The Idea in Brief
Many firms sacrifice sustained growth for short-term financial gain. For example, a whopping 80% of executives would intentionally limit critical R&D spending just to meet quarterly earnings benchmarks. Result? They miss opportunities to create enduring value for their companies and their shareholders.
How to cultivate the future growth your firm needs to succeed? Rappaport identifies 10 powerful practices. First among them: Don’t get sucked into the short-term earnings-expectation game—it only tempts you to forgo value-creating investments to report rosy earnings now. Another practice: Ensure that executives bear the same risks of ownership that shareholders do—by requiring them to own stock in the firm. At eBay, for example, executives have to own company shares equivalent to three times their annual base salary. eBay’s rationale? When executives have significant skin in the game, they tend to make decisions with long-term value in mind.
The Idea in Practice
Rappaport recommends these additional practices to create long-term growth for your company:
- Make strategic decisions that maximize expected future value—even at the expense of lower near-term earnings. In comparing strategic options, ask: Which operating units’ potential to create long-term growth warrants additional capital investments? Which have limited potential and therefore should be restructured or divested? What mix of investments across operating units should produce the most long-term value?
- Carry assets only if they maximize the long-term value of your firm. Focus on activities that contribute most to long-term value, such as research and strategic hiring. Outsource lower value activities such as manufacturing. Consider Dell Computer’s well-chronicled direct-to-consumer custom PC assembly business model. Dell invests extensively in marketing and telephone sales while minimizing its investments in distribution, manufacturing, and inventory-carrying facilities.
- Return excess cash to shareholders when there are no value-creating opportunities in which to invest. Disburse excess cash reserves to shareholders through dividends and share buybacks. You’ll give shareholders a chance to earn better returns elsewhere—and prevent management from using the cash to make misguided value-destroying investments.
- Reward senior executives for delivering superior long-term returns. Standard stock options diminish long-term motivation, since many executives cash out early. Instead, use . These options reward executives only if shares outperform a stock index of the company’s peers, not simply because the market as a whole is rising.
- Reward operating-unit executives for adding superior multiyear value. Instead of linking bonuses to budgets (a practice that induces managers to lowball performance possibilities), develop metrics that capture the shareholder value created by the operating unit. And extend the performance evaluation period to at least a rolling three-year cycle.
- Reward middle managers and frontline employees for delivering superior performance on key value drivers they influence directly. Focus on three to five leading value-based metrics, such as time to market for new product launches, employee turnover, customer retention, and timely opening of new stores.
- Provide investors with value-relevant information. Counter short-term earnings obsession and investor uncertainty by improving the form and content of financial reports. Prepare a corporate performance statement that allows analysts and shareholders to readily understand the key performance indicators that drive your company’s long-term value.
It’s become fashionable to blame the pursuit of shareholder value for the ills besetting corporate America: managers and investors obsessed with next quarter’s results, failure to invest in long-term growth, and even the accounting scandals that have grabbed headlines. When executives destroy the value they are supposed to be creating, they almost always claim that stock market pressure made them do it.