Ample evidence shows that when executives consistently make decisions and investments with long-term objectives in mind, their companies generate more shareholder value, create more jobs, and contribute more to economic growth than do peer companies that focus on the short term. Data also show that companies can achieve better long-term performance when they address the interests of employees, customers, and other stakeholders. But a survey of approximately 500 global executives conducted by FCLTGlobal and McKinsey shows that many continue to feel pressure from shareholders and directors to meet near-term earnings targets at the expense of long-term strategies.
Corporate long-term behaviors
Kevin Sneader and Sarah Williamson describe insights from their report on long-term value creation.
In one data point, respondents said they believed their companies would cut long-term growth investments by 17 percent, on average, when faced with a 15 percent decrease in revenue—even though the survey specified that the dip resulted from external factors (such as currency fluctuations), would not imperil the company’s existence, and would not persist. Other survey responses were similarly short-term oriented—and not just because of the COVID-19 pandemic or other economic shocks.
We wanted to understand better what differentiates long-term-oriented companies from others. How have they sidestepped the pressures? We reviewed and synthesized our own research and that of others in academia and the business world. We also surveyed executives and analyzed data on management and corporate performance. In the process, we identified five behaviors that managers and boards can take to reorient their organizations toward long-term value creation rather than just short-term performance:
- Invest sufficient capital and talent in large, risky initiatives to achieve a winning position.
- Construct a portfolio of strategic initiatives that deliver returns exceeding the cost of capital.
- Dynamically allocate capital and talent (through divestitures, if need be) to the businesses and initiatives that create the most value.
- Generate value not only for shareholders but also for employees, customers, and other stakeholders.
- Resist the temptation to take actions that boost short-term profits.
Global executives who choose to take these actions can, apart from gaining clear performance advantages for their organizations, resolve much of the perceived conflict between stakeholders’ interests and shareholders’ interests. In fact, the two sets of interests largely converge in the long run. Companies create long-term value for investors only when they satisfy customers, engage and motivate employees, and maintain good relations with communities and regulators across extended time horizons.
Invest sufficient capital and talent in large initiatives
Instead of playing to win, many established businesses play to avoid losing and, as a result, struggle to stay in front of competitors. Long-term-oriented companies identify strategic moves that will keep them ahead in the long run. They also commit ample resources to strategic initiatives, such as product innovation, marketing, sales, and talent development. Amazon and Microsoft are two such companies. During the past 15 years, both have invested large sums in their cloud-computing businesses. In 2020, those businesses generated revenues of around $45 billion and $59 billion, respectively—far more than competitors that put less money and talent into their cloud-computing plays.
Sustained investments in strategic priorities matter for long-term performance because they lead to higher rates of revenue growth, and revenue growth is an important driver of long-term TRS. Our research shows that companies in the top third of their industries in revenue growth generated TRS that exceeded those of their bottom-third peers by six to eight percentage points per year. Those trends held over a ten-year period—the additional gains of top-third companies yielded shareholder returns that were 80 to 110 percent greater than those of the bottom-third companies.
Of course, revenue growth alone won’t deliver shareholder value over the long term. It’s just as critical to deliver strong ROIC.
Construct a portfolio of initiatives whose returns exceed the cost of capital
According to a fundamental principle of corporate finance, companies create long-term shareholder value only when their ROIC exceeds their cost of capital. That seems obvious, yet large numbers of companies around the world still misplace their focus. They should consider reviewing the empirical evidence—among companies with similar growth rates, for instance, those with higher ROIC achieve higher valuation multiples and produce greater shareholder returns over the long term, according to McKinsey research (Exhibit 1).
The objective for long-term-oriented companies, therefore, should be to find the combinations of growth and ROIC that work for them, given the conditions in their industries and the opportunities they face. Consider how two US companies, retail giant Costco and spirits and wine maker Brown-Forman, created substantial long-term value in different ways. From 1996 to 2017, Costco’s after-tax operating profits grew by 11 percent per year, whereas Brown-Forman’s grew by 7 percent per year.
Yet the two companies generated identical shareholder returns of 15 percent a year. Brown-Forman matched Costco on that count because its ROIC of 29 percent exceeded Costco’s 13 percent.
Not every investment a company makes has to earn more than its cost of capital. Large companies can simultaneously make multiple bets—and not just on those initiatives with the highest chances of succeeding. They may make some risky bets with the potential to yield high rewards. If an entire portfolio of strategic initiatives earns more than its aggregate cost of capital, the company can expect to create value over the long term.
Dynamically reallocate capital and talent to high-value initiatives
Managing for the long term requires executives to monitor their companies’ standing in the market and to enter or exit businesses as the competitive landscape shifts—even if it involves shrinking a company. They must also be willing to move
talent and other resources to the highest-value initiatives and to do so frequently.
Consider the situation at Walmart. Leaders at the company chose to commit to a major omnichannel initiative, even as they anticipated that some investors would object to the short-term financial hit from the move despite its potential long-term benefits. Since 2014, the company has invested more than $5 billion per year in its e-commerce and omnichannel capabilities. It dynamically reallocated capital to match its new approach to serving customers by increasing funding for supply-chain improvements, store transformations, and digital initiatives. It also made strategic acquisitions, including Jet.com in the United States and a controlling stake in India’s e-commerce giant Flipkart. The strategy continues to evolve as Walmart adapts to changes in customer needs and the competitive landscape.
McKinsey research shows that companies that rapidly reallocated resources and talent were 2.2 times more likely to outperform their competitors on TRS than were those that reallocated resources and talent at a slower clip. It also reveals that taking swift action in anticipation of long-term trends is better than waiting too long: 43 percent of respondents in a survey on divestitures said they parted with assets too late or didn’t divest them when they should have.
Among the reasons they cited for delay were “waiting for business performance to improve” and “difficulty of replacing lost earnings” (Exhibit 2).
Those who worry that investors will frown on acquisitions and divestitures should take heart: the research shows that the stock market consistently reacts positively to both sales and spin-offs.
Generate value for all stakeholders
Long-term-oriented companies focus on improving outcomes for all their stakeholders, not just those who own shares in the business. They typically rely on environmental, social, and governance (ESG) initiatives to address the needs of a range of stakeholders. In doing so, the research shows, they stand to improve revenue growth, reduce costs, optimize investment decisions, improve employee productivity, and reduce regulatory and legal interventions.
In a 2019 McKinsey survey, 57 percent of respondents said they believed ESG programs create long-term value, and 83 percent said they expected ESG programs to contribute more shareholder value in the long term than they did at that time. Respondents also said they would be willing to pay a 10 percent median premium for a company with a positive ESG record compared with a company with a negative ESG record.
Such responses don’t mean that a company should act on every ESG idea that comes along. Rather, executives should actively search for and invest in initiatives that benefit both stakeholders and shareholders. The executive team at Walmart, for instance, will undertake environmental projects with negligible financial returns if managers agree, after debate, that those projects will yield other significant benefits to stakeholders. Many of Walmart’s other environmental initiatives offer positive net present value, and so, using a portfolio-level approach to managing risks and returns, the company can cover the costs of those that don’t.
When temporary changes in fortune—dips in revenue, for example—occur, moves to boost short-term results can seem very appealing to pressured executives. Such moves seldom turn out well, however. In our survey, respondents who said executives at their companies tried to meet short-term financial targets by taking actions that created no long-term value also said their companies had worse financial outcomes than others did. Respondents said those companies were half as likely as their peers were to realize more organic revenue growth and 27 percent less likely to generate higher levels of ROIC.
In our experience, long-term-oriented companies actively seek to resist three common temptations. The first is to starve long-term growth investments to make up for short-term challenges, such as earnings deviations.
The second is to cut costs to an extent that could weaken the company’s competitive positions. For example, to achieve ambitious earnings targets, a new leader at a retail company cut spending on the frontline sales force by reducing the number of in-store workers and curtailing training programs for those who remained. Over time, customers took notice—and took their business elsewhere. The company’s stock price soon plummeted.
In both cases of temptation, executives would do well to lay out their strategic plans. They can explain to key stakeholders that they aren’t choosing to depart from those plans just to hit short-term targets.
The final temptation is to reduce the natural volatility in revenue and earnings artificially. Many executives believe that “smooth” earnings growth somehow contributes to value creation. But according to our research, plenty of companies with more volatile earnings growth in the short term generate high TRS in the long term, and plenty of low-volatility companies generate low shareholder returns. Indeed, when institutional investors were asked to rate the importance of various factors in their investment decisions, very few prioritized companies’ ability to maintain low earnings volatility. More important to them were management teams’ credibility and willingness to take risks with the long term in mind.
Changing mindsets and behaviors
Getting a company to manage for long-term performance requires considerable effort. CEOs and directors must take up new behaviors, abandon old ones, and empower managers to make decisions with long-term outcomes in mind.
A board of directors ordinarily has a well-established role: thinking about the future of a company, approving its strategy, reviewing its performance, and evaluating management. Few boards spend enough time assessing the strategies and investment plans of the businesses they direct. Yet they can help orient management toward the long term in three ways:
Few boards spend enough time assessing the strategies and investment plans of the businesses they direct, yet they can help orient management toward the long term.
- Ensure that strategic investments are fully funded each year and have the appropriate talent assigned to them. To formalize the practice, boards can ask management teams to report on the funding and progress of strategic initiatives and review that report for signs of effective strategic implementation.
- Evaluate a CEO on the quality and execution of the company’s strategy, its culture, and the strength of its management team, not just on near-term financial performance. Responses to the survey by FCLTGlobal and McKinsey indicated that companies that evaluated executives’ performance primarily based on financial results—rather than on how they achieved those results—were 13 percent less likely to have revenue growth above peers.
- Structure executive compensation over longer time horizons, including the time after executives leave their companies. Adjusting some elements of executive-pay structures, such as the time horizon over which CEOs are compensated, appears to encourage long-term behaviors on the part of CEOs.
CEOs, supported by their top teams, are ultimately responsible for creating a focus on the long term in their companies. They must serve as role models for the rest of their management teams when making big decisions. They can also apply their influence and authority in four ways:
- Ensure that strategic initiatives are funded and staffed properly and protected from short-term-earnings pressure. Our survey found that companies whose CEOs allocated resources to critical growth areas were more likely than their peers to exhibit greater organic revenue growth.
- Adapt management systems to encourage bold risk taking and to counter biased decision making. For example, implementing a company-wide rather than a business-unit-level approach to resource allocation can help managers see that their portfolios can accommodate bets on relatively risky endeavors.
- Actively identify and engage long-term-oriented investors—and have the courage to ignore short-term-focused shareholders and other similarly minded members of the investment community. CEOs should spend more time talking with long-term investors. Such conversations can help reassure executives that a long-term outlook best serves their company and its shareholders.
- Demonstrate the link between financial and nontraditional metrics to prevent short-term trade-offs. To enrich the dialogue with long-term shareholders and other stakeholders, executives can select, track, and report on the nontraditional indicators, such as employee satisfaction, that are most material to their companies’ long-term performance.
Executives undeniably face real pressure to focus on and deliver satisfactory short-term results. However, they must weigh short-term demands against the flood of empirical evidence showing that companies that seek strong long-term results outperform companies that optimize short-term gains. By understanding which management behaviors distinguish successful long-term companies and expressly fostering those behaviors, CEOs and boards can help their companies produce value for stakeholders over the long run.