How short-termism can destroy companies

There is often a time lag between the taking of a decision and its impact, which makes it difficult to identify the cause and the effect.

Corporate decisions are very often taken with short-term outlook and their disastrous consequences are felt years later. Short-termism has crept into corporate decision making because of the way in which corporate ownership structures and management compensation structures have evolved.

Individuals to institutions There used to be a time when corporate ownership vested largely in individual hands (2/3rds) than in institutional hands (1/3rd), perhaps in the ’80s, before the advent and growth of mutual funds. Today, this ratio is reversed, and institutions can, through their equity holding, sway corporate management decisions. And they do.

Institutional investors have a short-term outlook, largely because the pay to the fund manager is linked to short-term performance. So is the pay of top corporate managers.

Consider the impact.

Mylan, a US pharmaceutical company, is under fire from law makers for having sharply increased (400 per cent) the price of EpiPen, an anti-allergy drug, which can sometimes save lives. Earlier this year, it was Valeant’s CEO Martin Shkreli who was similarly under fire. In both cases the management is under pressure from institutional shareholders to boost short-term profits, unmindful of the consequences on the customers who have to pay four times more to get the drug.

Mylan’s 400% price hike The fact that the CEO of Mylan is the daughter of a Congressman, complicates things further. As does the fact that Mylan spent $4 million in 2012-13 lobbying, successfully, to have the government legislate access to the drug in schools.

So, after paying to get legislation changed, the company is hiking prices 400 per cent. Presumably the pay to its CEO is also linked to annual performance.

Lucent’s jugglery Similarly, in the case of Lucent Technologies, short-termism, and accounting legerdemain succeeded in destroying the telecom equipment company, which was a spin-off from AT&T and contained the famous Bell Labs, a font of innovation.

Carly Fiorina led operations in 1995, reporting to Henry Schacht, the Chairman.

Initially, Lucent became the darling of Wall Street, beating analyst expectations with ease, and its stock price going to a peak of $84 in late ’90s. The accounting jugglery was done by lending money to customers (such as Path Net, with $1.8 million in sales, signing to buy $440 million from Lucent) to buy its products, in one case it lent more than 100 per cent!

$65-m bonus for Carly This boosted sales, whilst showing the receivables as being good (they weren’t). Ultimately, the stock went below $1, 1.3 lakh jobs were lost, and the company merged into Alcatel.

Carly herself left to become CEO at HP, taking a $65 million bonus!

(The writer is India Head, EuroMoney Conferences)

COMMENT NOW