Time to deal with ‘Short-Termism’.

Now, more than ever, there are indications that corporations and investors can work together to actively address the issue of stock market “short-termism,” The Conference Board reports in its latest report, Revisiting Stock Market Short-Termism.

Corporations and Investors Meet To Achieve Consensus

“This report represents a unique consensus achieved by leaders of major corporations and the investment community convened by The Conference Board to a high-level Corporate/Investor Summit held in London in July 2005,” says Dr. Carolyn Kay Brancato, Director of The Conference Board Global Corporate Governance Research Center and moderator of the summit (see the end of this press release for the names of summit delegates).

Quarterly Short-Termism Takes the Focus Away from Long-Term Corporate Growth

The study notes that short-termism has many negative effects including focusing investor and corporate attention on near-term quarterly earnings to the possible detriment of longer-term corporate growth. The pressure to meet short-term quarterly earnings numbers can cause undue market volatility. This may, in turn, cause management to lose sight of its strategic business model which would compromise its global competitiveness as well as its ability to make investments in such critical long-term focused areas as research and development and environmental controls.

Links in a Chain – Must Be Tackled All at Once – Not Individually

“Recently, economic distortions generated by short-termism have been accentuated by speculative factors and, in certain cases, less than desirable business ethics practices,” says Dr. Matteo Tonello, Senior Research Associate at The Conference Board Global Corporate Governance Research Center and the author of the report. “Our London Summit’s corporate and investor delegates agreed that ‘short-termism’ is a chain composed of three major links: the corporate link, the investor link, and the financial analyst link. Most importantly, delegates to the Summit agreed that it is time for a concerted effort among all of these market participants to tackle the issue.”

Why Now?

Dr. Brancato notes: “We have been looking at the issue of how to get companies and investors to focus on long-term growth for more than 10 years at The Conference Board. Now, several important, new developments make change more possible at the current time than at any time in the past.”

Among the key factors compelling change:

Both the business and investor communities, now more than ever, recognize the need to restore investors’ confidence and the credibility of the international capital markets, which have been undermined by the recent wave of corporate scandals.
Institutional investors, including large public and private pension funds and certain asset managers, have been taking unprecedented steps to monitor the management of their portfolio companies. They have done so by advocating accountability, the enforcement of shareholders’ rights, and the adoption of higher standards of business integrity, as well as by investigating the possibility of directing assets toward investments with a greater long-term focus.

Institutional investors are now, more than ever, revisiting the “pay-for-performance” issue, and encouraging companies to devise compensation schemes based on a more balanced combination of financial and extra-financial indicators of performance.

There has been an unparalleled process of international convergence of accounting principles, especially with regard to initiatives to design a new model of corporate reporting based on true value drivers and inclusive of extra-financial measures of performance (i.e. data on customer satisfaction and registered patents, indicators of employees’ professional development, and other intangible assets used by businesses to pursue their strategic goals).

Major empirical research projects have recently reported results supporting the linkage between sustainability (i.e. environmental, social and corporate governance) factors and improved stock prices and shareholder value.

Regulators, intermediaries and institutional investors have undertaken unprecedented efforts to focus financial sell-side research on long-term corporate value. In addition, for the first time, a major group of institutional investors in the Enhanced Analytics project have agreed to allocate a minimum of broker commissions to long-term securities analysis that effectively incorporates extra-financial measures of performance and corporate intangible measures of success.

By building on the discussion held at the London Summit, The Conference Board Global Corporate Governance Research Center intends to further the dialogue among corporate executives, fund mangers and financial researchers so as to facilitate a mutually beneficial and collective effort.

The following are the London Summit Delegates’ suggestions for future action:

To Unlock the Corporate Link:

Widespread adoption of an enterprise risk management (ERM) framework should be encouraged as an effective process to assess and respond to strategic and operating risks, not only to bring clarity to the long-term strategic direction a business should take but also to clearly communicate such long-term strategy to the market.

Further studies should be undertaken regarding the deployment of “intangible assets” (such as quality, customer and employee satisfaction, environmental compliance). Research should be diversified by type of industry and geographical region, so as to develop a set of sector-specific financial and extra-financial performance metrics.

Proposed disclosure frameworks to enhance corporate transparency on intangible assets and extra-financial measures of performance should be supported by empirical research on their application.

Research on intangible assets and extra-financial measures of performance should be based on voluntary trial programs where, in addition to filing their regular annual reports, participating companies provide financial analysts and large investors with a more comprehensive set of information on their value drivers.

To Unlock the Investor Link:

Pension fund trustees should develop internal governance practices consistent with a long-term investment outlook.
The transition from antagonism to engagement of certain long-term investors-especially regarding long-term strategic discussions-should be fully explored. Cases should be identified where companies have successfully discussed their long-term strategies with investors and where those investors have acted to support these long-term strategies by eschewing the lure of short-term price fluctuations.

Additional legal research would help understand the extent to which an investment manager may push for a long-term strategic agenda consistent with observing his fiduciary duties.

The motivations for the activism of hedge funds and other alternative investment vehicles should be investigated to ensure that their impact on certain market trends (i.e. short-termism versus long-termism) is fully understood.

To Unlock the Analyst Link:

Studies should be promoted to identify a viable business model to profit from the sale of high-quality investment analysis regarding how to build a durable, long-term portfolio.

Bold efforts undertaken to enhance disclosure and long-term analysis by organizations such as United Nations Environment Programme Finance Initiative (UNEP FI), the Enhanced Analytics Initiative (EAI) and the American Institute of Certified Public Accountants (AICPA) should be reinforced to develop a new cadre of securities analysts and financial intermediaries focused on long-term corporate valuation.

Enterprise risk management (ERM) frameworks should include a set of enterprise-wide procedures to better communicate extra-financial indicators of performance to the investment research community.

For more information at http://www.conference-board.org