. For the first time since at least the financial crisis, chief executives had shorter attention spans than the shareholders they work for.
The falling company numbers for members of the MSCI All Country world index are driven largely by recent enthusiasm for spending money on repurchasing stock. Buy-backs return earnings immediately to shareholders, rather than using the money for capital expenditure and research and development that could spur growth in the future.
The buyback wave topped out globally at $1.3 trillion (€1.2 trillion) worldwide last year, powered by the last of the low interest rates. These made it particularly cheap for companies to borrow money for buy-backs, according to separate research by Janus Henderson. Energy companies that saw profits shoot up after Russia invaded Ukraine also opted to retain less of their earnings.
Two-thirds of chief financial officers at big global companies surveyed by EY this year admitted to “tensions and disagreements” over how to balance short and long-term goals
Investment horizons, meanwhile, are lengthening for two reasons. More money is heading into low-cost index funds, which by their nature stick with companies, and into private funds which also lock up investor cash for much longer stretches, says FCLT research director Allen He.
These shifts should make corporate leaders feel more secure about prioritising long-term goals. But that isn’t happening. Instead, corporate time horizons have dropped 25 per cent in a decade, and top executives aren’t sticking around to see the results of their choices. Chief executive tenure in the S&P 500 has dropped 20 per cent since 2013, to 4.8 years.
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This year’s persistent inflation and concerns about a possible recession have crystallised the conflict. Two-thirds of chief financial officers at big global companies surveyed by EY this year admitted to “tensions and disagreements” over how to balance short and long-term goals.
Even worse, half of them said they were meeting near-term earnings targets by cutting areas that they considered long-term priorities. “CFOs have to balance protecting value, optimising earnings and long-term growth. When you have uncertain economic conditions they revert to short-term,” says EY partner Myles Corson.
Too many corporate pay plans still emphasise current earnings and share prices, say governance experts, and some boards have further weakened the ties to long-term growth by tying pay to fluffy qualitative measures.
But company boards now have a rare opportunity to make a big change. Higher interest rates are already forcing a rethink about the relative appeal of share buy-backs. And CEO and CFO departures at large UK and US companies are running at the highest rate in more than a decade. As directors consider potential replacements, they should grill any candidates on how they plan to create shareholder value and structure their new employment contracts accordingly. If now is not the time to go big, we might as well all go home. – Copyright The Financial Times Limited 2023
