Building Alliances For Long-Term Growth

Pick your caricature:

Activist owners are greedy short-term players willing to destroy the company long-term in return for a short-term stock price jump.

Executives are entrenched management, protected from the downside of their flawed decisions, but reaping the upside when their stock options kick in because of short-term earnings management.

Intriguingly, the only trait those opposing two-dimensional clichés share is a belief that the other side myopically focuses on the short term.

Fortunately, two recent developments might be rays of hope for those who believe owners and managers are three-dimensional, relatively rational human beings who have more in common than is commonly believed—including a desire to think longer-term than they are usually given credit for.

The first event was the mid-March release of a consultation document by a group of British institutional investors. These investors, headed by Sir Graeme Davis of the $38 billion Universities Superannuation Scheme, discussed the need for, and appropriateness of, fiduciaries allocating to long-term-long-only investment vehicles. “LTLO” is a new name for an old-fashioned concept: long-term investing based on a fundamental, research-driven investment process designed to produce absolute returns “over the long-term business cycle,” likely five to 10 years. In a development sure to be cheered in virtually every corner office, they also suggest a “no shorting” rule for LTLO funds. (For the consultation draft, introduced at the meeting of the Brits’ National Association of Pension Funds, see Related Resources in the box at right).

The attraction for corporate executives is clear: if LTLO mandates catch on, they will be a counterweight to short-term traders and raiders. Executives would, at least in theory, have more freedom to invest for the long-term health of the company, even at the expense of a hit to earnings for a quarter or two. Of course, the cost for that flexibility will be the need to assure the LTLO investors that their companies really are being managed for long-term profitability, rather than merely using a longer time frame as an excuse for a sequence of bad short-term decisions. That’s why another attribute of the group’s proposed LTLO mandates is “effective engagement with, and dialogue between, investment managers and the senior management of businesses invested in, to encourage the development of shared long-term strategies and more efficient use of capital invested within the businesses …”

That last requirement begs a question: Even assuming goodwill on both sides, is there an agreed set of metrics and semantics for that discussion? Does your company have the reporting devices in place to discuss what really drives long-term value, without running afoul of selective disclosure regulations and without revealing trade secrets? After all, most accounting measures are backward-looking and geared to quarterly or one-year periods. As a 2004 Deloitte/Economist Intelligence Unit report notes, traditional financial measures “shed little light on the key source of future revenue and profit in a firm: the state of product innovation. And they provide scant evidence of the effectiveness of the board and top management—that is, the efficacy of governance and management processes.” In fact, Deloitte reported that 92 percent of the 250 executives and directors surveyed believe traditional metrics alone do not adequately measure a company’s underlying strengths and vulnerabilities. (See Deloitte's report in the box at right).

Given that failing, how effective a discussion can a company and investors have about prospective long-term value creation?

A second recent development may help answer that question. The end of March concluded the consultation period for the third iteration of the Global Reporting Initiative’s sustainability reporting guidelines. The guidelines focus on indicators of sustainable economic, social and environmental performance. Last revised in 2002, GRI’s guidelines are already the de facto standard for sustainability reporting. As Sir Mark Moody-Stuart, chair of Anglo-American, says, the GRI Guidelines are “the most comprehensive and credible set of sustainability disclosure standards ever produced.” The third generation of those standards should be better yet (again, see box at right).

Of course, GRI’s guidelines are not the only long-term, values-based reporting system. Moreover, GRI is based on a stakeholder philosophy. Some corporations and owners may not want to focus as much on environmental and social metrics, or may prefer to view them (and others) through an ownership perspective. Fortunately, many accounting firms now have their own suggestions of how to report for long-term investors, such as PricewaterhouseCoopers’ “ValueReporting Forecast.” Both the GRI standards and those formats can give corporations a vocabulary to engage potential long-term, constructive shareowners.

LTLO investing is still in a formative period. How large the phenomenon will become—indeed, whether it will survive at all—is an open question. However, if you’re a corporate executive who believes in LTLO, you can affect the answer. By being proactive, you can both attract those LTLO investors already in the marketplace and encourage more to join in. Some suggestions:

Metrics—Get your metrics in place. Use GRI’s standards or another relevant reporting system so you can have a meaningful dialogue with long-term oriented investors.

Plans—Ask your investor relations department to find those investors focused on the long term, and to devise a plan to gain them as owners. Remember to also look overseas, as the concept seems to have traction in the United Kingdom.

Talk—If you do undertake to recruit LTLO investors as owners, remember your obligation to engage in meaningful dialogue.

Asset Allocation—If your company sponsors a pension plan, whether defined benefit or defined contribution, ask the trustees if an LTLO mandate might be appropriate as part of the plan’s asset allocation.

Maybe it’s true that the answer to “can’t we all just get along?” is not a simple yes. Owners and corporate officers don’t always share united interests. But it’s equally true that short-termism is a common enemy. That may just be enough to make both sides flesh out those caricatures a bit. And that would be real progress.