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How short-term thinking causes whirlpool effect KEN SYMON ON GUIDANCE OBSESSION
(The Sunday Herald Via Thomson Dialog NewsEdge) THEY amount to nothing more than "accounting games" or "operating acrobatics" in the view of Warren Buffett, the "sage of Omaha", who knows more about building company value than most people on the planet.
Most business leaders who are quizzed about them want rid of them and yet nobody actually ever seems to do anything to end the practice.Yet all that may now be about to change.
I am talking about the quarterly earnings guidance that major companies issue. These are effectively selfimposed targets which, critics argue, lead to short-termism, rather than executives and boards focusing on building the longer-term value of the business.
A significant report issued last week may just be the start of a move away from the guidance "obsession".
It came from the Business Roundtable Institute for Corporate Ethics (Brice) - an organisation made up of 160 American chief executives - and the CFA Institute.
As Dean Krehmeyer, executive director of Brice and one of the authors of the report published last week said: "The obsession with short-term performance does not create value for shareholders and in many cases destroys value."
In other words, business leaders are so busy concentrating on making the short-term targets that they lose sight of building the business for the longer term for all concerned.
But even more basic than that is the question of how much value there actually is in quarterly earnings figures. Are they really worth the paper they are written on or even the chips they are coded on?
As Bob Garratt, a corporate governance expert wrote in his excellent book The Fish Rots From The Head:
"Among its worst excesses is the notion that the CEO and CFO must sign off their quarterly results as true and accurate - does anyone know of an accounting system that can deliver true and accurate quarterly accounts? If so you will make a fortune."
So - whisper it softly - what happens is that there is a lot of casting around within the business on the right number to give and sometimes what is arrived at is really nothing more than a guess-timate.
But once the number is out there and public then it is set in stone.
As Steve Odland, chief executive of the retailer Office Depot and head of the Business Roundtable corporate governance taskforce put it: "Once a company puts a number out there, everybody within the business is focused on hitting the guidance rather than doing what is best for the company."
Companies should forget the short-term and make the decisions and take the actions that will see the long-term growth of the business:
real growth rather than a bit of a fudge and a gentle fiddle to make the quarterly numbers.
More companies are beginning to see the sense of this. Part of this is down to Warren Buffett's influence.
Companies in which his Berkshire Hathaway company invests, which includes Coca-Cola, Gillette and The Washington Post, dropped their quarterly figures. More recently, Intel, McDonald's, Motorola and Pfizer announced their intention to do the same.
Hopefully it will not stop there and others will begin to see the wisdom of this and follow the recommendations of the Business Roundtable report.
It calls for the earnings guidance to be replaced by more qualitative communication outlining the business's operations and what it is seeking to do and in what direction it is attempting to move.
A move away from short-termism should not stop there. As the report points out: "Recently the directors of Coca-Cola addressed share-owner concerns about short-termism in a unique manner.
"The board adopted an 'all-ornothing' compensation in which all directors' pay consists entirely of equity-based share units payable only when longer-term company performance targets are met. The initial performance period is three years."
As Coca-Cola chairman and chief executive officer Neville Isdell said when the move was announced in April: "This all-or-nothing approach to board compensation aligns the interest of our directors with those of share owners more closely than any other compensation formula I have seen."
It will be interesting to see how many businesses will conclude that things will go better if they follow the example of Coca-Cola in this respect.
That kind of scheme would really make a difference in aligning board directors' rewards with the long-term growth of the business.
Business history is littered with the corporate corpses of those who took the totally opposite approach and became hooked on the need to "hit the guidance" quarter by quarter by any means necessary.
Most prominent of these was Enron. The recent court case heard a lot of testimony about how much pressure was on key company employees to "make the quarter".
As the "growth" continued at Enron quarter after quarter, so did the pressure to continue this amazing "winning" record. The temptations proved too great and soon profits were being booked on new business streams that were hardly launched.
Clearly, it is best for businesses not to step on to that particular carousel.
The danger is the momentum forms a "whirlpool effect" that drags businesses under.
So, build for the long-term and communicate with your investors in a way that they can increasingly understand the business and where it's going, on its general forward momentum, and not on spectral quarterly figures that may lack substance.
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