A movement to make the economy more long-term oriented is on the rise, and we believe it’s here to stay. To encourage CEOs to make long-term thinking their short-term strategy, our leadership models need to change. If CEOs are to succeed, they need to operate in an ecosystem that encourages long-term management. So how can we create a world where going long is the norm?
Here are three recommendations.
1. Create Really Long-Term Stock Incentives
There is a growing perception among some investors and boards that executive compensation needs to encourage more long-term thinking. Vanguard chairman William McNabb, whose company manages $5 trillion in assets, is proposing to take a portion of a CEO’s restricted stock grants and vest it 5 to 10 years after the executive leaves the business.
He explains: 'The median tenure of a CEO is six years, and there is no way you can judge how well or poorly someone has done in that time frame. Someone who only lasts a short time in the job can make a lot of decisions that help them in the short run but not in the long run. I think finding a way to keep a linkage there might help change behavior.'
Typically, a CEO’s restricted stock grants vest after three years. Some companies like ExxonMobil encourage long-term thinking by vesting one-half of restricted stock grants in 5 years and the other half in 10 years. In the absence of this long-term incentive, a CEO of ExxonMobil might be tempted to cut back on exploration, which would bump up short-term earnings and make the CEO look like a hero to investors—for a while. Ultimately the CEO’s successor would bear the brunt of that short-term move, which would show up as diminishing oil and gas reserves.
Critics of the plan say that delaying executive pay that far out would only put greater burdens on CEOs and create yet another reason for companies not to go public. 'The fundamental problem that we have,' argues BlackRock CEO Larry Fink, 'is that we’re attacking more public CEOs. I think one of the greatest risks we have is that fewer and fewer companies are going public. It’s become harder and harder.'
2. Work More Closely with Investors
What makes McNabb and others optimistic about making our markets more long-term oriented is that investors like Vanguard and BlackRock are taking a more active role in how corporations are governed. These companies largely manage index funds, which by definition have to hold onto every stock in their portfolio—no matter what. Because they have to hold every stock in their sector basically forever, they are concerned about good performance for their investors not just this quarter or the next, but also five, 10, or even 20 years out.
By contrast, actively managed funds, which still represent the lion’s share of the market, don’t have much incentive to encourage CEOs to manage for the long run. The turnover in the stock portfolio of a traditional, actively managed mutual fund is 90% annually on average, which means the fund holds each stock for only about a year. That’s a high level of turnover. If you include hedge funds, the holding period is even shorter.
Big long-term investors believe good corporate governance leads to stronger long-term financial results. Vanguard, for instance, argues that to achieve strong stock performance decade after decade, boards should have a good set of governance rules in place—rules that should include, among other things, performance-based pay, accountability for CEO succession, and a rigorous capital allocation and risk assessment process.
BlackRock, State Street, and Vanguard have already had some success in engaging corporate boards on governance issues. Vanguard’s investment stewardship officer Glenn Booraem says that his firm now actively engages with directors of the companies they invest in and so far have found them to be responsive to its ideas about better governance.
As an example, Booraem recalls how Vanguard engaged with a company’s directors on compensation. The board had brought in a new CEO and had granted the executive hundreds of millions in equity that would just vest with the passage of time. There was no linkage to long-term performance. 'It raised a red flag for us,' says Booraem, 'and we engaged with the comp committee of the board over a multiyear period' Eventually the board reopened the CEO contract and took a portion of the equity compensation and tied it to relative performance against the S&P 500.
3. Change the Rules to Reward Long-Term Investors
CEOs who manage for the short term use the stock market as their report card. When their stock goes up, so does their bonus—and their mood. When it starts to falter, they scramble to cut costs and heads to make their quarterly numbers. This, of course, is not good for the long-term health of the company or its investors, employees, and the communities it serves. But what if CEOs had investors who got rewarded for backing their long-term strategies?
A group of Silicon Valley titans is addressing this issue but is taking a different tack. They believe that stock market indexes could be designed to reward long-term investing. They plan to launch the Long-Term Stock Exchange (LTSE), a trading platform meant to turn corporate governance on its head. The LTSE is the creation of venture capitalist Marc Andreessen of Andreessen Horowitz, an early investor in Facebook; Reid Hoffman, the founder of LinkedIn; and Eric Ries, an author and start-up expert who serves as the exchange’s CEO. The group says it has raised $19 million from around 70 investors. It is aiming to get regulatory approval to start operating in 2018.
Ries first floated the notion for his exchange in his 2011 book The Lean Startup. The idea was to get investors focused not on short-term financial results but on long-term strategies. Companies listed on the exchange have to agree to certain principles of corporate governance, such as a ban on tying executive pay to the company’s short-term financial performance.
Executive bonuses can’t be tied to financial-performance targets of periods of less than one year. Restricted stock grants can’t fully vest for at least five years. Companies on the LTSE still publish quarterly results (which is a requirement of the Securities and Exchange Commission), but they can’t give quarterly earnings guidance.
Strong political and financial interests could easily stand in the way of implementing, or at least delay implementation of, many of these ideas. The point is that change is coming.
Adapted from Go Long: Why Long-Term Thinking Is Your Best Short-Term Strategy, by Dennis Carey, Brian Dumaine, Michael Useem, and Rodney Zemmel, copyright 2018. Reprinted by permission of Wharton Digital Press.
Dennis Carey is vice chairman of executive search firm Korn Ferry. Brian Dumaine is the founder and editor in chief of the New York media company High Water Press and a contributor to Fortune magazine. Michael Useem is the Jacalyn Egan Professor of Management at The Wharton School of the University of Pennsylvania. Rodney Zemmel is senior partner at McKinsey & Co and its managing partner for New York, Boston, and Stamford.
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