Deferred pay-offs: Executive pay should be linked to long-run performance

With activists anxious for the UN’s climate change conference in Paris to reach an agreement limiting the average global temperature increase to 2 degrees above pre-industrial levels, many commentators warn against the catastrophe which awaits us, and the benefits which might come from deferred gratification.

 

Long espoused by successful business leaders, like Amazon’s Jeff Bezos, long-term planning has become increasingly difficult for companies. Bound by quarterly reporting, and with public companies facing fierce competition from ambitious startups in the digital marketplace, getting to the top is only half the battle. So, is delayed gratification still the key to long-term success?

 

On an individual level, self-control in the short term could pay dividends in later life. In the late 60s and early 70s, a series of experiments by Stanford psychology professor Walter Mischel found that children who were able to resist temptation were more likely to succeed in adulthood. 

 

Mischel offered participants a small treat immediately, or two if they were prepared to wait for 15 minutes. Follow-up studies revealed that those who waited tended to enjoy higher general educational attainment, as well as better performance on other quality of life indicators, such as having a lower body mass index. 

 

But when it comes to businesses themselves, executives have to contend with numerous factors when determining their planning – not least the demands of shareholders. According to Bank of England chief economist Andy Haldane, dividend payout ratios have fallen since the 80s on very rare occasions, “evidence that the short-term quest for smoothing shareholder returns has come to dominate payout behaviour, almost irrespective of profitability.”

 

Lengthening the time horizon of public companies will be a tough task, and one which will require “the involvement of all stakeholders”, according to a report by EY Poland. It recommends that companies gear their reporting framework towards long-term drivers of business success, tying a portion of executives’ pay to long-term company performance, and that governments provide incentives for the long-duration holding of securities.

 

But government interventions in this area have proved unpopular with institutional investors. The French government’s decision to grant double voting rights to any shares registered for more than two years has drawn fierce criticism from executives and investors. Known as the “Florange law”, all of France’s public companies will have to adopt it from 2016, unless two-thirds of shareholders vote to overturn it. Headed up by French fund PhiTrust, a group of institutional investors is campaigning against it, on the grounds that it will be “detrimental to the rights of minority shareholders”.

 

But the wrong kind of long-term thinking, if it leads a company to rest on its laurels and work through whatever plan it has devised regardless of circumstances, can be little more than complacency. The disruptive nature of the digital economy means that companies must fight off, or buy out, ambitious startups which are cropping up with increasing frequency. Companies like General Electric and Facebook try to run themselves like startups at scale, while investors in struggling companies are recognising the value of shaking things up and remaining nimble in the short term. Large mutual funds holding big stakes in Microsoft backed the activist ValueAct Capital Management  two years ago, in the hope that it would breathe new life into the software firm.

 

Long-term thinking may be crucial to business success, but the ability to pivot may be the key to survival.