Long term growth verses short term gain?
Creating financial value provides the impetus for all business and, in the broadest sense, this value is created through work. Both can be measured and what can be measured can be distilled into a headline-grabbing figure of profit made or output enhanced.
But from our privileged position at Luminous, where we read hundreds of annual reports every year, the temptation to grab the headlines all too often leads to ignoring other key drivers of long-term value. According to an EY report on long-term value, more than half of an organisation’s value can be attributed to intangibles such as its employees, brand, reputation, technology and client base. Yet how often do you see such intangibles clearly accounted for in company reports? Put another way, if a company does not report clearly on its non-financial drivers of value, shareholders are missing out on half the story of the company’s success!
So what can be done? Investors have a lot of power to work with companies to change things, starting with the realisation that the pursuit of short-term profit at the expense of long-term value creation is unsustainable. But the role of the long-term investor is not just to understand long-term trends; it requires an overall view of the market and its connectivity, and a broad view of how ESG matters affect the capital markets.
Narrow financial measures lead to short-term indicators that do not reflect a company’s true value. And companies must take ownership of the ‘runway’ before them if they are to take off for the long haul to sustainable success. Flash-in-the-pan chief executive tenures (where rewards are linked to current-year financial performance alone), under-investment and disregard for human capital are all symptoms of short-termism and the potential for a bumpy landing.
Taking a long-term view helps to chart the route forward, especially in a world uncertain of the exact nature of the business environment it will be operating in just two or three years’ time. FCLT Global (specialists in looking beyond the business horizon), in partnership with McKinsey, researched the performance of companies with a long-term value focus. Published in the Harvard Business Review, the results indicate that ‘companies that manage for long-term value creation have consistently outperformed their peers since 2001, across almost every financial metric that matters’. McKinsey released its own discussion paper in this area, ‘Measuring the Economic Impact of Short-termism’. Its findings are that firms with a long-term view exhibit stronger fundamentals, deliver superior financial performance, retain investment in difficult times and add more to general economic output and growth than those whose focus falls mainly on the next quarter or half-year figures.
Firms with a long-term view exhibit stronger fundamentals. All of this has not escaped the attention of standard setters and regulators who are now acting to catch up. The Dutch corporate governance code, for example, which places culture and long-term value creation at the heart of its guidance, has been warmly welcomed. It contains no suggestion that increased emphasis on the long term should come at the expense of performance today – rather, the code gives both equal importance. While there is still some way to go – the code is not exhaustive in its view of what should come under non-financial reporting, it is an enormous step in the right direction.
It has become less detailed about management board remuneration and more principle-based, focusing on long-term value creation and taking into account the social context companies operate in. But what about the UK? The FRC has proposed changes to the strategic report, placing greater emphasis on corporate purpose and value generation in line with the EU’s Non-Financial Reporting Directive. The changes aim to more closely reflect the aims of section 172 of the Companies Act, which states that Directors must: promote the success of the company; have regard, among other matters, to the long term; consider the interests of employees, suppliers and customers; assess the impact of the company’s operations on the environment and the community; act fairly; and maintain a reputation for high standards of business conduct.
The Luminous view
Luminous firmly advocates taking a long-term view. We have been recommending the proposed FRC amendments to our clients for some time. We hope the new Code will use value creation and long-term thinking as its anchor. Additionally, we hope to see greater focus on boards’ role in culture, and strong consideration of the needs of stakeholders. Let’s move away from value protection and embrace long-term value creation.