A growing concern in governance circles is whether the desire to meet or beat quarterly earnings can be aligned with long-term business strategy. That disconnect that has even led some to propose doing away with quarterly earnings guidance as a strike against “short-termism.”
The National Association of Corporate Directors has stepped into the fray with a new report stressing that it is indeed possible for board members to help management navigate business complexities without allowing short-term pressures to undermine the organization’s focus on long-term strategic objectives. The report distills the work of an NACD Blue Ribbon Commission, a panel of governance experts and corporate directors who, in aggregate, serve on 34 publicly traded, 10 privately held, and 62 nonprofit company boards.
“Instead of viewing short-term results and long-term strategy as mutually exclusive, boards and executives should view them in terms of degrees of alignment," says Karen Horn, co-chair of the NACD Blue Ribbon Commission and a board member for Eli Lilly, Simon Property Group, and T. Rowe Price Mutual Funds. “It should be possible to draw a clear line from the company's day-to-day activities to its long-term objectives.”
The report identifies ways boards can ensure a stronger alignment between short-term activities and long-term value creation, including exerting influence on CEO selection and evaluation, discussions about strategy and performance goals, capital allocation decisions, incentive plan design, board composition and assessment, shareholder communications, and strategies for responding to activist investors. It also details red flags that indicate misalignment, and proposes.
“Phrases such as ‘long-term profitable growth,’ ‘sustainable competitive advantage,’ and ‘value creation over time’ are common features in annual reports and investor roadshows. Yet companies—from the CEO and executive team to the latest hire—generally operate on a month-to-month or quarter-to-quarter basis and must be prepared to respond to events as they arise,” the report says. “It can be extremely difficult for management (and often for boards) to set aside immediate demands and concerns in the interest of long-term goals that might seem distant and abstract.”
The importance of strong alignment between short-term moves and long-term objectives are most apparent in industries that need to reinvent all or part of their business to remain competitive: tech companies were forced to evolve from mainframes to PCs to mobile; brick and mortar retailers had to embrace e-commerce; pharmaceutical companies face patent expirations.
The NACD authors concede that “factors encouraging a short-term focus are stronger now than ever before.” Some are external, such as macroeconomic volatility, regulatory uncertainty, and a vocal activist-investor community. Other sources of short-term pressure are, however, “not only within a company’s control, but are directly within the board’s sphere of responsibilities.” These include strategy development, capital allocation, management incentives, oversight of corporate culture, establishing risk appetite, and communication with analysts and investors.
Directors are advised to ask four key questions. Do we have a coherent long-term strategy? How closely do our short-term actions and targets connect with that strategy? Can the management team and members of the board articulate the connection? Do current and potential shareholders have a sufficiently clear understanding of the connection to make informed investment decisions?
indicators of misalignment: board room discussions about emerging risks and opportunities and other future oriented topics occur infrequently or only in response to a specific request or event; C-suite and executive compensation is primarily in the form of cash, salary, and bonuses instead of long-term equity plans; incentive plans, including annual bonuses, are tied to short-term goals and metrics; high CEO or C-suite turnover based on failure to meet short-term goals; and a push for dividends and stock buybacks without consideration on longer term investment alternatives.
Directors need to factor “substantial preparation time” into their duties, the report says, noting that business complexities are steadily increasing the workload for directors. That level of preparation has greatly increased. “Board agendas need to accommodate sufficient time for substantive discussions about long-term opportunities and risks, rather than being dominated by backward-looking reviews of past performance," says Bill McCracken, co-chair of NACD’s Blue Ribbon Commission, former CEO of CA Technologies, and a director at MDU Resources.
Among the recommendations for directors: consider how a company’s capabilities, resources, and culture could change over time; include a component related to progress against long-term goals and objectives in annual incentive plans for the CEO, C-level executives, and mid-level managers; and evaluate stock ownership guidelines. Also, the nominating and governance committee should approach board composition and succession planning with long-term needs in mind.
The report, available to NACD members, can be found here.