As part of the Focusing Capital on the Long Term initiative, some of the world’s foremost economic actors, including CEOs, board members, investors and regulators, were invited to present their views about what it will take to change the current system. The result is the essay collection “Perspectives on the Long Term: Building a stronger foundation for tomorrow," which was launched in March 2015 at the Long-Term Summit in New York co-chaired by Dominic Barton (McKinsey), Mark Wiseman (Canadian Pension Plan Investment Board) and Larry Fink (Blackrock). The entire publication is available here. Edward Speed, chairman of Spencer Stuart and co-author of the following essay, moderated a discussion at that summit on the role of long-term planning in board creation and effectiveness.
Short-term thinking increasingly dominates corporate decision making, particularly in the listed sector, where the pressure to meet quarterly earnings expectations has never been greater. Such is the pressure on CEOs and their management teams that all too often they are distracted from their true mission, which is to steer the business toward its strategic goals. While boards do have a duty to monitor performance against plans, they have an equally important role to play in keeping management focused on the long-term health of their companies. Boards need to become far bolder if they are to make an effective stand against the forces of short-termism, whether these come from inside or outside the organization.
Boards can choose to shake free from the straitjacket of quarterly capitalism, but doing so will require discipline and nerve, backed by a strong culture, shared values, and, most important, board leadership. Regardless of whether the chairman is independent or doubling as the CEO, he or she will need to take a strong lead, both philosophically and practically, in encouraging the board and management to look beyond short-term investor requirements to the needs of the wider community of stakeholders. The board should pay attention to short-term performance, naturally, but any pressure to change course or make decisions that merely satisfy short-term demands must be countered with a clear articulation of the company’s long-term vision. The board’s responsibility is ultimately to the long-term, sustainable health of the business.
Part of the board’s ability to take a long-term view is informed by how it sees its responsibility to shareholders. The profile and expectations of investors have changed substantially over the past several decades, and all the evidence would suggest that in many markets long-term investors are a dying breed. Therefore, listed-company boards have to ask themselves whether their decisions should be driven mainly by a desire to satisfy shareholders impatient for short-term results or whether they should focus their efforts on working with management to develop a long-term vision for the business. This may arouse criticism and mistrust in some quarters, but it has the potential to create greater and more sustainable value in the long run.
Long-Term Vision and Strategy
Definitions of the “long term” vary. We subscribe to the view that short term means one year or less, medium term is one to five years, and long term is more than five years. On this basis, we believe it is safe to say that few boards (and even fewer management teams) spend any significant time developing a truly long-term vision for the business.
On the whole, independent directors are appointed to the board for their ability to provide insights into the strategy proposed by management, yet boards commonly complain that they spend too little time discussing it. The preoccupations inherent in quarterly capitalism are often an unwelcome distraction for both management and the board, whose energies are better directed toward the bigger picture. As one chairman put it, “You can spend all your time trying to prevent accidents, or you can remember that your job is to create value.”
We would argue that the board’s first priority is to establish a long-term vision for the business, working collaboratively with management, and that this is a necessary precursor to management’s development of strategy. What is the distinction? While corporate strategy is critical and comes with a set of milestones and goals that enable the board to measure management’s progress, it is rarely fixed over a long period, necessarily evolving in the face of changing circumstances. By contrast, an overarching long-term vision acts as the lodestar that can guide the board and management as they look beyond the five-year horizon.
Boards should display greater confidence in communicating their organization’s vision to the market. There are recent examples of companies behaving one way for investors but keeping their longer-term thinking under wraps for fear of a negative reaction. Many boards are nervous about committing to the long term and reluctant to reveal their forward thinking by admitting to investments that may not guarantee a return, at least not in the near term.
An impending EU rule change designed to discourage short-term thinking in financial markets may give the boards of European-listed companies more confidence in committing to long-term investment plans: interim management statements will no longer be mandatory, leaving companies to decide on the timing and content of their communications to the market. Boards should take full advantage of this new flexibility by refocusing investors on the company’s longer-term goals.
One of the board’s main tasks is to minimize the principal-agency problem. Since the wrong incentives lead to the wrong behavior, boards have to gear a major portion of the CEO’s and senior management’s reward package toward an appropriate set of performance-based objectives that stretch over five years and are benchmarked against a relevant group of companies, thus creating alignment between management and shareholders. We recommend that some element of the package should be held back until two years after the CEO leaves the business.
CEOs who have to hold their shares beyond their retirement or departure date will, we think, be more concerned about their legacy and the performance of their successor, since some portion of their wealth will remain locked up in the business. A well-managed CEO-succession process is vital for creating stability and continuity in the organization and for reassuring investors. We believe the process should start early in a CEO’s tenure, be run by a dedicated committee of the board, and allow enough time for internal candidates to gain the necessary exposure and experience to prepare them for the role.
Hiring mistakes are costly and can easily derail a long-term strategic plan, which should not change just because a new CEO has been appointed. As the strategy takes shape and continues to evolve, the board must review whether the current CEO is the right person to lead the organization through the next phase, bearing in mind that the person who led the development of strategy may not always be the best person to execute it.
The Right Board
With today’s emphasis on compliance, the governance pendulum may have swung too far in our view, requiring directors to be too distant from the business. Every board has to consider carefully the trade-off between independence and knowledge. There is a strong argument holding sway in private-capital environments that a board made up of insiders who have an intimate knowledge of the business and a strong personal commitment to its success is more likely to be effective than one that contains detached outsiders with no day-to-day involvement in the company and no deep understanding of the issues it faces.
The reality is that independent directors will always be the majority on the boards of listed companies. However, if they are going to think long term and contribute to strategy in a meaningful way, they need to have experience in a relevant industry, a sophisticated understanding of the business, to know where its source of value lies, and to dedicate enough time to make a difference. Therefore, the board needs to consider four critical issues.
First, only people capable of developing that kind of understanding should be considered as directors. Having the best possible talent around the boardroom table really matters, and each individual should bring a unique set of skills and experiences directly relevant to the company’s strategy. This means a rigorous assessment of candidates’ intrinsic qualities to ensure that they have the intellect, judgment, and personality to contribute in the right way. Every new appointment to the board should be framed by the question, “Will this person uphold the long-term vision of value creation for the business?”
Second, directors must spend more time in the role and have fewer commitments. It may be appropriate for a select group of independent directors (committee chairmen, for example) to deepen their involvement in the business on a more formal basis. If this means that boards have to impose tougher rules on the number of directorships an individual may hold, so be it.
Third, directors need to be rewarded at a level that reflects these expectations. To secure the necessary time commitment, director fees should reflect the need for a deeper level of engagement, compensating them for any limits on their portfolio. Rewards for the chairman should properly reflect the significant level of responsibility and time commitment that goes with the role.
Fourth, chairmen or board leaders wanting to change the orientation of a board can strengthen this way of thinking by importing director talent from industries that are by their nature oriented toward the long term. Listed boards could benefit from the experience of family-controlled businesses in the appointment of executive and independent board directors. Family-controlled companies tend to hire directors who share their belief in preserving the company for the next generation. Many of the directors of the largest and most successful family-controlled companies have either been executives of other family-controlled companies who share a conviction about the importance of the long term or they are owners of other businesses run in a similar way. This is particularly noticeable in Germany, an economy powered by family-run businesses thriving in capital-intensive industries with long innovation and product-development cycles, some of them lasting 20 years or more, as in the case of Merck’s ongoing investment in research and development of liquid crystals, which has resulted in their strong position in this sector.
Boards need directors who will become closely identified with the long-term vision for the business and are prepared to place the big bets. Some directors are more concerned with avoiding problems (and protecting their reputations) than making critical decisions for the business that may take time to bear fruit. Excessive risk aversion is as dangerous for the business as reckless behavior is at the other end of the spectrum.
Such concerns are rarely found on the boards of private-equity-portfolio companies, where hierarchical relationships (which can cause risk aversion) are all but eliminated. Private-equity boards not only tend to be highly engaged and knowledgeable but are also smaller and more hands on, so every director’s contribution counts. Operating under fewer regulatory constraints and away from the scrutiny of external shareholders, analysts, and the general public, they have more time to devote to value-adding activities. They also tend to be highly analytical, working closely with management in a way that streamlines decision making and creates a strong culture of accountability.
The Right Board Leadership
It is impossible to overstate the importance of board leadership. (We refer below to the role played by independent chairmen, but we recognize that effective board leadership can take different forms. For example, in some US companies, different aspects of board leadership may be divided successfully between the CEO or chairman and the lead director.) The chairman sets the tone and direction for the board and has to ensure not only that an appropriate long-term vision is in place but also that the business has the human, financial, and technological means to realize that vision. Without a chairman continually upholding the long-term view, the idea will never gain traction.
The chairman must have sufficient conviction, influence, and resilience to stand firm in the face of short-term pressures. He or she is ultimately responsible for assembling the most engaged and knowledgeable team of directors possible to assist in this goal, although it is extremely difficult for any new chairman inheriting a board to change the attitudes and composition of the board overnight; constructing the right board can itself be a long-term endeavor.
The chairman’s skill in setting and managing the agenda is critical, ensuring that sufficient time is allocated to longer-term strategic considerations, which can easily be crowded out by process issues, governance requirements, and urgent matters of the day. A good chairman will always be looking for the most efficient way to deal with the formalities to free up time for more expansive debate.
The chairman’s commitment to the long-term health of the company needs to permeate the board and filter through to the whole organization. The board has a responsibility to ensure that the CEO is aware of and actively managing culture and values, articulating the company’s strategic vision in a simple, clear, and consistent way. That message needs to be reiterated constantly to audiences inside and outside the organization, in language that reinforces the importance of the long-term health of the business.
As leader of the board, the chairman has to have the ability to switch between standing back and acting as a guide for the CEO and stepping forward to intervene. The skills required to do this effectively are rare. It is of course a huge advantage for the chairman to have run something of scale, and even better to have been exposed to crisis, if not failure, since being able to help a less-experienced CEO to apply the lessons from such experiences is invaluable.
The principle of long-term planning should apply as much to the board as it does to the business itself, hence the importance of a properly conducted board-effectiveness review. When directors approach it with a positive, open attitude and a shared desire to improve the board’s dynamics and behaviors, the review can be a powerful tool, especially when the uncensored results are discussed openly by the full board.
There should be no stigma attached to changing the composition of the board if a rigorous evaluation of the collective skills and experience suggests that new directors are needed to help the company achieve its long-term vision. It is possible for boards to get stale and fall into the trap of “fighting the last war” rather than focusing on the needs of the company several years out.
The review should contain questions relevant to the long-term orientation of the business:
- Does the board articulate its role in supporting a long-term vision for the business effectively?
- How often is this vision discussed at board meetings?
- Does it inform decision making?
- Is the board sufficiently engaged with long-term opportunities and threats, such as digital transformation, sustainability and the environment, or global shifts in the balance of economic power?
- What different skills are needed on the board to deal with these issues?
- How willing are individual directors to make way for new directors when fresh skills and experiences more closely aligned to the strategic goals are called for?
- Is there a role for term limits?
If long-term considerations are going to prevail over short-term interests, then the board has to become bolder and more courageous in exercising its collective responsibility, setting the tone for the business to think about its mission in a different way. Directors need clarity about whose interests they are representing, what the trade-offs are, and how best to address conflicting needs. They do not have to accept that their hands are tied, that they are simply there to do the bidding of shareholders who may be involved with the company but fleetingly. They can make a difference in a number of ways by committing themselves more deeply and exclusively to the business and by ensuring that all board activities and interactions with management and investors are underpinned by a clear understanding and articulation of the organization’s long-term vision and values. By looking after the long-term interests of the company as a whole, directors can foster an environment that creates sustainable value for all stakeholders.