Blinded by the Short Term: How to Frustrate Sustainable Value Creation
Vincent Tophoff | June 18, 2014
In an interview with IFAC, South African Governance icon Mervyn King talked about the “extraordinary socio-economic development” that has occurred over the last hundred years, in which “the greatest shareholder today is no longer the wealthy family, but the individual via his or her financial institution and pension fund.” This is reflected in the growth of the assets owned by these financial institutions, on behalf of the participating individuals, and their large market shares across the globe.
Arguably, as most participants in life insurance plans, pension schemes, mutual funds, etc., are signed up for the longer term, they’d rather have their institutional investor pursue sustainable value creation on their behalf than chase a quick profit. Additionally, as these institutions have a longer-term relationship with their clients and have sufficient capital to diversify, you would expect them to take a longer-term investment approach that would yield the most sustainable value.
Following the financial crises in 2008, there has been a renewed, loud, and widespread clamor for both companies and their institutional investors to take a longer term view.
- In the same interview, Mervyn King said that “there is absolutely no doubt that institutional investors have an onerous duty. They are making decisions which will impact people’s lives 30 to 40 years hence, and they must assess the quality of governance, of management, and all these so‐called non‐financial aspects which make up the economic value of a company, before investing your and my money in a company.”
- Institutional investors and their business organizations echo this call. For example, the Association of British Insurers (ABI), notes on its website that it “engage[s] with the government, regulators, and policymakers to ensure legislation and regulation encourages investment for the long term.” It also says that “when investing on behalf of their customers, ABI member companies have an important responsibility to protect and enhance their long-term interests.”
- A large majority of board members and C-suite executives from around the world declared that using a longer time horizon to make business decisions would positively affect corporate performance in a number of ways, including strengthening financial returns and increasing innovation (86%, according to a 2013 McKinsey and the Canada Pension Plan Investment Board survey).
- IFAC and the accountancy profession also believe that the creation and optimization of sustainable stakeholder value should be the objective of governance, as argued in IFAC’s International Good Practice Guidance, Evaluating and Improving Governance in Organizations. The guidance argues that governing bodies in all types of organization have the responsibility to use their resources responsibly in order to create and optimize sustainable value for their stakeholders.
In this light, it is rather shocking to learn that short-termism even has gained ground after the latest financial crisis! Even though they believed the opposite, the majority of board members and C-suite executives said that “the pressure to generate strong short-term results had increased over the previous five years” (63%, as per McKinsey). An even larger percentage (79%) felt especially pressured to demonstrate strong financial performance over a period of just two years or less, and almost half (44%) said they use a time horizon of less than three years in setting strategy.
Here is the issue: we all believe that taking a longer term perspective is in the interest of all stakeholders as it enhances the creation of sustainable value. Nevertheless, corporate executives continue to resort to short-termism, according to the survey, because their boards demand they do so and, in turn, these board members continue to resort to short-termism because of the increased short-term pressures of their investors.
So, everybody is blaming another link in the stakeholder supply chain, and the situation deteriorates rather than improves. How do we break this cycle? More regulation? Wider use and perhaps even enforcement of responsible investor codes, such as the UK Stewardship Code, the Code for Responsible Investing by Institutional Investors in South Africa, or the many other responsible investment codes as published at the International Corporate Governance Network? Engaging the ultimate beneficiary, the individuals, to transfer their money to better governed, more sustainable funds? What do you think would work to finally shift the focus?