Investment managers, along with many smaller shareholders who take an active interest in the performance of listed companies, reasonably expect that companies are focused on securing long-term value creation.
This requires companies’ boards to clearly communicate how they are proactively developing and adjusting strategy in order to guide companies through uncertain times.
In 2015, State Street Global Advisors found that despite clear signs of a global economic downturn, most Australian companies were operating in a ‘business as usual’ mode, as the Australian economy itself had not yet shown signs of significant softening.
Few companies had clear answers in terms of how they were prepared to shift strategy if and when macroeconomic conditions in Australia changed.
A company’s long-term success is very much linked to its long-term strategy, as well as its practices and policies related to corporate governance, compensation and sustainability issues.
It is important that boards periodically evaluate the viability of the strategy based on changes in the business environment, competitive landscape, regulatory requirements and other macroeconomic factors.
Any change in strategy should prompt an assessment of director skills and expertise to ensure that the board collectively has the background and knowledge to oversee the implementation of the strategy.
Further, short-term and long-term performance goals based on key strategic drivers should be established, and boards should incentivise and evaluate senior executives against these goals over the strategic turnaround or other appropriate time horizon.
Based on pre-season discussions with companies, SSGA has found several that are significantly changing executive compensation plans to accommodate a changing economic reality.
Some companies are shifting their compensation orientation from long-term to short-term priorities and changing pay drivers to significantly reduce or remove long-term stock performance targets as these become more challenging to achieve.
The rationale for the changes is simple, though not convincing. It is a means of focusing management on the short term to guide companies through macroeconomic challenges that boards should have anticipated and prepared for.
While it is easier to forecast short-term performance in uncertain times, shifting focus away from the long term can create even more short-term pressure on management, as investors are deprived of any perspectives on the company’s long-term prospects.
In times of uncertainty, shareholders are looking to see if the directors they have appointed understand and are appropriately monitoring the risks facing a company.
A frank dialogue between investors and directors on a company’s long-term business strategy, and potential risks to that strategy, is necessary to help set investor expectations and provide a basis for us to contextualise short-term performance while keeping all of us focused on long-term value.
Rakhi Kumar, managing director and head of corporate governance, State Street Global Advisors