Why so short-sighted?
The CFA/ Business Roundtable effort is concerned that short-termism is hurting the U.S. economy.
By Justin Fox, FORTUNE Magazine editor at large

NEW YORK (FORTUNE Magazine) - Sitting around the meeting-room table at the Palace Hotel in New York City one mid-March morning are a few money managers, a corporate investor-relations guy, and a stock analyst.

They're supposed to figure out how to rid corporate America of its obsession with quarterly results. Will they? No, probably not. But it's fascinating to hear them try.

The meeting is the last in a series organized by the CFA Institute (representing investment practitioners) and the Business Roundtable (big-company CEOs), which share a concern that short-termism is hurting the U.S. economy.

They were inspired in part by a survey of financial executives conducted by professors at Duke University and the University of Washington, which found that 76 percent said they'd sacrifice economic value to keep earnings rising smoothly.

Failure to communicate

I was invited to sit in on the meetings. What I learned was that, while there are real forces at work driving both money managers and executives toward myopia, the most striking problem may be a failure to communicate. The corporate types mostly said that their companies tried to think long-term but were badgered by Wall Street to meet impossibly precise earnings targets.

"It's like trying to land a 747 on a postage stamp," said one executive, who preferred not to see his name in print.

But the money managers claimed not to care a whit about those targets. "Our average holding period is between four and 11 years," said Steve Bepler, a senior vice president at mutual fund giant Capital Research & Management. "Why would we have any interest in quarterly earnings?"

So why do corporations pay so much heed? Partly because Capital is an anomaly -- the average holding period among mutual funds is just under a year. But blame was also heaped upon analysts at big brokerages, who serve as intermediaries between companies and investors.

"Too many issuers [corporate executives] are seeing the world through the lens of the large brokers," said Steve Galbraith, a former Morgan Stanley (Research) chief investment strategist now with the hedge fund firm Maverick Capital.

While sell-side analysts have lost a lot of clout since their glory days in the late 1990s -- one investor-relations chief said they'd devolved into "cruise directors" whose main job is to arrange investor visits to corporations -- they remain the ones who make the most noise.

Most important, it is the sell-side analysts' estimates of quarterly earnings, compiled and averaged by the likes of Thomson First Call, that create the targets that companies feel they must meet or beat every quarter.

Proposed remedies

What is to be done? The favorite remedy of the moment -- sure to be a key recommendation of the CFA/ Business Roundtable effort -- is for companies to give up trying to influence analysts' earnings estimates.

Many FORTUNE 500 companies, from pioneer Coca-Cola (Research) in 2002 to Motorola (Research) this past January, have said they'll no longer provide forecasts of quarterly earnings. That is, however, a mostly superficial fix. Truly substantial changes in how executives and money managers are paid -- so they favor sustained performance over short-term gains -- will be harder to make reality.

More encouraging news comes from a recent study by three University of Washington scholars. They found that after 2002, companies stopped getting a stock-price boost when they beat their earnings targets by a penny. That is, investors appear to have gotten wise to the earnings game. Now if someone would only tell the CEOs and CFOs. Top of page