‘Capitalism for the Long Term’ by Dominic Barton, Harvard Business Review

The author is MD of McKinsey’s global operation and the article has to be seen in this context. The essential thrust of the article is that, following the trauma of the global recession, companies cannot go back to business as usual, and this is not just about the banks. The argument is that there has been a general failure of governance, leadership and decision making and, based on several surveys, a loss of trust from the public. I am not sure that CEOs in all sectors would agree but I guess it is in McKinsey’s interests to make us believe it and allow them to provide the cure.

The answer according to the author is to move companies away from their short term orientation and serve the interests of all stakeholders and not just those shareholders who are looking for short term return. And to do this they need a board of directors that should govern the companies as if they were the long term owners; the problem as seen by McKinsey is that the ownership of the company has become dispersed and disengaged, so that management have been able to get away with managing in their own interests. The article fails to quote the obvious reason why shareholders of a public company fail to act like other owners – they can sell their shares any time they want to.

The author sees this as a key difference between business in East and West and a factor in the East’s competitive advantage; CEOs in Asia think much longer term, partly because they have greater security of tenure when short term results are adverse. They can therefore take the difficult decisions and make the long term investments that are constrained by the short term focus on quarterly profitability.

Though this makes sense, it is not exactly new thinking and there are already examples of top western companies breaking out of the cycle of short term profits, for example Unilever, Coca Cola and Ford have stopped issuing short term guidance. There is also some similarity between this thinking and the recent articles by Michael Porter, advocating ‘shared value’ between stakeholders and a longer term approach to running businesses. But I guess that McKinsey would not want to credit their thinking to a mere academic!

Where this article does improve on Porter’s ideas – see January Blog – is that there are some interesting suggestions for delivering the longer term approach. The author rightly points to the increasing trend towards short term shareholdings as ‘Hyperspeed’ traders move in and out of equities on a daily basis; apparently the average holding period is now seven months rather than seven years in the 1970s. His interesting suggestion is that the voting rights should be greater for those with longer ownership periods. There is also a suggestion that CEO compensation should be more oriented towards long term performance

Even more important is for boards of directors to ‘act like they own the place’, in particular to make sure that they understand the business and know what is going on; far too many are there because of who they are and whom they know, rather than for being able to challenge the CEO with the right questions. To achieve this aim the non-executive directors need to devote more time to the role and acquire more industry knowledge so that they can have independent and informed views on the strategy and the risks involved.

Whilst it is hard to disagree with many of the sentiments in the article, there is the same problem as the British Government trying to curb the excesses of bank practices and remuneration. There has to be some incentive for companies to make these changes and many CEOs who are less confident than Coca Cola, Ford and Unilever, might feel like turkeys voting for Christmas. And it is only when the shareholders, and the analysts who advise them, take the same view, that such long term thinking will really become embedded.

Click here to read the article in full:
http://hbr.org/2011/03/capitalism-for-the-long-term/ar/1