by Dr. Farid A. Muna
February 2010

Leaders and CEOs realize that they need to know much more about creating long-term value for their stakeholders, especially in the aftermath of the housing crisis and the world-wide economic meltdown of 2008-2009, which overshadowed the accounting scandals, imprudent financial investments, and lax corporate governance at the turn of this new century.

However, corporate leaders are under great pressure to produce short-term results rather than focus their efforts on long-term strategies and value creation. This overemphasis, especially in the USA, on short-term considerations imposes high costs on stakeholders (including shareholders) and the economy. Short-term outlook (known as short-termism) is the result of several factors which boards of directors, stakeholders, and CEOs can address to help alleviate the negative consequences of this phenomenon.

Let us begin by examining the factors contributing to short-termism and provide some recommendations to reduce its destructive effects. Needless to say, some of these recommendations fall outside the CEO’s power and authority. Some recommendations would require changes in policy and regulations; others would require determined efforts by boards of directors and other stakeholders.

• Many organizations have been highly criticized for not putting enough time, effort, or emphasis into succession planning and the development of their internal managerial talent. This lack of long-term planning is forcing organizations to recruit outside executives for the top job, who are increasingly hired on short contract basis which, in itself, causes more short-termism. Boards of directors and CEOs should be held accountable for succession planning and career development of their top managers.


• Executive compensation and incentive plans (including stock options) are linked to short-term results. Boards of directors should strengthen the link between long-term performance and executive compensation, especially when making decisions on a CEO’s recruitment, retention and termination.


• Lack of support by the board of directors for strategic, long-term plans (longer than five years). Corporate governance should define and promote metrics and measurements of long-term performance in order to guide top executives in their strategic thinking and long-term planning.


• Many organizations provide quarterly guidance on revenues and earnings per share. Wall Street analysts, hedge fund and asset managers, private equity funds and other investors are often looking for short-term results, sometimes making huge stock trading decisions based on quarterly earnings or earnings outlooks. Recently, nearly half of large publicly-traded organizations have stopped the practice of providing such estimates to Wall Street. The quarterly earnings obsession is not healthy for long-term strategic planning.


• In the USA, the role of chairman and CEO is usually occupied by the same person (around 70 % in the Standard & Poor’s 500), while in Europe and Canada the role is split (around 80% in companies making up the Eurotop 100, and over 90% in British companies making up the FTSE 100). Separating the roles allows the chairman and board members to keep an eye on the executive team and in turn the company’s overall performance on behalf of the stakeholders. Separating the roles also allows the Chairman and the CEO to focus on different, equally vital aspects of the company’s long-term performance.


• By law, the US Securities and Exchange Commission requires large public companies to report their financial results quarterly (Form10-Q) and annually (Form 10-K). In contrast, many organizations, for example in the UK, Europe, and Japan, report earnings only on a bi-annual basis. Should the USA eventually follow the reporting practices of overseas companies? Will semi-annual reporting lesson the pressures of short-termism? One comparative study (comparing the quarterly reporting of the USA and Canada with the semi-annual reporting of the UK and Australia) suggests that semi-annual reporting leads to less volatility in stock prices (Mensah and Werner 2008). This subject is worthy of further research.

Recently, we have witnessed a movement on the American scene spearheaded by prominent groups of business leaders, public policy leaders, and academics calling on organizations to take a longer-term view of corporate performance and to fight short-termism. These groups include the Aspen Institute’s Corporate Value Strategy Group (2008), the Conference Board (2006), and the Business Roundtable (2006). Their publications, cited below in References, should be mandatory reading for current and aspiring leaders.

Recognizing that corporate leaders have limited power to implement some of the above recommendations, the question becomes: “What else can the CEO do to create long-term value for stakeholders?” Well, there has been a fair amount of debate in the last decade on innovation and value creation.

The CEO and Innovation

During the first decade of the 21st Century, innovation has become the fashion—the latest strategic weapon for organizations. In a 2004 survey of global CEOs, The Economist stated that in most global companies around 25% of revenues came from products and services less than three years old; most companies must innovate to meet new customer demands. The Economist concluded that, “Innovation is now recognized as the single most important ingredient in any modern economy.”

The 36th World Economic Forum (WEF) held in Davos, Switzerland during January 2006 witnessed a new and unusual theme. In addition to the normal topics on world economic and political conditions, the theme of “Innovation, Creativity, & Design Strategy” was included on that year’s agenda.

There is no doubt that innovation requires a corporate culture of creativity and learning reinforced by top management’s active involvement and support. When a culture of innovation becomes a critical success factor, innovation becomes a way of life! People should be allowed to experiment, think outside the box, tolerate failures and risk, learn from their mistakes, and work in multidisciplinary teams.

One more thing has become clear about innovation; you do not merely ask potential customers “would you like us to invent a Walkman, post-it notes, an MP3, an iPhone, a Wii video game console, a flat panel HDTV, an iPad, or a GPS for the car?” Customers simply cannot imagine all new possibilities and products, nor are they familiar with the current or upcoming technical capabilities of organizations. Nevertheless, customers should be intimately involved in the development of new products, services and design from the start; and not only through questionnaires, surveys, and study groups.

Innovation and creating value must involve the customer; give the customer an experience that will keep driving the business. This is not a new concept: being customer-friendly has always been advocated as another way to create value to both customers and companies. The authors of The New Age of Innovation (Prahalad and Krishnan 2008) state that there is a fundamental transformation of business underway that focuses on customers’ experiences with a certain product or service. The authors wrote “Value is based on unique, personalized experiences of consumers, one consumer at a time. Firms have to learn to focus on one consumer and her experiences at a time, even if they serve 100 million consumers.

Apple Inc. is one of the numerous companies cited by the authors where the focus on customers’ experiences is practiced. Apple’s entry to the digital music space with iPod and iTunes software allows users to personalize their experiences with their music selection one song at a time. The iPod’s capacity to store a great number of songs allows individual users to personalize specific music lists depending on their mood or the time of the day, which they can select from whether at the gym, in a park, at home or school, or in their cars while driving around.

Meanwhile, more and more large companies are making innovation part of their corporate culture and structure. Consider how companies such as Toyota, General Electric, Procter & Gamble, 3M, Microsoft, Sony, Hewlett-Packard, DuPont, IBM, Whirlpool, and Google (to name a few) are approaching the subject. They have taken key actions in order to structure and incorporate innovation efforts into their organizations. Most have created innovation teams with considerable decision-making power. They have also set aside special innovation budgets that are independent from other departments and divisions. For example, Procter & Gamble (P & G) has established an innovation fund which provides financing for the development of disruptive innovations and for new businesses. P & G´s Crest Whitestrips were financed by this type of fund.

A.G. Lafley, former Chairman and CEO of P & G, in an interview with Fortune magazine (2006) explained how his company views innovation and why they use outsiders as partners in innovation. “We’re good inventors but probably not better in a lot of areas than others outside. What we’re really good at is developing, qualifying and commercializing for our industries and our channels. So we just opened up the front end. In 2000 a little more than 10 percent of our innovation was partnered with at least one external partner. We set a goal of 50 percent. Last year a bit more than 40 percent of what we commercialized had at least one external partner.” In hard economic times, it is becoming more common for companies to place some of their research and development projects with outside firms or partners. Chesbrough and Garman (2009) call this strategy “the inside-out open innovation”, which is practiced nowadays by Eli Lily, Unilever, Philips Electronics, SAP, to mention a few.

In an interview with Harvard Business Review (2006), Jeff Immelt, CEO of General Electric, described his future vision of imagination breakthroughs as “…a protected class of ideas—safe from the budget slashers because I’ve blessed each one. They help make organic growth real to the company and to the Street. At this point, there are about 100 of them, half involving brand-new products and half involving changing commercial structure. Ultimately, I’d like to see the concept morph and spread into the organization so that we have 1,000 imagination breakthroughs and the focus is less on these big elephants and more on creativity throughout the business.”

Without a doubt, innovation and improvement initiatives have to be closely linked to financial measures and long-term value creation for stakeholders. What is urgently required at both the national and organizational levels are long-term investments and long-term thinking.

References

Chesbrough, H. and Garman, A. (2009), “How Open Innovation Can Help you Cope in Lean Times”, Harvard Business Review, Vol. 87, No. 12. pp. 68-76.

Fortune Magazine,(2006), “Q & A: On the Hot Seat”, an interview with A.G. Lafley and Jeff Immelt”, November 27, 2006, available at, http://money.cnn.com/magazines/fortune/fortune_archive/2006/12/11/8395440/index.htm

Harvard Business Review,(2006), Growth as a Process”, an interview with Jeff Immelt, Vol. 84, No.6, pp.60-70.

Mensah, Y.M. and Werner, R.H. (2008), “The Capital Market Implications of the Frequency of Interim Financial Reporting: an International Analysis”, Review of Quantitative Finance and Accounting, Vol. 31, No. 1, pp. 71-104.

Prahalad, C. K. and Krishnan, M. S. (2008), The New Age of Innovation: Driving Co-Created Value Through Global Networks, McGraw-Hill.

The Aspen Institute (2008), “The Aspen Principles: A Better Way Forward”, Directors and Boards Annual Report, pp 4-6, available at www.aspeninstitute.org/site/c.huLWJeMRKpH/b.612437/k.79AA/Publications_and_Speeches.htm.

The Business Roundtable (2006), “Breaking the Short-Term Cycle”, CFA Centre for Financial Market Integrity and Business Roundtable Institute for Corporate Ethics, available at www.darden.edu/corporate-ethics/pdf/Short-termism_Report.pdf.

The Conference Board (April 2006), “Revisiting Stock Market Short-Termism”, available at www.conference-board.org/publications/reports.cfm