The dangers of short-term corporate thinking have become something of a cause célèbre of late. In the U.S. presidential race, Hillary Clinton has proposed tax reforms to curb what she calls “quarterly capital,” the focus by public companies and investors on rapid returns instead of long-term profitability and economic growth.

Such concerns aren’t restricted to politicians seeking to channel voters’ economic insecurities. “Short-term behaviour destroys value,” says Poul Winslow, head of thematic investment and external portfolio management at the Canada Pension Plan Investment Board. Corporations focused on smoothing quarterly earnings and meeting the expectations of the market may fail to make the far-sighted decisions and investments necessary for sustainable growth. That may be fine for hedge fund managers or day traders who flip stocks early and often, but it’s less positive for investors building a portfolio to retire on.

Read: CPPIB’s fiscal report reflects long-term challenges for pension funds

This drive for longer-term corporate vision has found its champions in two Canadians: CPPIB’s chief executive officer Mark Wiseman and McKinsey & Co. managing director Dominic Barton. In 2013 they led the creation of Focusing Capital on the Long Term, a coalition of institutional investors and corporations. (Clinton’s particular turn of phrase echoes a 2011 Harvard Business Review article in which Barton called for a new kind of future-oriented capitalism.)

The discussions that came out of that project guided Standard & Poor’s in creating the S&P Long-Term Value Creation Global Index (LTVC), launched in January. Constituent companies are chosen based on their score on two sets of measures: a quantitative assessment consisting of their return on equity, balance sheet accruals ratio and financial leverage ratio; and a qualitative score derived from management’s responses to a survey about such topics as corporate governance, risk and crisis management, customer relationships and tax strategies.

Of the 246 companies on the index, 12 are Canadian, including Royal Bank of Canada, Canadian National Railway and Telus Corp. Back-tested, the LTVC produced a 10-year annual return of 7.7 per cent, a healthy premium over the 4.9 percent the S&P Global 1200 returned over the same period.

Read: Management vs. shareholders and long-term value creation

As an active owner of both public and private companies, CPPIB already lives its long-term investment philosophy, notes Winslow. What the LTVC does is provide a passive alternative for the benefit of other market participants, though CPPIB and its institutional cohorts have committed an initial US$2 billion to it. Retail investors may soon be able to follow; Winslow says asset managers have expressed interest in offering exchange-traded funds that track the LTVC.

Being favoured by both groups of investors might lower the cost of capital for index constituents, giving corporate leaders the incentive to try to meet its criteria. “So you’re both supporting the case of an investment belief — that these corporations will do better than the market, because they are long-term focused — and you’re also creating a new trend that would support corporations in general to think more long term,” says Winslow.

Still, a stock index is not about to eradicate a quarterly focus that market watchers have noted as far back as the 1970s. Out of earshot and off the record, company managers are apt to blame shareholders for driving them to respond to immediate concerns.

Read: Investors urged to consider mid-size private companies

But Maria Loumioti, assistant professor of accounting at the University of California and co-author of two studies on the subject, says that’s not strictly true. Investors tend to have either a long- or short-term orientation, and executives use their public statements to influence which kind invest in their companies. Moreover, the firms that make a short-term decision one quarter are likely to do so repeatedly. “Short-termism is something embedded in a company’s culture,” Loumioti says. Financial performance does make a difference, of course — companies facing a cash crunch can’t afford to focus too much on the future.

If you don’t have time to analyze the transcripts of conference calls, as Loumioti does, there are other signs to watch for that point to a short-term focus. Firms that are so inclined often create abnormal accruals to just meet or beat analyst forecasts, or avoid reporting losses. They also engage in earnings management, cutting expenditures like research and development and advertising to meet immediate goals. Excessive use of leverage, especially for the purpose of share buybacks, is another symptom. A short-term focus has also been linked to the heavy use of stock options in executive compensation and a high number of analysts following the company.

Read: Weak loonie triggers jump in pension plans’ risk appetites

There are voices, notably Financial Post columnist Terence Corcoran, that argue short-termism is neither as widespread as claimed nor antithetical to the growth of companies and the economy in general. And it should be noted that the pension funds backing the LTVC have different imperatives than the average investor. “You probably do see a longer time horizon in the institutional world,” says Wayne Kozun, head of public equities at the Ontario Teachers Pension Plan, another LTVC supporter. “We have young teachers who have just started working in Ontario who are going to be collecting a pension 80 or 90 years from now.”

Further, some chief executive officers could use their supposed long-termism as cover for wasted resources or inefficiencies. If so, it’s a rare occurrence. Loumioti’s research found that companies whose communication suggested a long-term focus collectively outperformed their benchmarks, while those that were deemed short-term-oriented had more volatile stocks and faced a higher than average cost of capital.

Read: Despite challenges, Teachers’ 2015 return climbs

Whether or not far-sighted companies ultimately generate higher returns, retail investors have one important reason to buy and hold them. “Transaction costs will probably be a big drain on people’s portfolios over time,” says Kozun. “Transaction costs have gone down, [but] if you’re trading a lot, that will still add up.” Long holding periods also cut down on repeated capital gains and income tax expenditures.

The lure of making a quick buck remains strong. Turn on the TV, and you’re more likely to see breathless coverage of a stock that’s up or down 10 per cent today than of a company’s 20-year plan, observes Kozun. But suppress your instinct to buy or sell based on the latest statement. Focus on long-term holdings, and you’ll do better in the long run.

This article was originally published in Benefits Canada’s sister publication, Canadian Business.

Copyright © 2019 Transcontinental Media G.P. Originally published on benefitscanada.com

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