Dated: 14 January 2011

In its response to the enquiry ‘A Long-Term Focus for Corporate Britain: A Call for Evidence’ initiated by Business Secretary Vince Cable, which closes today, the Institute of Directors (IoD) argues that the short-term pressures facing companies are best addressed through improving boards rather than through regulatory changes or changes to the shareholder voting regime.

The IoD suggests that governments, with their own short-termist tendencies, are not well placed to criticise companies for not always following a long-term stratgey, and it would be better if the Business Department focussed totally on supporting businesses and helping them create new jobs, rather than carrying out yet another corporate governance enquiry.

Sources of short-termism:

• A potential source of short-termism in listed companies is clearly the fear of short-term declines in the share price. However, the possibility of significant movements in the share price is an inevitable consequence of a stockmarket listing. Movements in share prices arise, in part, from the high levels of corporate transparency and disclosure that are demanded by stockmarket listing rules.

• Share price volatility is undoubtedly exacerbated by the short-term investment horizon of many institutional shareholders. The investment strategy of a significant proportion of fund managers is orientated towards share trading rather than long-term company ownership. However, there is no obvious way of changing this without many fund managers changing their business model.

What should we do?

• The IoD believes that the board must become more active in ensuring that the company adopts a time horizon that maximises corporate value creation. There are several ways in which it can do this.

1.Companies should seek out long-term investors

• Boards should actively seek to attract shareholders to the company that share the strategic time horizon of the company. Although many UK institutional shareholders do not have a long-term investment horizon, shareholders are not a homogeneous set of actors. Certain types of shareholders may be willing to adopt a longer-term orientated investment approach.

• This is more likely to be the case if shareholders fully understand the company’s strategy and key performance indicators. Boards should therefore place a high priority on clearly communicating the corporate mission and strategic timeframe of the company to potential investors and other stakeholders.

2. Remuneration should be aligned to the strategic timeframe of the company

• The board should ensure that the timeframe of executive remuneration policies is matched to the overall strategic timeframe of the company.

• If corporate success is defined on a longer-term basis, the board should avoid incentivising executives to pursue short-term financial targets that might exert a negative effect on long-term performance. The remuneration committee should give detailed thought to the financial and non-financial performance criteria that will best align the time horizon of executives with that of the company.

3. More board support for management during share price volatility should be provided

• If short-term market pressures are brought to bear on management, e.g. through the volatility of the share price or the emergence of a hostile takeover bid, the board should play a key role in shielding management from these external pressures if they remain convinced that the existing management team is best placed to implement the long-term strategy.

• During times of short-term uncertainty, the board should not allow the CEO and the executive team to become distracted from their operational management of the business. Boards should support them by playing a significant role in communicating the existing business strategy to the market, and by building a supportive dialogue with investors.

Commenting on the enquiry, Miles Templeman, Director-General of the IoD, said:

“The main underlying causes of short-termism in corporate Britain cannot be overcome with new Government policies or regulations. Some short-termism is an inherent part of a stockmarket listing. However, this doesn’t mean that we should just sit on our hands. Company boards need to become more active in ensuring that companies adopt a time horizon that maximises corporate value creation.”

He added:

“With seven Business Secretaries in less than 10 years, politicians and governments are not particularly well placed to lecture corporate management teams on the need for continuity and a long-term strategy. Instead of conducting yet another enquiry into corporate governance the Business Department would be more effective if it focused all of its time on supporting businesses and helping them create new jobs.”

To read the full IoD submission to the enquiry please go to the contact point below.