Investor short-termism can have negative effects. Our panel looked for some solutions.
‘Short-termism’ among some investors can have negative effects such as under-investment and even, potentially, fraud. The reasons behind the problem, and how to address them, were the subject of a panel discussion chaired by KPMG at the ICGN Annual Conference in Kuala Lumpur, Malaysia, in July.
As Mun Kong Foong, chair of the discussion and Head of Audit at KPMG in Malaysia, observed, short-termism is partly driven by the reporting requirements placed on public companies such as quarterly reporting and results forecasts.
Amy Borrus, Deputy Director at the Council of Institutional Investors (CII) in the US, echoed this, saying that there was concern among institutional investors in the US and Canada about quarterly earnings forecasts and a view that “companies should not feel obligated to issue earnings guidance”.
Indeed, for Blair Cowper-Smith, Chief Corporate Affairs Officer at Ontario Municipal Employees Retirement System (OMERS) in Canada, short-termism is a “major problem” for long-term institutional investors such as pension funds. “It drives institutional investors to actually focus more on the private market … When we invest in the private markets, we get almost perfect information … As a fiduciary and an investor, that reduces risk very materially.”
So how can a longer-term view be effectively encouraged among investors? Amy Borrus made the point that you need directors at companies who take a longer-term view themselves, people who “keep their eyes on the horizon, rather than around the corner”.
An important element is better engagement between companies and their investors. Yoshikazu Maeda, Head of Responsible Investment at Governance for Investors in Japan, said that encouraging better engagement is “an important activity to fill the gap between what companies really are and what’s in their corporate reporting”.
That said, there was a consensus that corporate reporting is itself a key piece in the puzzle, and this was extensively discussed. As Mark Vaessen, Partner, KPMG in the Netherlands and Project Lead for the Value of Audit, pointed out, reporting is about much more than just the financials, which, on their own, “don’t provide the full picture”. Future value drivers are currently not always reported on, at least not comprehensively or consistently.
Blair Cowper-Smith agreed, saying that there was a need for “more very good non-financial reporting to marry to our financial reporting. That has to be integrated. It has to tell a full story … There is a tsunami of consensus that non-financial reporting information is critical.”
Amy Borrus noted that a group of institutional investors in the US had recently called on the SEC for a rule-making to “standardize” disclosures around such areas as human capital management policies, practices and performance. “This is information that some companies are disclosing but not in an organized way,” she said. “Companies can disclose information, but if it’s not comparable, if it’s not standardized, it’s very hard to process.”
Citing a KPMG report – Room for Improvement – that considered ways of improving disclosure, Blair Cowper-Smith called for more “structured disclosure” that standard setters, regulators and policy makers need to be involved in shaping. Indeed, Mark Vaessen warned that there is an urgent need for a global body “to take the lead and start coordinating the various reporting initiatives and requirements with respect to non-financial information”.
Speakers in the video: Yoshikazu Maeda, Head of Responsible Investment, Governance for Owners; Amy Borrus, Deputy Director, Council of Institutional Investors; Blair Cowper-Smith, Chief Corporate Affairs Officer, Ontario Municipal Employees Retirement System (OMERS); Mark Vaessen. Partner, KPMG in the Netherlands and Project Lead, Value of Audit.
But there is also the problem that companies’ natural inclination is often to be to say as little as possible. Yoshikazu Maeda noted companies “are reluctant to disclose more information, because of the fear that they are releasing their competitive edge.” At the same time, regulatory reform efforts have been to reduce the reporting burden for companies. “The current balance is too skewed towards promoting short-termism,” he said.
Blair Cowper-Smith said a perceived litigation risk leads to “a great resistance to talking about things that aren’t clearly establishable or evidentially provable … and a great reluctance to talk at all”, and added: “We have to somehow unscramble that mess. Change is required.”
A number of possible solutions were put forward to ease the problem. Yoshikazu Maeda said that investors need to be given more insight into the corporate culture and vision of the company rather than just strategy, as strategy can change. He also said that the CEO should set out his/her vision for the organization for the next 5-10 years.
Blair Cowper-Smith suggested that companies should have to set out their answers to a number of standard questions so as to achieve “more specificity” about strategy.
In addition to companies being more transparent in their reporting, another area that received plenty of attention was expanded auditor reports. These have been used in the UK and Netherlands for several years now and are rapidly becoming the global norm, including in Malaysia where they were introduced in 2016.
Speakers in the video: Pru Bennett, Head of Investment Stewardship APAC, BlackRock; Amy Borrus, Deputy Director, Council of Institutional Investors; Roger Tay, Head of Audit, KPMG in Singapore; Mark Vaessen. Partner, KPMG in the Netherlands and Project Lead, Value of Audit.
As Amy Borrus said: “There is a strong indication, based on the experience in the UK of more fulsome auditor reports, that they provide more information that will help investors have a better understanding of the company.”
Mark Vaessen of KPMG said that these reports had “opened up the black box of what we do as auditors” and crucially given investors “a hook for further communication with management”. They have also triggered more discussion with audit committees, who have an important role of their own to play in overseeing the quality of corporate reporting.
In some countries, Mark noted, the enhanced auditor reports were introduced in combination with a requirement for audit committees to prepare their reporting. As Mun Kong Foong observed: “Auditors can’t be the only ones talking about the risks of the company and the judgment areas. There must be similar disclosures in the annual report or audit committee report.” There could also be a role for auditors to provide more assurance over non-financial metrics, he said.
In the final analysis, short-termism is created because of “investors’ expectations of immediate returns”, said Mun Kong Foong.
There may be no quick fixes, but the signs are that a number of approaches are being developed that could help to ease the problem.