An In-Depth Look At Improving The Investor-Corporate Dialogue
Straight Talk for the Long Term is an output of the Focusing Capital on the Long Term (FCLT) initiative. Its development was led by Lincoln Liburd with support from Tim Koller, Werner Rehm, and Robert Palter of McKinsey & Company along with an FCLT working group comprised of delegates from the investor and corporate communities:
Richard Chenga-Reddy, Head of Regulatory Affairs, Standard Chartered
Adeline Diab, Head of Responsible Investment Integration, Aviva
Jon Duncan, Head of Sustainability Research and Engagement, Old Mutual
Robert Holl, Investment Analyst, Wellcome Trust
S. Padmanabhan, Executive Chairman, Tata Quality, Tata
Roger Seabrook, Vice President, Investor Relations, Unilever
Vasuki Shastry, Group Head of Public Affairs, Standard Chartered
Lex Suvanto, Managing Director, Financial Communications, Edelman
David Tien, Senior Portfolio Manager, Global Tactical Asset Allocation, Public Market Investments, Canada Pension Plan Investment Board
Allyson Tucker, Senior Investment Officer, Risk Management and Asset Allocation, Washington State Investment Board
Introduction: why a longer-term dialogue matters
Short-term behavior is becoming the norm in today’s capital markets. Rather than pursuing long-term strategies, many public companies dedicate significant resources to meeting quarterly earnings guidance and communicating their performance relative to this guidance.
This focus on short-term actions and communications seems counterproductive, considering that more than 50% of a typical company’s value is created by activities that will take place three or more years in the future.1 Moreover, research shows that the current emphasis on short-term earnings targets leads to value-destroying behaviors. One survey found that 55% of CFOs would avoid undertaking an NPV-positive investment if it meant falling short of the quarter’s consensus earnings per share. And 78% of executives said they would take actions to improve quarterly earnings at the expense of long-term value creation.2 Companies that expressly seek to manage short-term earnings in order to narrowly beat consensus also underperform peers after two years.
The investor-corporate dialogue can help counteract this short-term bias. We define “investor-corporate dialogue” as the flow of information and ideas between corporations and their current and future investors. A healthy dialogue can empower management to make strategic and operating decisions that build value for the long term. Companies can start by changing the focus of their communications to investors, which currently tend to stress short-term performance and metrics. Partly in response to regulatory requirements, these communications have become increasingly complex over the years and focus mainly on historical results. The effect of this trend has been the growth of overwhelming amounts of data that often obfuscate the information that is critical for longer-term investors. When companies file 10Ks that are more than 700 pages long, how can investors understand a company’s performance and future prospects?
Financial and performance disclosures tend to be written in confusing legalese that yields little insight into the company’s value drivers or future potential. Rather than highlighting the most important recent developments, many corporate disclosures simply maintain the status quo. These disclosures rarely connect recent performance to long-term strategy and objectives. Instead, opportunities and risks are expressed in generic terms such as “increased competition” or “changes in commodity prices”. At this level of abstraction, it can be difficult for investors to discern what differentiates a company (or a company’s businesses) from others in its industry, and what that differentiated value proposition says about its future prospects.
Some companies are reluctant to disclose their long-term strategy for fear that business and industry trends will not unfold as expected, leaving them accountable for plans they can no longer achieve. Others worry about violating fair-disclosure regulations. These are reasonable concerns. However, we believe that all corporate stakeholders stand to benefit from an investor-corporate dialogue that adequately considers long-term performance and health as well as short-term performance. A Harvard study suggests that effectively communicating long-term strategy and consistently using long-term terminology (such as the future and years) on earnings calls is correlated with a lower cost of capital, lower stock price volatility and a longer-term investor base.
Companies that articulate a long-term strategy effectively tend to attract investors who are more willing to look beyond short-term under-performance. The challenge remains creating an environment in which corporations and investors both see the benefit of communicating long-term strategies without sacrificing the level of discipline and financial disclosure imposed by quarterly performance targets.
We have three primary recommendations for companies that seek to strike a better balance between short-term performance and long-term value creation:
- Build a compelling long-term strategy and communicate it to investors.
- Measure long-term value creation and performance relative to a set of long-term metrics specific to the company’s long-term strategy.
- Report to and engage with investors regarding long-term value creation.
This report seeks to provide actionable recommendations to investors and publicly traded corporations. To support our analysis, we have included examples of what we consider to be sound investor-corporate dialogue. We recognize that the companies we discuss may face significant challenges today and in the future. However, we believe that these concrete examples help to support the report’s observations and should be viewed from the context of investor-corporate dialogue best practice.
A diverse group of institutional investors and corporates was brought together to collaborate on this piece and each may pursue the recommendations expressed to varying degrees. Within the context of their unique situations, we encourage organizations to evaluate, adapt and adopt recommendations, enhancing long-term value created for all stakeholders.
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