Sunday, February 14, 2016

Plea for Long Term Thinking in Business and Finance

Public companies in the US are required by law to report their quarterly earnings.  As a result, they are often under a lot of pressure from investors to maximize earnings and reduce costs on a quarterly basis in a dynamic referred to as "short-termism."  This can often hurt long-term performance for example by laying-off employees to reduce costs.  It also often results in irresponsible environmental or human rights practices.  At the same time it's really difficult to address these issues since they almost certainly require a multi-year commitment.

Larry Fink, the CEO of BlackRock, periodically sends letters to investors and companies imploring both groups to get beyond short-termism.  Last week he sent his latest letter to S&P500 companies.  Fink has been a prominent figure in advocating for good corporate governance, which typically refers to having board members that are not related to each other and subjecting the executive leadership to board oversight.  He says,

Generating sustainable returns over time requires a sharper focus not only on governance, but also on environmental and social factors facing companies today. These issues offer both risks and opportunities, but for too long, companies have not considered them core to their business – even when the world’s political leaders are increasingly focused on them, as demonstrated by the Paris Climate Accord. Over the long-term, environmental, social and governance (ESG) issues – ranging from climate change to diversity to board effectiveness – have real and quantifiable financial impacts.

At companies where ESG issues are handled well, they are often a signal of operational excellence. BlackRock has been undertaking a multi-year effort to integrate ESG considerations into our investment processes, and we expect companies to have strategies to manage these issues. Recent action from the U.S. Department of Labor makes clear that pension fund fiduciaries can include ESG factors in their decision making as well. We recognize that the culture of short-term results is not something that can be solved by CEOs and their boards alone. Investors, the media and public officials all have a role to play. In Washington (and other capitals), long-term is often defined as simply the next election cycle, an attitude that is eroding the economic foundations of our country.

Public officials must adopt policies that will support long-term value creation. Companies, for their part, must recognize that while advocating for more infrastructure or comprehensive tax reform may not bear fruit in the next quarter or two, the absence of effective long-term policies in these areas undermines the economic ecosystem in which companies function – and with it, their chances for long-term growth.

A particularly interesting and bold recommendation was to reform the capital gains tax. policy too often lacks proper incentives for long-term behavior. With capital gains, for example, one year shouldn’t qualify as a long-term holding period. As I wrote last year, we need a capital gains regime that rewards long-term investment – with long-term treatment only after three years, and a decreasing tax rate for each year of ownership beyond that (potentially dropping to zero after 10 years).

*clap clap clap*

Who manages your 401k, and what are their positions on corporate governance, short-termism, and ESG?

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