The Long-Term Value Moment

The Long-Term Value Moment

Corporate America is realizing that there is more to life than quarterly earnings. Now is the time for progressives to help businesses figure out what taking the long view actually means.


Lee Drutman | July 9, 2007 | web only


Has corporate America had finally had it with short-termism? In late June, the Committee for Economic Development issued the latest in a series of reports by business think tanks illustrating a growing change in the way American business is thinking about value. "Built to Last: Focusing Corporations on Long-Term Performance," lays out a strong case against a destructive short-term focus that has infected American capitalism in recent years. It calls on companies to stop issuing quarterly earnings guidance and instead take the long view: "Decision making based primarily on short-term considerations damages the ability of public companies -- and, therefore, of the U.S. economy -- to sustain superior long-term performance."

This is not an isolated development. Just the week before the release of the "Built to Last" report, the Aspen Institute's Corporate Values Strategy Group (another prominent consortium of business leaders) came to essentially the same conclusion. The group released its Aspen Principles -- "dedicated to re-asserting long-term orientation in business decision-making and investing" --- with all the same sturm and drang about how the focus on quarterly earnings is undermining the American economy ("short-termism constrains the ability of business to do what it does best -- create valuable goods and services, invest in innovation, take risks, and develop human capital").

Other major business policy stalwarts, The Conference Board ("Revisiting Stock Market Short-Termism"), the Business Roundtable ("Breaking the Short-Term Cycle") and the Chamber of Commerce ("Enhancing America's Long-Term Competitiveness: Ending Wall Street's Quarterly Earnings Game") have also recently sermonized on the pathologies of short-term thinking.

Add it up, and it's starting to feel like maybe American business is doing a little collective soul-searching. Surely, business leaders seem to be saying, there must be more to life than devoting everything to Wall Street earnings expectations every three months? As Chamber of Commerce President Thomas Donohue put it: "I can tell you that CEO frustration with earnings expectations is widespread and growing rapidly."

Maybe, just maybe, American business leaders are yearning for something more meaningful, something they can feel good about in a larger sense. And maybe, just maybe, progressives have a real opportunity to help these executives think about how to expand their purpose. Looking through these reports, one gets the sense that business leaders are not sure how to think about and measure long-term value. This is new territory, and there are competing views. Now is the time for progressives to pipe up about what taking the long view could and should mean for American business.

Of course, advocates of socially responsible business have for years been stressing that if you take the long view, being socially responsible is not just its own reward -- it's good business, too. Sure, energy efficiency is a big up-front cost, but it saves money over the long term. Sure, providing your employees training and benefits can be expensive, but over time, happier, skilled employees contribute more. Sure, cutting corners on product safety and quality is a great way to meet those quarterly goals, but safe, high-quality products build lasting relationships with consumers. Sure, investing in local schools and community institutions is an extra cost, community goodwill and support are crucial (though intangible) assets.

The problem is that in a world of instant earnings gratification, it gets real hard to justify things that will eventually be profitable. In such a world, business's only responsibility is to make money for its shareholders -- now! This puts executives in a tough position: ship jobs overseas, pollute, and generally cut corners to meet the numbers today, or see your company's stock price go for a serious tumble tomorrow, taking your stock options with it.

But why now? After all, it's not like you need a Stanford MBA to realize that sacrificing everything at the altar of quarterly reporting just can't be the smartest strategy for continued success. (Remember the parable of the goose that lays golden eggs? Keep the goose happy, and you get a steady stream of golden eggs for the foreseeable future. Cut it open to get all the golden eggs now, and sure, you get an extra egg or two today. But good luck finding a new golden-egg laying goose .) Is America's business elite really just figuring this out now?

Well, probably not. But what has happened is that three recent trends -- the growth of hedge funds, the rise of private equity, and new accounting and financial reporting rules -- have transformed quarterly earnings from something that corporate executives could easily control and exploit into something that has become increasingly burdensome, and something that may even undermine their managerial control.

First, consider the rise of hedge funds. There is now an estimated $1.4 trillion in 9,400 hedge funds, up from about $150 billion in 2,000 hedge funds in 1997. These funds tend to be rather aggressive in their investing strategies, often making very big bets. (Between 1997 and 2006, the annual volume of trading on the NYSE more that quadrupled, from 133 billion to 588 billion shares traded, a development that tracks the rise in hedge funds.) Aggressive traders like quarterly earnings guidance because they provide ready benchmarks for big gambles. But big gambles mean big volatility. And big volatility means that companies can get beaten up pretty bad for one rough quarter.

Now, add in the rise of private equity. In 2006, $440 billion of private equity went into buying companies, as compared to $100 billion in 2003. There is a lot more money out there now just waiting to gobble up a company whose stock is temporarily undervalued. And with all these hedge funds adding to market volatility, one bad quarter and boom -- your company could suddenly be a target for a hostile takeover if the market cascades in the wrong way. But take away the focus on short-term metrics, and aggressive investors have fewer clear benchmarks to bet on, which means less volatility. Hence fewer undervalued companies to take over, and more management autonomy.

Finally, there are the post-Enron changes in accounting and reporting regulations, which further erode executives' ability to control the market. Under the old system of loose rules and looser enforcement, corporate managers discovered remarkable freedoms in managing the quarterly numbers. This was what many of the big accounting scandals were about -- corporate executives with massive stock option grants learned how to manipulate "earnings" through various devious accounting tricks (some of which were actually remarkably straightforward), and Wall Street played right along. The investment banks were generally in on the secret, getting rich themselves from lucrative underwriting. This helped send stock prices higher and higher. Executives then cashed in at the highs. And those not in the know were left holding the bag when the house of cards crumbled, and the ineluctable nosedive finally came.

Now, however, CEOs can't get away with those same old tricks. New regulations mandate clearer accounting, more straightforward financial reporting, and hence more transparent markets. But all this information does give hedge funds and private equity more power vis-à-vis corporate executives, knowledge being power and all.

The cynical view, then, is that all this mumbo-jumbo about "long-term value" is just a ploy by corporate managers to make sure they continue to enjoy the kind of autonomy and freedom they have grown accustomed to. Give outside investors too much information (the current trend), and pretty soon, they might start using that information to make life difficult. But replace the easily interpretable quarterly earnings figures with more amorphous metrics of "long-term value," and corporate executives soon regain their ability to control the spin and in doing so, retain their freedoms (such as the cherished freedom to pay themselves whatever the heck they want to be paid).

Look closely at the arguments by Chamber of Commerce's Donohue, and you begin to wonder whether the shift to a long term focus isn't just an excuse to do away with unwelcome financial reporting regulations. According to Donohue,

The rules have now been changed to favor a culture of immediate financial gratification without regard to long-term costs… Washington and Wall Street felt obligated to buy into the view that accounting should be made into a precise science. GAAP [Generally Accepted Accounting Principles] is being treated like 2+2 arithmetic instead of broad guidelines requiring judgment.

Translation: we don't like being told how to do our accounting. (Notice how Donohoue elides Wall Street and Washington as co-conspirators in a push towards short-term thinking, even though the shift to short-termism preceded accounting regulation by almost a decade.)

Still, regardless of the rationale behind it, the move away from quarterly earnings focus is genuine. In 2002, only a few intrepid companies were refusing to play the Wall Street quarterly earnings game. Now roughly half of publicly-traded companies are. Probably within a few years, almost all will be.

On the whole, this is good news. The quarterly earnings obsession is not particularly healthy for progressive business principles that value environmental sustainability, investing in workers, making safe, quality products, and building strong community relationships (all long-term projects).

But if quarterly earnings reports disappear as the primary metric of evaluating business, what replaces them? Well, some measure of long-term value. But what? It's not clear yet -- that's what these reports are all trying to hash out. The accepted metrics of long-term value are still up for grabs, at least for a little while. And therein lies the great challenge and the potential battle.

Management-oriented groups like the Chamber of Commerce and the Business Roundtable are going to want to fudge the definition so they can maximize executive autonomy and control. (They don't have a history of caring too much about workers or the environment.)

But the fact that the Aspen Principles were drafted with the help of unions and pension funds is a good sign. More progressive voices need to get into the conservation and think about ways to define long-term corporate value so it includes social and environmental concerns. A window is opening in the debate over what could and should go into a long-term measure. But progressives need to act quickly. It may not be open long.


Lee Drutman is the co-author of The People’s Business: Controlling Corporations and Restoring Democracy.

http://www.prospect.org/cs/articles?article=the_longterm_value_moment