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The article below was published in Agenda, a Financial Times private subscription newsletter for corporate directors, and is presented with permission.


Agenda, September 21, 2009 article





Article published on September 21, 2009
By Kristin Gribben

The No. 1 problem with corporate governance in the U.S. is pressure to focus on short-term results, according to an Agenda survey of independent directors.


Those directors are concerned that the debate over the causes of the financial crisis has focused too much on a lack of shareholders’ rights. In fact, only 1% of respondents to the survey, which was conducted in July and included 294 independent directors, pointed to lack of shareholder rights as the biggest problem in corporate governance.

Now, the Aspen Institute Business & Society Program’s Corporate Values Strategy Group is trying to shift the debate to the problem of short-termism. A new statement by the institute calls on Congress to adopt a number of policies designed to improve the problem of short-term investing.

A diverse group of directors, executives, academics and investors signed the statement, including the likes of Warren Buffett, The Vanguard Group founder John Bogle, Duke Energy CEO Jim Rogers and former chairman of Goldman Sachs John Whitehead.

While some observers say short-termism has been a problem for the past decade or longer, it has become more prevalent in recent years due to lower trading costs, the advent of technology, the increased use of derivative products and the introduction of 401(k) plans.

The Aspen Institute first made waves in this area when it released a set of principles in 2007 that called for an end to quarterly earnings guidance from companies and aligning compensation incentives with an eye toward the long term.

The latest advocacy is “taking it a step further,” says Lynn Stout, a law professor at the University of California, Los Angeles and one of the signatories to the latest statement. “It’s not enough to simply discourage quarterly earnings guidance,” she says.

“This round of work is really saying, ‘OK, we need to look at whatever leverage points exist in policy to shore up this direction,’” says Judy Samuelson, executive director of the Business and Society Program at the Aspen Institute. “Our focus at this point is Capitol Hill and the administration.” She says the institute is using the networks of its signatories to spread the word in Washington.

Hearings on this issue are expected soon in both the House and Senate, several people involved say.

The Aspen Institute and its signatories want to revise the capital gains tax provisions or implement an excise tax to reward long-term stock holdings; remove limitations on capital loss deductibility for very long-term holdings; and adopt minimum holding periods or time-based vesting in exchange for more shareholder rights. The institute also advocates for increased disclosure from investors and applying more enforcement of the fiduciary duties of investor advisors — a topic of conversation at the SEC’s investor advisory committee’s first meeting this summer.

The sentiment coming from the Aspen Institute is also supported by other organizations. A recent report from a task force of the Corporate Governance Committee of the ABA Section of Business Law, which was sent to members of Congress and the SEC, recommended that policymakers encourage shareholder interest in the long term through tax incentives and enhanced voting rights.

The obvious direction to take is reforming capital gains taxes, says Stout. The current tax laws give preferential tax rates if investors hold stock for a minimum of 12 months. “You can get a lower tax rate for short-term trading than holding down a regular job,” she says.

Issuing Guidance

The Aspen Institute has had success with its previous advocacy in this area. Many companies have eliminated quarterly earnings guidance since the organization’s initial call to do so. General Electric, for instance, said it would stop the practice last December after missing and revising its earnings guidance amid the recession.

But progress has stalled of late. A 2009 National Investor Relations Institute survey shows 60% of respondents provide earnings guidance compared to 64% in 2008. Analysts, naturally, want companies to continue issuing guidance. In a recent survey conducted by MWW Group, 76% of 100 sell-side analysts said they believed the stock market would penalize companies that suspend earnings guidance in this economic environment.

There are even some voices calling for the continuation of earnings guidance, saying it is in the best interest of management. “Abolishing earning forecasts by issuers will not abolish the forecasts; it will only mean analyst forecasts will be less informed,” says Hal Scott, a Harvard professor and director of the Committee on Capital Markets Regulation, an independent and nonpartisan research organization.

Scott’s committee commissioned a study released last week that concludes that management forecasts actually provide better alignment of market returns with long-term performance. Gregory Miller, a business professor at the University of Michigan and author of the study, recommends that boards become involved in creating a written policy for when and in what form forecasts will be provided and how they relate to the company’s overall disclosure regime.

Other Forces at Work

There are two main problems with the investing public, says William Sihler, a business professor at University of Virginia and a director at Curtiss-Wright. One is the problem of vote lending, which is when an investor borrows shares to vote but has no underlying economic interest in the company. This is an issue SEC chairwoman Mary Schapiro will likely look at as part of an overall review of the proxy voting system. Sihler’s second concern is short-term hedging.

One solution to these problems is to give long-term institutional investors greater voting power, he says. It can also be worth a company’s time and effort to recruit the right kind of shareholders, he adds. To encourage long-term stockholders you have to “cultivate institutions that are known to be sympathetic with the idea you can show them what is happening,” he says. Analysts can’t be ignored either. This means sending CEOs and CFOs on the road to trade shows and spreading the message of the company’s long-term vision.

AutoNation CEO Michael Jackson told McKinsey Quarterly recently that when he took over eight years ago, he knew that to succeed he needed to attract a new shareholder base that would be willing to sacrifice short-term profit for long-term gain. “The investors I have now understand the business model, and that’s been a huge plus. But it didn’t happen by itself,” he tells McKinsey Quarterly.

Another possible solution is to give shareholders more rights in exchange for time-weighted voting, says Stout. This is a concept that is embedded in the SEC’s proxy access proposal, which the commission is expected to rule on this fall. If shareholders want to have the right to exercise proxy access they have to hold stock for at least one year. While many businesses would like to see an even longer time period, the concept of encouraging longer holding periods is a good one, says Stout.

However, some directors are less hopeful that anything can be done to break the cycle of short-termism. Even if you try to recruit the right kind of shareholders and change tax incentives to encourage more long-term shareholders, management will be chasing numbers to meet their bonus target, says Leigh Abrams, a director at Impac Mortgage Holdings and chairman and former CEO of Drew Industries. “No matter how you boil it down, human nature says, ‘What’s my bonus going to be next year?’” The best way to accomplish a long-term mind-set at the company level is through having the right tone at the top with your managers, he says.

Compensation committees can also work with management to identify metrics with a longer-term horizon, suggests Barbara Allen, a director of RLI Corporation and a veteran of several other boards. Those metrics can include economic value-added (EVA) or ones focused on return, she says. “It may not be obvious in the metrics that the rest of the world is focusing on and it requires a lot of communication,” she says.

Meanwhile, Abrams cautions that it’s not always a bad thing to think in the short term. “You’ve got to make sure today is all right,” he says. “You better be able to make money right now.”







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