What is the goal of the public company’s board of directors? To maximize shareholder value, you suggest? I believe that is not only not correct, but it is one of the reasons companies end up in the hungry hands of the restructuring community. While it can seem heretical to argue that it is not in shareholders’ best interest to run the company that way, the impact of short-term focus is clearly damaging. The damage, however, is difficult to measure.
Maximizing shareholder value as the board’s focus took root in the 1970s and is not easy to shake. As it is difficult to define what maximizing shareholder value means, we naturally default to the simplest measures: the current stock price, and quarterly earnings trends. When the stock price is the measure of success, perspective is lost.
In his October, 2015, Harvard Business Review article “Yes, Short-Termism Really Is a Problem” Roger Martin points out that it is not easy to isolate specific causes of results. It is according to him “much more likely that a whole lot of x’s combine to cause y and a bunch of other stuff.”
In short, pun intended, Martin observes mildly that results produced by businesses are a function of decisions made by executives, and if those decisions do not focus on the long-term, it seems reasonable to expect the long-term performance of business will suffer.
Several studies help us see this. John Graham, Campbell Harvey, and Shiva Rajgopal interviewed 400 CFOs of large US public companies. Almost 80% of them said they would sacrifice economic value in order to meet that quarter’s earnings expectations. Though it may be that all respondents would do it, fully 80% actually admitted it, when executives might reasonably avoid any answer that would smack of that unsavory activity called earnings manipulation.
Research into the rise of share buybacks by Bill Lazonick shows that a disproportionate share of corporate earnings is being used to repurchase company stock rather than invest in future growth. A University of Illinois study indicates that buybacks often occur when a corporation would miss its earnings per share target if not for the effect of the buyback. And the research suggests buybacks do boost share price in the short term. So buybacks, plain and simple, are a tool for boosting short-term performance, regardless of their impact over the long haul.
Executives want their companies to do as well as possible in the long run. They believe, however, that the capital markets place damaging constraints on them. According to Martin, they are constantly assessing how much they can invest in the long term before Wall Street makes their lives so miserable that their ability to manage at all is at risk. CEOs already under pressure, especially from activists, can invest almost nothing at all.
Research analysts focus on benign sounding organic growth, which continues the relentless demand for profit growth this quarter and every quarter. For many companies, buybacks are an explicit, ongoing part of their EPS growth formula, which may include, for example, 5% from organic growth, plus 3% from acquisitions, plus 2% from stock buybacks to arrive at the desired double-digit EPS growth.
As Malcolm Gladwell pointed out in his piece about concussions and chronic traumatic encephalopathy (CTE) in football, when clever interested parties employ lack of definitive scientific evidence as their defense, they can keep the gravy train going for a long, long time. Coal-mining companies did this to stave off concerns about black lung for half a century. Tobacco companies did it to ignore concerns about lung cancer for decades.
Martin offers a great punch line. Despite unclear scientific data, if you were a coal miner’s wife or the husband of a two-pack-a-day smoker, you would not need definitive scientific evidence. You could see the damage with your own eyes. Yes, we see it with our own eyes. Short-termism is chronic, pervasive, damaging, and a problem.
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Deborah Hicks Midanek, President, Solon Group; Author, The Governance Revolution: What Every Board Member Needs to Know, NOW! This post was also seen in Turnarounds & Workouts July 2018 Issue.
Reach the author at DHMidanek@SolonGroup.com, and BUY the book at https://www.amazon.com/author/dhmidanek
And find the full article from Dr. Martin here: https://hbr.org/2015/10/yes-short-termism-really-is-a-problem