In the world of business, there are companies that wisely chart a course to long-term success, and others that implode under a series of bad decisions. While the factors that separate the failures from the fortunate are plentiful, one sign of impending doom is short-term thinking by the management that seeks immediate gains at the expense of the long-term health of the company. And according to Douglas Chia, a corporate lawyer and compliance expert, the entire corporate world is set up to reward the kind of self-destructive decisions that lead businesses into the abyss — and it’s getting worse all the time.
Chia is the executive director of the Conference Board, a nonprofit group that promotes good corporate governance. He will speak out against what he calls “short termism” at a meeting of the Princeton Chamber of Commerce on Thursday, November 3, from 11:30 a.m. to 1:30 p.m. at the Princeton Marriott. Tickets are $70, $50 for nonmembers. For more information, visit www.princetonchamber.org or call 609-924-1776.
According to Chia, and other experts like Harvard business professor Lynn Stout, the culprit in short-term thinking is the philosophy of shareholder primacy. The dominant philosophy in corporate governance is that management is primarily responsible for increasing the value of the company for shareholders. “The investment community has essentially won the argument to convince people that the shareholder comes first, and that the company should not take action that does not directly benefit the shareholders,” Chia says.
The argument has been persuasive ever since economist Milton Friedman first proposed it in the 1970s. Changes in investing have made it take hold more strongly over the last few decades, Chia says. “There’s been a huge shift over time in ownership of public companies, from retail shareholders, who are individuals making investments in individual stocks, to individual investors going through mutual funds and index funds, ETFs, and money managers. So the decision making around this has moved towards the institutional side.
“And,” he adds, “institutional investors have had the philosophy in terms of looking at companies as existing primarily to drive shareholder value, as opposed to looking at holistically the principle that a company exists to serve its customers first and also has obligations to its employees and the community, and that the company is not just a mechanism to make shareholders rich.”
But what’s wrong with increasing shareholder value? After all, anyone buying stock in a company wants to see their investment pay off. Chia says the consequences of pure shareholder value thinking can be destructive both to the company and the community. For example, many older corporations have robust philanthropy programs. However, institutional investors have been pushing to devote less money to charitable works and more toward dividends, share buybacks, and other ways of returning cash to investors.
The trend has been bad for employees too, as companies have steadily been reducing employee benefits. “For shareholders cost cutting is in their best interests,” Chia says. “Reducing benefits to the employees and outsourcing contracts is in the best interests of the shareholders, but not in the best interest of the company employees.”
However, cutting employee costs can harm companies in the long run because they lose talented and experienced employees. The result of all this is the demise of the generous benefits that corporate America was once known for. Chia, who worked at Johnson & Johnson before joining the Conference Board, says older companies like J&J and Eastman Kodak once cultivated a “family” attitude and earned the loyalty of workers who would stay there for their entire careers. “All that stuff has gone by the wayside,” Chia says.
Many shareholders don’t care about the long-term health of the company because they plan to hold on to their shares for only a short time. “They’re looking for a company to have a quick increase in the stock price and then sell and get out.”
The company management is also incentivized to short-term thinking because of the way bonuses and compensation are tied to the company’s stock price as opposed to actual business results, Chia says. An obsession with quarterly results also contributes to short-termism. Leaders are less likely to make investments in research and development, which hurt the bottom line on corporate reports, but which can pay off later down the road.
There are companies that buck this trend, Chia says. For example, Amazon was a money loser for decades, insisting that its investors be patient as it poured money into building its business. “If the leaders did not have the courage of their convictions, Amazon would probably have succumbed and gone out of business a long time ago,” Chia says. “To have a company that has a long-term strategy is very difficult to do these days because of the pressure to produce immediate results.”
Chia knows what he’s talking about because he has spent his career working with the executives and shareholders who are making these decisions. He was born in New York State where his father was an executive at Citibank and his mother was a homemaker. Both were born in China, having fled to Taiwan in 1948 to flee the Communists, and making their way to the U.S. by the 1950s. He moved around a lot growing up, and went to college at Dartmouth aspiring to go to law school and become a prosecutor. “My dream job was to be some kind of district attorney,” he recalls.
But the job market took him in another direction. After graduating from Georgetown with his law degree in 1997 he was recruited by a company that was looking for lawyers who were familiar with China and could work overseas. He became a securities lawyer and took his first job in Hong Kong, where he worked for three years with the law firm Clifford Chance.
He stayed in Hong Kong until 2004, working with Simpson Thacher & Bartlett, before moving to Princeton to work for Tyco, helping the company recover from a devastating corporate governance failure. The next year he joined Johnson & Johnson, where he was assistant general counsel and corporate secretary. He joined the Conference Board in 2016.
In his new role Chia is pushing for structural solutions that would help combat short-term thinking. He urges executives to be aware of “short-termism” and deliberately resist activist investors and others who want to make short-term decisions. He says investors should also learn to favor strategic business decisions over short-run performance.
Companies can also structure their shares differently so that investors are rewarded for holding on to shares longer, although this idea is unpopular with investors. Lastly, he says, the government can change the tax code. Currently, capital gains tax breaks kick in to reward investors for holding securities for one year, but Chia says that time period should be made much longer.