By Julie Linn Teigland, Andrew Hobbs, EY
2. Companies Can Directly Address Many Of The Key Challenges To Their Long-Term Value Strategy
While encouraging progress has been made, significant challenges — both external and internal — still stand in the way of driving long-term value and meeting the interests of investors and other stakeholders.
Our analysis finds that “short-term earnings pressure from investors” is the critical external challenge facing the “leaders” in our survey. While leading companies appear to be making significant progress, we did find that around one in three (32%) have not put in place a consistent approach to decision-making that balances near-term and long-term value creation. This may help explain why the number one external pressure facing this group is the short-term pressure. It suggests that as you focus on long-term value, the tension and awareness of balancing near-term and long-term growth may increase, not decrease. Investor pressure on short-term earnings risks causing companies to redirect capital and human resources from long-term strategic initiatives to meet short-term financial goals. All those in the sample who selected “short-term earnings pressure from investors” as a critical challenge were also asked how this short-term pressure manifests itself. The answer is increased price volatility.
The major challenge of short-term pressure reflects a number of issues: first, the growing importance of institutional investors with a limited length of share ownership, which creates pressure on boards to focus on the short-term market value of the share; second, the continued emphasis on short-term disclosures within listed companies, including quarterly returns and earnings guidance, which can drive a focus on short-term financial performance. For this reason, it’s crucial that boards establish effective engagement with investors — including activists — to build trust, explain purpose, identify common ground and ensure support for long-term value oriented strategic approaches.
This is not a new idea, yet it feels more relevant than ever. Warren Buffet made the point in 1979 in his letter to Berkshire Hathaway shareholders when he said: “In large part, companies obtain the shareholder constituency that they seek and deserve. If they focus their thinking and communications on short-term results or short-term stock market consequences they will, in large part, attract shareholders who focus on the same factors.” The opposite should also be true.
Sustainable Growth: A Spotlight On ESG
The focus on long-term value has emphasised the critical role that ESG programs play in sustainable growth. Based on discussions with EY subject matter professionals, we have identified five themes that are driving the importance of ESG, as well as some key considerations for boards:
- Societal, government and consumer scrutiny of companies’ ESG performance has intensified, with the pandemic leading to intensifying public attention on the social dimension of ESG in particular.
- Investor focus on ESG disclosures has also increased during the pandemic, as stakeholders focus on a company’s ability to manage long-term risks, including environmental risk. Given that climate change time horizons extend over 30 to 50 years, they are meaningless in conventional risk management terms. This means breaking down these issues to shorter-term steps — and modelling will also be key.
- Trusted ESG disclosures require robust processes and controls, and independent assurance plays a key role in driving reliability and consistency. The large number of voluntary standards today make comparability and reliability difficult, and the IFRS Foundation is working on a coherent approach. The credibility of ESG disclosures is also critical, with the onus on issuers to demonstrate outcomes.
- Board directors are increasingly focused on ESG performance, and it is no longer a niche area that is the preserve of the sustainability officer. This is because ESG performance and reporting are important in raising funds, green bonds and credit lines, and attracting the right investors.
- Board education will be increasingly important to arm members with the knowledge they need to understand the impact of sustainability on areas such as risk and finance. Board composition, and the quality of the nonfinancial information boards use in decision-making, will also be key.
The greatest portion of respondents chose the following as an internal challenge to long-term value orientation: “CEO and executive compensation are tied to short-term performance.” Shifting to an approach that supports long-term value creation will require boards and compensation committees to rethink the design of executive compensation plans.
Ilham Kadri, CEO, Solvay Group
Solvay is a Belgian, science-based multinational that was founded in 1863 and which is today focused on three segments: advanced materials, chemicals and solutions. Julie Linn Teigland — EY EMEIA Area Managing Partner — spoke to CEO Ilham Kadri to understand her perspectives on long-term value.
Can you tell us how long-term value thinking is shaping your strategy for Solvay?
The primary mandate I received from the board when I joined was to unleash the significant potential of this company and today I am here to lead a purpose-driven transformation of Solvay that creates long-term value. Our purpose reflects the thinking of our founder, Ernest Solvay, who said that the company’s scientific and technology capabilities have a ‘positive role to play for the progress of mankind’. You cannot transform a company in a sustainable way by simply demanding that the presidents of your business units step up EBITDA and cashflow. At least that’s not how I see transformation. The way we like to think about it is through the concept of ‘cathedral thinking’. Like the construction of great cathedrals, different generations are inspired by the long-term vision and the goal of benefitting future generations. It’s a multiple generation process.
That said, there is no long-term value without short-term performance. Finding a balance is key. I like to say that it’s important to keep one eye on the ‘microscope’ — the short-term performance, and one eye on the ‘telescope’ — the long-term strategy.
What are some of the main changes you are focused on to deliver your long-term value approach?
A key responsibility I have is to identify the new behaviors in my company that will drive long-term value. Our purpose is about sustainable and shared value, including purposeful responsibility, unity but not uniformity, and passion for performance. That’s the new Solvay. So, if you take ‘passion for performance’, that means encouraging people to not only behave like ‘farmers’ but also ‘hunters’ who seek new business, which in turn drives long-term value. We also need to be customer-obsessed — not just intimate, but obsessed. Last but not least, innovation is key to long-term value. Since I joined the company, we have launched three innovation platforms: EV batteries, thermoplastic composite and green hydrogen. This is the long-term value, ‘telescope’ part of our strategy.
Can you tell us about the role of the board in delivering Solvay’s long-term value strategy?
Governance is key and I have been focused on strengthening the relationship with the board through openness and transparency about the issues we face. Like many companies, the crisis has shown areas where we can improve that perhaps we did not see before. We have been very transparent with the board about what we are seeing so that we are aligned on the environment for the company.
The board and executive management work hand-in-hand to find the right balance between both short-term value creation and long-term value creation. For example, resource allocation was decentralised in the past and now it is centralised with me. Business unit presidents have to earn the right to investments and it allows us to be guardians of shareholder value, balance the short and longer term projects, and ensure initiatives don’t conflict with our sustainability ambition memorialised through ‘Solvay One Planet’.