Shareholder Value: Time for a Longer View?

Experts—among them Jack Welch—are expressing reservations about the long-popular practice of managing for the short term. Are they getting through?

By David Bogoslaw

The idea for "Shareholder Value: Time for a Longer View?" came from BusinessWeek.com reader Kurt Nybroe-Nielsen, owner and managing director of NewBridge-Invest. He lives in Marbella, Spain.

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A wholesale reassessment of values is occurring in the business community, fueled by the financial crisis and widespread anger at both Wall Street and the billions taxpayers have been forced to contribute in bailouts. One part of this review is the notion of shareholder value, and the principles by which companies are managed. For years, many investors and companies calculated the reward of ownership on brief periods, often no longer than three months. The value of an enterprise was frequently seen solely through its stock price.

Jack Welch, the former boss of General Electric (GE), brought this discussion to the fore in a newspaper interview published Mar. 12. Welch (who is also a BusinessWeek columnist) called maximizing shareholder value "a dumb idea" when used as a business strategy. Instead, he argued, this value is merely an outcome of sound practices geared toward long-term growth. During Welch's two-decade-tenure as GE's chairman and CEO, the conglomerate's consistent meeting or beating of quarterly earnings targets helped to drive Corporate America's focus on short-term profits and the stock price. "[Y]ou would never tell your employees, 'Shareholder value is our strategy,'" Welch said in an online Q&A. "That's not a strategy that helps you know what to do when you come to work every day."

What "Short-Termism" Has Brought Us

Even before Welch reiterated this point, there had long been awareness of the problem of public companies focused on short-term profitability to the detriment of sustainable growth over time. A paper by John Graham and Campbell Harvey of Duke University and Shiva Rajgopal of the University of Washington, published in December 2005 in the Journal of Accounting and Economics, found that 78% of more than 400 executives interviewed admitted that they had sought to smooth earnings between quarters at the expense of long-term value.

In June 2007, the Aspen Institute published a list of principles aimed at shifting the focus for companies and institutional investors from short term to long term when measuring value creation. The principles were developed in cooperation with the Business Roundtable Institute for Corporate Ethics, investor groups such as the California Public Employees' Retirement System (CalPERS), and the Center for Audit Quality. They advocated industry best practices to develop forward-looking strategic metrics and suggested companies improve the way they communicate their business strategies to investors to avoid offering—or responding to—quarterly profit estimates. Companies such as Google (GOOG) do not provide revenue or earnings guidance, while others such as GE, Coca-Cola (KO), and McDonald's (MCD) no longer target quarterly per-share income for investors. The principles also proposed ways to improve performance-based executive compensation plans.

"Now is a very good time to think about what the focus on short-termism has brought us, and what it's brought us is killing the goose that lays the golden eggs … the kind of market that produces sustainable growth," says Nell Minow, editor and co-founder of the Corporate Library, an independent research firm that analyzes corporate governance issues.