Corporate governance is rooted in values of transparency, accountability, and security. Yet these ideals face the pressure of the quarterly earnings season, in which the investment world measures three months of a company’s finances against analysts’ expectations. Meeting or missing those expectations can have consequences for company stock market value.
This short-term mindset risks running counter to a more holistic perspective—one that blends strategic planning, effective management of human and natural resources, and adept financial oversight to create an organization capable of sustaining itself into the future.
Short-Termism in Corporate Governance
The CFA Institute, a standard-setting organization for the investment management industry, defines short-termism as “an excessive focus on short-term results at the expense of long-term interests.”
While quarterly earnings have traditionally served as a core driver of stock performance, this relationship has at times encouraged financial manipulations. McKinsey research finds that 61% of companies without a long-term culture would work to soften an expected earnings miss. Of those companies, 71% would consider trimming investments such as research and development, 55% would consider delaying a new initiative, and 34% would consider postponing an accounting charge.
Yet the CFA Institute suggests that by targeting the near term, a company could risk weakening both its health and shareholder returns down the road. In Short-termism Revisited, it argues that there is a correlation between poorer returns in three to five years and underinvestment in research and development; selling, general, and administrative expenses; and capital expenditures.
Short-termism Revisited does allow for occasional near-term prioritization; crisis-heavy 2020 makes a compelling case for this exception. Yet overall, the report encourages a long-term focus for corporate leaders: actively engaging with investors and supporting strong environmental, social, and governance (ESG) data standards, along with compensation plans that align with related outcomes.
The Broader Consequences of Short-Termism
What harm can come of short-termism? In Coping, Shifting, Changing 2.0, the UN Global Compact and the Principles for Responsible Investment conclude that short-termism deflects attention from the UN Sustainable Development Goals. Furthermore, it may distract leadership from fundamentals, which could result in dismissing ESG considerations, limiting innovation, and restricting new market opportunities.
A July 2020 report by the European Commission recommends that future European Union legislation fosters “more sustainable corporate governance.” To this end, the report recommends that corporations change the responsibilities and accountability of company directors and adopt progressive board-level policies that reduce the ability to act solely toward short-term goals.
The concept of short-termism is not without its critics, as some push back with arguments that activist investors are primarily to blame and that quarterly stock swings are driven by automated program trading. However, given the systemic change that some impact investors seek, it is worth understanding a management team’s commitment to the long haul.