CEO Leading for the long term PART II
Simon London: Maybe they are momentum metrics. You have to deliver on the earnings per share, in the current quarter, or the current year. But the emphasis placed on market share by Ivan Seidenberg [former CEO of Verizon] seemed to say, “OK, we’re delivering today, but you also have to look at the momentum—are we winning in the market?”
Or Sir George Buckley, with the new product vitality index, I think he called it. How much of our revenue is coming from products that are less than five years old? That’s the momentum of the business.
Mike Useem: Simon, this issue of momentum is really important in looking at the long run, say, three to five years out. We know we want to get there, but we do need interim measures, or interim signs, that we’re going in the right direction. Call that momentum.
Rodney Zemmel: This is particularly true when making the right long-term move might make you go backward in some areas in the short term. To be able to justify that, I think you had better have your longer-term markers ready to be able to make the countervailing story.
Maybe it ties back to your earlier question around: Is the market to blame, and how much should CEOs listen to the market when they’re making these moves? I think what we’d say—and I’d be interested to see if you agree with this, Mike—is that CEOs should not overly listen to the market in the short term.
If you believe 75 percent of your stock is held by long-term investors, that still means there’s a lot of stock held by short-term investors who can create a lot of movement in the short term. But if what you’re doing is the right thing, then the long term will win out overall. So it is about being courageous and, in some cases, being patient.
Mike Useem: For the book, we did sit down and talk with the chief executive at Vanguard and the chief executive of BlackRock.
Both of them, and others in that investment world who preside over trillions of dollars of assets, much of it indexed or much of it very permanently invested, all said, “Look, we’re in this business together. We’re here for the long run. We’re indexed.” Chief executives should remind themselves that the Vanguards, the BlackRocks, and the State Streets are natural allies in helping you think four or five years out.
Simon London: Yes, because by definition, the [index funds] can’t sell. In fact, there’s a lovely quote in the book: “We may be passive investors but that doesn’t mean that we’re passive owners.”
Rodney Zemmel: Yes. There’s a very interesting debate around the effect that passive funds are having on long-term focus. There’s one school of thought that says, “Look, because the passive funds are, by definition, passive, share of voice in the market is going to go more and more to asset managers who are moving money actively, which is going to create more short-termism.”
The other school of thought says, “Actually, this is a real opportunity for the passive funds.” If you go back into recent history, you’d say passive funds had three choices for how they could differentiate [in the asset-management sector]. They could differentiate either on their fee structure, they could differentiate on their service offering, or they could differentiate by being better stewards of your assets.
You could argue that the basis of competition on the first two of those, price and service, is so narrow now, that competition really becomes about being a better steward of your assets. I think this is why you see so many of index funds, or at least the big three index firms, focusing more and more on stewardship and governance.
Mike Useem: The flip side of that is that if three-quarters of the shares out there are held by the long-term investors, if you’re a top executive, a chief financial officer, and a director of investor relations, why not go and actually meet with them? Build a relationship with them?
That gets us then to a chapter we wrote on the power of the board to help as well. We reference, in particular, a person named Maggie Wilderotter who, serving on the Hewlett Packard Enterprise board said, “Thinking strategically about the world we’re in, we may end up with an activist investor or two, and we’ve got to be prepared to work with that kind of an investor if they do come along.”
Maggie Wilderotter pressed the company to become more savvy about looking at itself as an activist investor would. And then maybe to make a few changes to help solve problems before they are brought to their attention by an activist. I think the board of directors has a particular role to play in working with top management with the equity market.
Simon London: What’s your take on the role of the board, Rodney?
Rodney Zemmel: We have the view, and our interviewees had the view, whether it was the chief executives or the board directors, that there’s a greater role for the board to play than they commonly do. In particular, and this may sound trite, the board has to really understand how the company makes money.
A surprising number of CEOs will say, “Not everybody on the board really understands how the company makes money now and how the company will make money in the future.” If that basic understanding isn’t there, it’s pretty hard to have a meaningful conversation about the long term.
If that basic is there, then the board really can play a role in shaping the direction around long-term strategy. Most boards will say they don’t want to be presented with a fully baked answer on this topic, they want to be part of the discussion. It is one of the places a board can add value.
But it needs to be a real conversation that has with it both the performance and the health metrics. You end up laying out a road map that includes a set of markers against which you can then measure the quarterly conversations that you’re inevitably going to have to have.
Almost all boards, if you ask them what they’d like to spend more time on, this is almost always at or near the top of the list. By the way, if you ask chief executives what they would like to spend more time on with their boards, this is also usually at or near the top of the list. There aren’t many topics where the boards and the CEOs would both like to spend more time.
Simon London: The obvious question is why isn’t it happening?
Rodney Zemmel: First of all, I think it is the pressures of the day to day. It is quite hard for board chairs and lead directors to be able to say, “Look, let’s timebox the discussion on the day-to-day matters, and let’s make sure we’ve got an agenda that really is driven by the long term rather than by the short term.”
Second of all, boards may simply just need to spend more time. We did an analysis of time spent by board members of public companies versus private companies. What we found is the public company boards are, on average, bigger and, on average, spend less time—in fact, it was half the time that some private boards spend.
The reality is these are difficult topics that are hard to get through if you’re going to spend three or four hours a year on them. It may just require board directors just to be able to dig in a little deeper with management, to be able to add value on these topics.
Simon London: Is there something boards should be doing around CEO compensation?
Mike Useem: It’s a really important issue in that sometimes we are what we eat, or we do what we’re paid to do. If compensation is primarily leveraged around this year’s performance, predictably, there’s going to be a lot of focus on this year. Having said that, and having looked at data going back to the early ’80s on the compensation of the top eight people of 40 of America’s largest industrial firms, there has been a remarkable sea change in how individuals are paid at the top.
There’s a movement away from fixed compensation. That’s good. Much more variable. That’s good. The variability depends on the performance, especially total shareholder return to the company. But most important, two-thirds of the compensation now for the top eight people depends on multiyear, essentially stock-based compensation.
Some of that is two-year, some of that is three-year. I will say that’s not a terribly long run, but it’s unequivocally twice or three times longer than one year! In some compensation plans now stock options vest after five years, actually. So boards are, increasingly, putting that long-term plan, or that long-term thinking, into actually how executives are paid.
Rodney Zemmel: I think that’s very well said, Mike. It’s clear there isn’t a silver bullet. I think everybody would agree that EPS [earnings per share] metrics alone are bad metrics [on which to base executive compensation] because they’re eminently gameable. But almost nobody still does that. It’s probably just as clear that a five-year long-term metric alone is also a bad metric.
Mike Useem: Totally.
Rodney Zemmel: And it’s going to require an intelligent conversation and a real understanding of the company’s context, and of what time frame actually makes sense, for the company to be able to get to a good answer.
Simon London: What does all this mean for private companies? We focused very much here on publicly listed companies.
Rodney Zemmel: That’s a good question. So much of the economy now is owned by private-equity owners. It’s easy to stereotype private equity as being short-term owners. They might only hold a company for three years, five years, maybe seven years at the outside for most of them. However, we have a couple of observations. First of all, even the shorter of those time periods is longer than the average holding period of public-market stocks.
In addition, as any private-equity leader will tell you, if you’re owning a company, intending to own it for five years, you’re going to sell it to someone who also will intend to own it for at least five years. So you have to have at least a ten-year plan for that company. Being able to have a ten-year plan, plus or minus, away from the pressures of the public markets with quarterly reporting, can be a very beneficial thing. Now, does that mean all private-equity companies automatically act with the best long-term interests in mind? No, of course it doesn’t. But I think it also means it’s grossly unfair to characterize private equity as a more short-term form of ownership.
Simon London: That raises the bigger point about ownership structure. Who owns the equity, the attitude that they bring to the table, and how you, as a management team, engage with them can be a form of competitive advantage. This can be true even for public companies right? Courting long-term owners. Really getting under the hood with them so that you understand jointly the strategy. Investor relations isn’t something that is passive, answering questions from equity analysts and that kind of thing. Or it doesn’t need to be that.
Mike Useem: On investor relations, we’ve witnessed, without quite appreciating it, a quiet revolution on how that particular function has morphed from giving information to the equity market when questions are asked to a much more proactive and quote unquote, “strategically driven agenda.”
The typical investor-relations director will report to the chief financial officer. But the director of investor relations is also in touch with all kinds of parts of the firm, with the top talent people, often very actively working with the nonexecutive directors as well, to not just be a source of questions that come from the market but also take a role in helping the company work with the market to the company’s advantage.
On a prior project, I was involved in talking with directors of investor relations and chief financial officers. They often would talk about how vital it is to bring in investors that fit their profile for the kind of strategy they’re pursuing. What’s happened in recent years, at many of the larger firms, is that that investor-relations job has been professionalized and disciplined around what we’re talking about.
Rodney Zemmel: We can have a long debate as to what extent companies really are able to choose their investors. Of course they can’t in a technical sense, but there are three things they can do that we think have a very significant influence on the investors they end up with.
First of all, arguably the most important decision is which investors to spend time with. Are you spending your time with people who are the long-termers and who are the fundamental owners versus the short-termers?
Are you spending your time with people who you feel have a reason and an interest in understanding your stock and understanding your story versus the people who are more the in and out? Even more specifically, are you spending your time on the buy side versus the sell side? The sell side, of course, will always want to meet you and will always want to be able to write a story. But the value of time spent with them versus time spent with the buy side has to be weighted very carefully.
Simon London: And the buy side is the owning institutions, right?
Rodney Zemmel: Yes.
Simon London: As opposed to the intermediaries, the investment banks, and so on.
Rodney Zemmel: Yes—the analysts who are writing research reports and so on. The second choice is then what you choose to talk about. You have to talk about performance and you have to give financial information. But how much do you choose to talk about strategy and direction?
When you read investor presentations from different companies there is a huge variation in the extent to which they talk about the long-term strategy in a specific way, rather than just one general introduction slide.
Then the third choice is what you do on guidance. Certainly there are many chief executives or chief financial officers who would like to wave a magic wand and make the obligation to give guidance go away. I don’t think we see that happening wholesale. But we would probably say the company shouldn’t be giving quarterly guidance. They need to give quarterly results, but quarter-to-quarter guidance may well be a step too far, in terms of creating a straitjacket for yourself on short-term focus.
Mike Useem: To anchor this in some of the accounts we offered up in the book, Paul Polman, CEO at Unilever, when he embarked on the remake of the company along the lines we earlier described, one thing he pretty quickly decided to do was to stop offering quarterly guidance.
Simon London: I think that’s all we have time for today. Thank you very much, Mike Useem and Rodney Zemmel, for being with us. And thanks to you, our listeners. If you want to buy the book Go Long: Why Long-Term Thinking is Your Best Short-Term Strategy, look for it in all the places that you buy your books.