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Capitalism for the Long Term
Featuring:
Dominic Barton, McKinsey & Company’s global managing director and author of the Harvard Business Review article “Capitalism for the Long Term.”
Adi Ignatius, Editor In Chief, Harvard Business Review
JULY 1, 2014
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OCTOBER 17, 2012
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JULY 1, 2014
Dominic Barton, McKinsey & Company’s global managing director and author of the Harvard Business Review article “Capitalism for the Long Term.”
Adi Ignatius, Editor In Chief, Harvard Business Review
Capitalism for the Long Term
Today’s Speakers
JULY 1, 2014
@HBRexchange | #HBRwebinar
McKinsey & Company | 6
Contents
1
2
3
The rise of short-termism
The importance of long-term thinking
Shifting to a longer-term mindset
Focusing Capital on the Long Term | 77
Short‐term pressures are escalating
Average duration of London Stock Exchange holdings fell from 5 years in 1966 to only 8 months in 20071
55% of CFOs will reject an NPV‐positive investment if it means missing next quarter’s earnings targets
Average CEO tenure has dropped to < 7 years todayfrom 10 years in 1995, and 4.2 years for Fortune 500 CEOs
63% say that the pressure has increased over the past five years to generate short term to results
73% say that they should use a time horizon of more than 3 years
2011 20122013 2014
Of 1,000+ surveyed C‐suite executives and board members, 44% use a time horizon of less than 3 years in setting strategy
20132014
1 Similar trends exist in the US – average duration of NYSE stock holdings has fallen from 6 years in 1975 to only 7 months in 2009
THE RISE OF SHORT TERMISM
Focusing Capital on the Long Term | 88
Executives report that short‐term pressure is increasing, and that the board, investors and their own actions are to blame
SOURCE: McKinsey‐CPPIB ‘Focusing Capital on the Long Term’ survey 2013
63% of respondents report feeling increased pressure to deliver short‐term results
Percentage of respondents,1 n = 474
2
63
25
9
Don’t know/not applicable
Increased
No change
Decrease
Short‐term pressure most often comes from directors and executives
Percentage of respondents,2 n = 474
2
3
5
6
10
14
15
20
20
23
43
47
Retail investors
Proxy advisory firms
Hedge funds
Regulators and/or government officials
Customers
Competitors
Sell‐side analysts
Banks and/or debt holders
Institutional shareholders
Private‐equity investors
Executive team
Board of directors
1 Figures may not add up to 100%, because of rounding2 Respondents who answered “other”, “none”, or “don’t know/not applicable” are not shown..
THE RISE OF SHORT TERMISM
Focusing Capital on the Long Term | 99
Executives report that while they should be using a 3+ year horizon for strategic decision making, they rarely look out more than 4 years
SOURCE: McKinsey‐CPPIB ‘Focusing Capital on the Long Term’ survey 2013
1
4
11
41
33
11
Time horizon today
Don’t know
7 or more years
5 to 6 years
3 to 4 years
1 to 2 years
1 year or less
2.9
0
11
19
43
20
7
Ideal time horizon
3.7
44% currently use less than 3 years' time horizon to assess strategic plans; 73% believe the ideal time horizon should be more than 3‐4 years
3
3
4
11
35
44
7 or more years
Don’t know
5 to 6 years
3 to 4 years
1 to 2 years
1 year or less
79% of respondents report feeling the most pressure to demonstrate financial performance within 2 years
"When your company's management team conducts a formal review of corporate strategy, what is the primary time horizon for future strategic planning?”Percent, Total Respondents = 474 (Single response)
"In your current role, over which of the following time periods do you personally feel the most pressure to demonstrate strong financial performance at your company?”Percent, Total Respondents = 474 (Single response)
Avg years
THE RISE OF SHORT TERMISM
Focusing Capital on the Long Term | 1010
Increased short‐termism is evident across the investment value chainTHE RISE OF SHORT TERMISM
Time Horizon1 Pressures
20‐30 years
1‐5 years
3‐12 months
< 5 years
< 4 years
Savers
Management
Corporate boards
Asset managers
Institutional investors
▪ Despite long horizon, savers increasingly allocating assets using short‐term performance metrics largely due to declining real returns and the end of defined benefit pension plans
▪ Most pension funds and other institutional investors are reducing their allocations to public equities and placing a greater share in passive investments
▪ Asset managers are focused on a game of relative performance while stock turnover has increased with speculation and trading replacing fundamentals
▪ Boards and management have come under increased pressure from media and sell‐side analysts
▪ CEO tenures have declined but asset lifespans have not, meaning that few CEOs last long enough to see the full consequences of their strategic decisions
1 Based on current incentive structures for most actors
Focusing Capital on the Long Term | 1111
It took P&G, Coca‐Cola and Walmart 8‐11 years to become profitable in China
Intel abandoned manufacturing memory chips in 1985 to focus on microprocessors
Long‐term thinking is essential for long‐term success
Apple’s share price fell 25% the year the first iPod was released
86% executives agree that a longer time horizon for business decisions would improve corporate performance
70‐90% of a company’s value is related to cash flows
3+ years out
THE IMPORTANCE OF LONG‐TERM THINKING
Focusing Capital on the Long Term | 1212
If institutional investors and corporate boards act in a coordinated fashion, they have the ability to re‐orient the system to the long‐term
SHIFTING TO A LONGER‐TERM MINDSET
▪ Fiduciary duty – Legal and moral imperative to represent the interests of shareholders, which is usually best served by a long‐term mindset
▪ Link between investors (IIs) and executives – IIs can reorient boards, but only boards can reorient management
▪ Successful models exist – Boards of private equity‐owned firms provide successful models for long‐term governance, metrics and incentives
▪ Concentrated decision making – Top 10 institutional investors control $10 trillion in assets (15% of all global assets)
▪ Significant share of equity markets – Directly or indirectly own 70% of outstanding stock in largest 1,000 US public corporations (2011)
▪ In it for the long haul – Many institutional investors recognize that the scale of their investments places them in a position to help shape the company’s success (and also makes it difficult to fully exit a position)
Why they can make a difference
Savers
Management
Corporate boards
Asset managers
Institutional investors
Focusing Capital on the Long Term | 1313
There are a number of practical actions that can be taken as a group to tackle short‐term thinking
Board focus▪ Pay non‐executive directors for at least 40 days work per year▪ Review the proportion of Board time spent on long‐term issues, and explore whether a long‐term health committee would help increase the amount
Investor‐corporate dialogue▪ Commit to highlight 5 long‐term metrics that are material to the long‐term health of the business model in earnings calls and annual reports
▪ Discontinue quarterly earning guidance by 2015
Reorient portfolio▪ Use a portion of new asset manager mandates to pilot a range of longer‐term incentives and evaluations
Engagement▪ Set up a collaborative engagement platform and test it by engaging with companies on executives' long‐term incentive plans
SHIFTING TO A LONGER‐TERM MINDSET
Savers
Management
Corporate boards
Asset managers
Institutional investors
How they can make a difference
Focusing Capital on the Long Term | 1414
Practical changes for institutional investors
Ensure board members are independent, experienced and have a long‐term approach (e.g., Norges Bank Investment Management maintained its long‐term strategy through volatile equity markets)
Unlock value through engagement and active ownership (e.g., Larry Fink encourages companies to work directly with BlackRock and other shareholders, rather than focusing on winning over proxy advisory firms)
Define long‐term objectives and risk appetite (e.g., GICmaintains a 20‐year time horizon for value creation)
Demand long‐term metrics (e.g., Puma developed environmental and social impact “P&Ls”, Natura publishes sales force satisfaction and turnover metrics)
SHIFTING TO A LONGER‐TERM MINDSET: INSTITUTIONAL INVESTORS
Focusing Capital on the Long Term | 1515
Several large institutional investors have taken steps towards setting longer horizons for their investments
The Ontario Teachers’ Pension Plan has been a leader in allocating capital to illiquid long‐term assets – today 23% of its portfolio is in real assets (e.g., water utilities, retail and office building)
GIC, Singapore’s sovereign wealth fund maintains a publicly‐stated 20‐year time horizon for value creation, deliberately investing up to a third of its portfolios in companies in volatile emerging Asian markets
Berkshire Hathaway uses the rolling five‐year average performance of the S&P 500 (rather than annual returns) as its benchmark to signal its longer‐term focus (benchmark is less impacted by year‐to‐year volatility)
The Canadian Pension Plan Investment Board is experimenting with innovative ideas to encourage a longer‐term outlook with its investment professionals (e.g., committing capital for 3 years, basing performance‐based payments on long‐term track records, rather than annually)
SHIFTING TO A LONGER‐TERM MINDSET: INSTITUTIONAL INVESTORS
Focusing Capital on the Long Term | 1616
The Equity Engagement Spectrum
Ownership stake in company
<2% 1‐5% >10%Ongoing engagement Active ownership Relationship investing
CalPERS screens its portfolio to identify companies that have underperformed and works with them to improve their strategy and governance
▪ Continuously monitors companies – both reacting to performance and providing ongoing input
▪ May build micro‐coalitions with other investors
▪ Works publicly or privately to persuade the board and management to change long‐term strategy
▪ Tries to build micro‐coalitions with other investors
▪ Works collaboratively with management on long‐term strategy
▪ Often has board seats
SHIFTING TO A LONGER‐TERM MINDSET: INSTITUTIONAL INVESTORS
Focusing Capital on the Long Term | 1717
The role of boards in shifting to a longer‐term mindset
Boards of directors need to …
Spend more time (e.g., directors of public companies devote only 12‐20 days per year to their duties, compared to 54 days for private equity‐owned companies)
Focus more on long‐term strategy (e.g., 75‐80% of directors’ time is spent on fiduciary issues, while only 4% of companies have a long‐term strategy committee)
Have more relevant experience (4 of 5 non‐executive directors of large companies lack industry knowledge)
46%of executives named their board as a significant source of increased pressure to demonstrate short‐term performance
over the past 5 years
SHIFTING TO A LONGER‐TERM MINDSET: CORPORATE BOARDS
Questions?
OCTOBER 17, 2012
To ask a question … click on the “question icon” in the lower-right corner of your screen.
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JULY 1, 2014
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