It’s hard to ignore that a seemingly large percentage of Wall Street has “lost the plot” in recent years. Now that we’re emerging from the worst financial downturn since The Great Depression, we need to be keenly focusing on what lead us to that dark place. We all know that in order to create value, the return on capital needs to exceed the cost of it. Unfortunately it seems in recent years Wall Street has lost sight of this, instead focusing on short-term shareholder satisfaction. I feel that we all need to focus on enhancing long-term shareholder value, which will also enrich the value for all stakeholders.
An article by Marc Goedhart, Tim Koller and David Wessels that appears in this quarter’s McKinsey Quarterly titled “The real business of business” addresses this very notion in some depth. Their underlying point is “creating shareholder value is not the same as maximizing short-term profits – and companies that confuse the two often put shareholder value and stakeholder interests at risk.” They then go on to introduce the expression ‘short-termism’, saying that managers can make “value-destroying” decisions and deploy “accounting or financial gimmicks” in the name of increasing short-term profits – something that seems to always have a negative effect on long-term profits and productivity. The authors propose what’s needed is “a clearer definition of shareholder value creation” in order to bring what really matters into sharper focus.
This raises the question – what really matters? The authors have found a positive correlation between companies with a high return on capital who take a long view and increased organic revenue growth – an important driver of shareholder returns. Using a long term approach to enhance shareholder value will, by nature, also enhance the value for all stakeholders associated with the company.
Goedhart, Koller and Wessels later propose that the short-termism problem might be tied to managers reporting their performance against potentially short-sighted measures such as EPS. This can be a huge factor leading management to feel pressure to make things look good in the immediate sense, but such a focus can contribute to “not seeing the forest through the trees”?
There is a need for real-time performance measures, however is there a better short-term metric than EPS? I’m not sure, but I am certain more companies need to take a longer view.