Seven Principles for Understanding and Avoiding Short-Termism

Six years ago, Warren Buffett, John Bogle, Barbara Hackman Franklin, and two dozen other business luminaries sounded the alarm about short-termism by signing Overcoming Short-Termism: A Call for a More Responsible Approach to Investment and Business Management. This manifesto highlights an unhealthy focus on short-term results that overwhelms “the desirable long-term growth and sustainable profit objectives of the corporation.”

Despite this call to action, overcoming short-termism remains a stark challenge for many companies. In fact, as the National Association of Corporate Directors’ (NACD) 2015 Blue Ribbon Commission observed, “factors encouraging a short-term focus are stronger now than ever before.” Additionally, in a 2015 report, the Conference Board contemplated whether short-term biases might jeopardize future business prosperity altogether.

Yet if short-termism is a sizable challenge, so too is the commitment to understanding why short-termism is so entrenched as a business practice and the task of mitigating its harmful effects. In July, the Anti-Fraud Collaboration, a group of organizations focused on fighting financial reporting fraud, hosted a webcast on Coming to Terms with Short-Termism. The discussion, which I was privileged to moderate, featured top experts and generated a wealth of useful takeaways for participants across the financial reporting supply chain.

Let’s look at a few key takeaways from the discussion.

1. Acknowledge and Define the Complexities of the Issue

To address the challenge of short-termism, it helps to understand the complexities of what companies are up against. For one thing, “short-termism” doesn’t equate to short-term activity, which isn’t necessarily bad. NACD Chair Karen Horn, director of Simon Property Group, observed at the outset of the webcast that the “long term is made up of many, many short-term actions.”

Another tricky step to understanding the complexities of short-termism is how to define “short-term” at your company. Is it a month? A quarter? A year? “It depends on the company,” said panelist Bill McCracken, president of Executive Consulting Group LLC. McCracken, who previously served as CEO of CA Technologies, added that even within a company the meaning of “short-term” can change according to different contexts, such as strategy or compensation.

2. Think Strategically

However complex a challenge combatting short-termism may seem, there are several simple solutions for directors to consider. One of them is this: think strategically. A strategic mindset helps short-term actions align with long-term goals. “Boards really need to be conversant with the company strategy,” said Horn. McCracken agreed, noting that board members should become “activist directors” who immerse themselves in the details of the company, its strategy, and its industry. This engaged approach, he added, can help directors be prepared to handle situations such as share buybacks or changes to dividend policy where questions of short-termism may arise.

Similarly, strategic thinking can also help directors gauge the validity of the use of non-GAAP measures. “Shouldn’t the use of non-GAAP measures also tie in to the strategy of the entity?” asked Douglas Chia, executive director of the Conference Board’s Governance Center. “Absolutely,” responded fellow panelist and KPMG Partner Jose Rodriguez.

3. Strengthen Tone at the Top…

One danger of short-termism is that it can heighten fraud risk across the enterprise. Companies need to ensure that management is setting the right tone at the top. “I can’t underemphasize tone at the top,” said Rodriquez. “How do [senior executives] talk to employees? Is everything geared around meeting that analyst’s [earnings] expectations?” From his auditor’s viewpoint, he added, “that would be concerning."

4. …But Don’t Forget the “Mood in the Middle” and “Buzz at the Bottom”

While emphasizing tone at the top, panelists also stressed that short-termism shouldn’t be a point of concern for only senior management. Many instances of fraud, noted Rodriguez, occur outside the C-suite. “It’s middle management and lower management that had to get that sales number to a certain amount of dollars,” he said, and this pressure can lead to channel stuffing or other undesirable activity. Such activity is what audit committees, auditors, and the board ought to be looking for, added Bill McCracken.

5. Dial Down the Emphasis on Quarterly Results

“Our entire [financial reporting] structure is built around quarterly reporting,” said McCracken. While eliminating this quarterly focus might not be possible—or even desirable—panelists agreed that reducing the quarter-to-quarter mindset was an important part of addressing short-termism. “Obviously you can’t get entirely away from that,” said Chia, “but there are ways you can reduce the emphasis and build on the timeline that you think is appropriate—not what you’re being told by the analyst community.”

6. Communicate!

Fostering robust communication internal and external communication is a core priority for the Anti-Fraud Collaboration, and communication at all levels was a recurring theme throughout this webcast. When discussing the use of non-GAAP measures, Horn noted that “the chairman of the compensation committee should be talking to the chairman of the audit committee as these measures work their way in to [compensation] programs.”

Likewise, communicating effectively with external investors and other stakeholder parties is critical. “Boards need to really understand investor communications,” said Horn. “The way that we can pursue long-term value creation is in partnership with our investors.”

7. Commit to Continuous Learning

As auditors, boards, managers, and investors grapple with short-termism, they can draw on a growing body of resources on the subject. The Anti-Fraud Collaboration’s website, for example, contains the webinar discussed here, along with articles on corporate culture, publications on building fraud-resistant organizations, videos on ethics, and other resources. All of these resources can help align short-term and long-term goals for the benefit of companies and investors.

A securities lawyer, Cindy Fornelli has served as the Executive Director of the Center for Audit Quality since its establishment in 2007.

This post originally appeared on the NACD Board Leaders Blog.