Corner Office: The Profit Addiction, June 2012

Corner Office: The Profit Addiction, June 2012

Short-termitis is destroying American business.

American business’s focus on quarterly results versus long-term growth is not new, nor is the long-term planning of Asian business leaders compared with America’s focus on quarterly and annual results. What is new is the urgency with which we need to act. We cannot treat the problem of short-termitis as something that someone else will have to deal with someday. It’s a systemic issue that must be addressed, or the sustainability of America’s global leadership will be in peril.

The Issue

The pressure felt by corporate directors from equity investors to meet quarterly goals is unprecedented. Mutual fund managers are becoming more activist, as are major investors and stockholders, who are gaining increasing control over boards and their decision-making.

Part of the reason is Sarbanes-Oxley and the recent Frank-Dodd legislation, which gave individual stockholders more influence than at any time in the history of capitalism. I am an ardent capitalist and want those who hold equity in a company to be able to influence corporate decision-making and act like real owners, as the owners of a family-owned business do. However, when ownership is focused solely on short-term profit results for the gain of the investors, at the expense of the long-term vitality and success of the corporation and all of its stakeholders, the system doesn’t work—it’s broken!

For example, when “customer service” becomes a cheaper automated phone system that requires customers to push 20 buttons on their phone, the reputation and brand of the company is tarnished, and customers, who are expensive to acquire, are lost forever.

The problem of short-termitis is both compounded and illustrated by the realities of today’s equity market. In the 1970s, the average holding period for U.S. equities was about seven years; now it’s about seven months. And that doesn’t account for “hyper-speed” trading that sometimes holds stocks for only a few seconds—and which is estimated to account for 70 percent of all U.S. equities traded. How can business executives be held accountable to these investors? They can’t.

The Results

Some American companies have resisted this trend, but overall, short-termitis has permeated nearly all aspects of our businesses. It causes companies to:

  • Starve resources for long-term strategies that assure sustainable growth and value
  • Experience increased turnover of executive leadership, resulting in lost industry experience, internal knowledge, and employee loyalty
  • Be vulnerable to illegal or unethical actions by management to falsify results to achieve short-term expectations
  • Sacrifice the corporate vision and mission to quarterly and annual objectives.
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The Solutions

We must collectively acknowledge the need for change—then act decisively.

First, directors and executives should promote a “social institution” model of business that great companies including Intel, GE, Southwest Airlines, and IBM have adopted. The common sense behind this model is that the value a company creates should be measured not by profits alone, but by how it nourishes conditions that cause the company to thrive over a long period of time—providing social and economic value as well as financial returns.

The business community does not easily accept new theories of corporate purpose and capitalism—after all, institutional logic can’t be measured by cost/benefit analysis or converted to a spreadsheet. But there is a growing number of advocates for this new kind of capitalism, where both business and society win together.

Second, executive compensation must be changed to reward long-term performance. The current system based on short-term earnings, revenue, cash flow, share price, and return on investment numbers does not do so. In fact, the opposite is true: This short-term focus can lead to reckless risk-taking and value destruction. Put in real-life terms, it’s too tempting to overlook the need to invest in research and development because it impacts the executive team’s annual bonus.

We need to push for change to link compensation to long-term measurements such as innovation, employee development, and contributions to society. Executive evaluations need to be extended to rolling three-year performance or to five-year plans, and should include disincentives for non-performance. And huge severance packages for executives who didn’t achieve goals should end.

Third, corporate directors must take ownership on behalf of all stakeholders, and stand as champions of high ethical standards. Capitalism is grounded in public trust; its survival is at stake when the public doesn’t trust business and starts looking to the government for leadership. Corporate directors must serve all stakeholders, including customers, employees, communities, and future generations.

Corporate directors need to have long-term goals in mind and ask questions like: Why do employees come to work here? To what degree do we meet their expectations? Do they trust our managers? What is our long-term vision and mission, and how can we reasonably achieve it? What is our industry position and what do we need to do to be the leader? And how is society better off because we exist?

Above all, directors need to ensure that the articulation of values is at the core of the company’s work, that they nurture dialogue that keeps social purpose at the forefront of everyone’s mind, that employees use the organizational values as a guide for business decisions, and that regular audits ensure that corporate values are being translated into actions.

This kind of deep, lasting change is achievable if corporate directors, executives, and investors acknowledge that short-termitis is not healthy for their companies and their investments, and become involved in pushing for and implementing longer-term solutions that consider social as well as financial benefit. Again, the easy part is talking about solutions; the hard part is implementing them. But the right thing is not always the easy thing, is it?

Mark W. Sheffert (mark@manchestercompanies.com) is chairman and CEO of Manchester Companies, Inc., a provider of financial-advisory, corporate-renewal, and performance-improvement services.

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