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21st century economy : Too much short term kills the long term

by Henri de Courtivron

Our economy is currently particularly dull and very few are those who can see any prospect of improvement in the near future. One of the reasons possibly explaining this situation is perhaps an unbalanced mix between all the numerous parameters to be taken into account when preparing a successful recipe for a lasting economic growth, built on dynamic enterprises. It seems indeed that the short term approach is today largely overweighed to the detriment of the long term vision.

Everything straight away

Our way of life privileges the search for the most immediate possible satisfaction: “I want all, immediately”. Just as a child requires that his desires are satisfied at once, the economic elite of our country wants to exert the power as soon as possible, without waiting until the experience learns, with time, how to manage in the long term. How many parachutings of allegedly omniscient but without experience managers have resulted in disasters for the enterprises, with an extremely high social cost? The risk for the pitchforked mercenary is low anyway: a gratifying package if he is successful, an absurdly high compensation in case of failure, plus the re-integration into his administrative body of origin as a life buoy.

This requirement of immediate satisfaction also appears in a particularly insidious way in the role played by the shareholder. The shareholding structure fundamentally changed over the last quarter century, under the triple effect of the generalization of the mutual funds, the development of the pension funds, mainly Anglo-Saxon, and the globalization phenomenon which internationalizes the participations in capital. The typical shareholding used to be traditionally characterized by the stability of the investor, who sought a regular profitability and privileged the placements of « good family father ». Besides, a small minority of speculators ensured the liquidity of the market.

Today the environment is quite different: a majority of investors, who manage on behalf of third parties, are obliged to show the highest possible profitability as quickly as possible. These new investors, who collectively represent the majority in many listed companies, can dictate their law and impose profitability constraints under penalty of changing the executive managers who would not succeed in meeting their requirements for short-term profitability.

The ROE dictatorship

It is there that the frightening measuring instrument intervenes which is the ROE (Return On Equity). The shareholder requires a very high ROE, often about 20%, without any reference neither to the inflation rate, nor to the growth rate of the economy, and everyone pretends to believe that it is possible for a company to create value in a perennial way at a rate eight times higher than the inflation rate or ten times the growth rate.

From there, the disaster scenario is set up. On the one hand, the shareholder requires a maximum ROE and pockets the result in the form of dividends initially, then as a capital gain at the end of two or three years, knowing perfectly that the company will not be able to sustain this rhythm of profitability over the long run. This shareholder will therefore stand together with the company in which he has invested only for the short period of time necessary to generate a maximum return, even if it means that the survival of the company might be endangered. The runner of a marathon who starts the race at a hundred meter race speed is certain not to finish the race. On the other hand, the manager of the company, badgered by the ROE dictatorship, has no choice but to privilege short-term profitability to save his job: he will consequently look for all possible cost savings (specially by laying off jobs), will concentrate on the most profitable activities, even if they are not recurring, will get rid of the least profit making ones, even if they are useful to attract and keep customers and will seek maximum capital gains by disposing of assets, even if they are strategic. He will thus succeed in satisfying his shareholders during two or three years by delivering the required ROE. Finally, the shareholder resells, the manager, after having received substantial bonus, pockets his golden hand-shake and again tries the same adventure elsewhere and the company, bloodless, is cheaply bought over by a wise investor.

In order to occult his lack of experience when arriving and to fall down back on his feet upon his departure, the parachuted manager needs the solidarity of his peers: hence the reciprocal helping hands between members of the same brotherhoods, the boards of directors too incestuous to oppose the outrageous requirements from the ROE dictatorship, the development plans polluted by promises of astounding ROE which only hide the lack of strategic vision, the recruitments at high price of mercenaries who make gleam the miraculous formula to reach the promised ROE.

Too volatile shareholders

The abuse of short term thus clearly contributed to make the shareholder, become the most volatile actor in the life of the company, play a disproportionate role compared to the other actors who are the employees, the managers and the customers. How can one entrust to the shareholder the capacity to decide on the future of a company whereas he has the possibility of withdrawing from the game by not more than a mouse click? The price to be paid for this shortsighted policy is the priority given to the tactics to the detriment of the strategy, the progressive disappearance of any corporate culture, the development of the hiring of mercenaries and the unwillingness to invest in the future through R&D, in a word, the slow and scheduled death of the company.

Let’s decrease the proportion of exclusively short term considerations and let’s support the long-term visions and strategies, and we will see again industrial groups managed by experienced industrialists, qualified managers who will organize a perhaps lower profitability but a more lasting one, more motivated employees who will adhere to genuine corporate projects and less greedy shareholders who will not blow any more in bubbles which always end up bursting.

The United States showed us the harmful consequences of an improper use of the short term and the recent financial scandals are there for us to remember. Strong of these lessons, “old” Europe has today a great opportunity to give up its usual follower attitude to invent a new approach to management and to find a right balance between the short-term considerations and the long-term objectives. Let’s hope that Europe will be able to take advantage of its perspicacity and its economic weight to open the way in leading the change.

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