6 minute read 11 Mar 2020
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What board perspectives are on the long-term value debate

By

Jean-Yves Jégourel

EY EMEIA Assurance Leader

Audit partner heavily involved in corporate governance and audit committee matters. Father of two. Avid marathon runner.

6 minute read 11 Mar 2020

Boards can strengthen their oversight role by guiding management to focus on the long term.

A recent EY EMEIA Center for Board Matters webcast explored board perspectives on the long-term value debate that is currently taking place. The webcast considered topics including frameworks for long-term value creation, ways to activate long-term value, and management incentives to drive appropriate behaviors.

The webcast was hosted by Jean-Yves Jégourel, EY EMEIA Assurance Leader and EMEIA Center for Board Matters Leader. He was joined by Leena Linnainmaa, Secretary General of Directors Institute Finland, Robin J Stalker, Supervisory Board Member and former CFO of Adidas, Barend van Bergen, EY Global Long Term Value Methodology Leader, Jan-Menko Grummer, EY Long Term Value Leader and Jens Massmann, EY EMEIA Reward Leader.

Shift from shareholder to stakeholder capitalism

Do companies create long-term value primarily by delivering profits for shareholders or by generating positive impacts for a broader range of stakeholders? Participants in the webcast recognized that this important debate is now in the mainstream and has gained further impetus after influential US business group Business Roundtable abandoned its declaration that “corporations exist principally to serve their shareholders.” Instead, it announced in August that companies “share a fundamental commitment to all of our stakeholders.”

It is time to update how we value companies and measure their impact on all stakeholders, not just on shareholders.

Commenting on this development, Jean-Yves Jégourel said, “It is time to update how we value companies and measure their impact on all stakeholders, not just on shareholders.” Nevertheless, the shift from shareholder to stakeholder capitalism has significant implications for board strategy, business models, management incentives and corporate reporting. It requires companies to integrate sustainability with their business operations and make decisions that reflect the expectations of a wide range of stakeholders, including customers and employees, as well as investors. It also requires them to create, maintain and value their intangible assets, including their brand reputation, human capital and environmental footprint.

A framework for measuring societal, human and customer value

Frameworks can help companies understand and articulate how they achieve long-term value creation and protection. At present, however, there is no generally accepted framework that enables companies to provide a comprehensive view of how they provide value to a wide range of stakeholders. To address this, the Embankment Project for Inclusive Capitalism, convened by EY and the Coalition for Inclusive Capitalism, has further developed EY’s Long Term Value framework with four key steps: establish the business context; determine stakeholder outcomes; understand drivers of value creation and protection; and develop metrics to articulate value. “The model responds to the increased need for broader information to support the making of sustainable investment decisions on more of a financial value basis,” explained Jan-Menko Grummer. As a result, the framework measures societal, human and customer value, providing a broader view on a company’s long-term value performance.

While frameworks are useful, many boards are not yet adopting them. This is often because they cannot identify the right key performance indicators (KPIs) or benchmarks to use. They may also be reluctant to be the first mover in a space if their competitors are not providing similar information, or to publish results that do not appear to be heading in the right direction. Yet there is a strong desire from investors for comparability and standardization when it comes to how companies articulate the long-term value they create. So, companies that take the initiative in this space are likely to become market leaders. “They will be role models and others will follow,” said Leena Linnainmaa.

How can boards activate long-term value?

“Long-term value can be quite a nebulous, high-level concept,” said Barend van Bergen. “So how can boards hardwire it into the company to strengthen the direction of travel?” The answer to that question is they can set the right tone at the top by engaging in dialogue with investors, regulators, employees and other stakeholders. In addition, they could challenge the organizational strategy and ask for targets and metrics which should be linked to remuneration to ensure that sustainable long-term value creation is a top priority for management teams. When activating long-term value, it is important that companies focus on:

  • Communication – articulating the long-term value strategy and objectives
  • Visibility – reporting on long-term value in the annual report and making employees aware of which trade-offs might need to happen in order to create long-term value
  • Enablement – using long-term value in decision-making to inform the allocation of both core and noncore capital
  • Accountability – incorporating long-term value into the remuneration packages of both executives and employees, and creating goals that the organization can use to hold itself to account
  • Culture – making long-term value the mindset within the organization so that it defines behaviors and influences everything that the organization does

The role of incentives

Companies are increasingly using qualitative criteria relating to sustainability in their remuneration schemes for executives, alongside financial KPIs. Yet these criteria are not perceived as realistic. “Institutional investors have been quite reluctant to use these targets because with qualitative targets, you usually have a high target achievement rate,” said Jens Massmann.

Where sustainability targets are quantitative rather than qualitative, and therefore more measurable, they often relate to very narrow focus areas – for example, employee satisfaction, or the number of occupational accidents that have taken place. Performance can also be judged according to a company’s ranking on an externally administered sustainability index, which is a holistic approach that enables transparent comparability with other companies, but is an expensive option. Ultimately, a company’s compensation framework needs to be in line with its long-term business strategy. So, it should be based on setting the right KPIs and rewarding executives for achieving those KPIs. 

Ultimately, a company’s compensation framework needs to be in line with its long-term business strategy. So, it should be based on setting the right KPIs and rewarding executives for achieving those KPIs.

Profits matter

It is important to emphasize that an increased focus on long-term value does not lessen the importance of profits in any way. “I’m not suggesting that companies should not make a profit,” said Robin Stalker, “because if we don’t make a profit, we can’t grow and we can’t be innovative.” Neither should long-term value lead to conflict arising between shareholders and stakeholders. A profitable company creates long-term value while a company that is genuinely focused on sustainability will achieve good results.

Top five questions for boards

  • How does the company define long-term value? Would a broader definition of value, supported by nonfinancial metrics, allow the company to better articulate its value to investors, other stakeholders and the markets?
  • Does the company explain its purpose, culture, investments, innovations and other initiatives and how they are linked and incorporated into strategy in ways that are enhancing the company’s competitive position?
  • What information or communications do key investors and other stakeholders say they need to invest their capital and resources in the company for the long term? Does the company clearly provide these communications in decision-useful ways?
  • Do current company performance metrics and executive compensation packages reflect the objectives of the company’s long-term strategy?
  • How does the company communicate the value of its board, in view of its composition, effectiveness and leadership, and overall governance framework?

Board perspectives on long-term value

A replay of the EY EMEIA Center for Board Matters webcast on board perspectives on long-term value.

Discover more 

Summary

There is a strong desire from investors for comparability and standardization when it comes to how companies articulate the long-term value they create. Companies that take the initiative in this space are likely to become market leaders. To achieve this, boards must ensure that sustainable long-term value creation is a top priority for management teams.

About this article

By

Jean-Yves Jégourel

EY EMEIA Assurance Leader

Audit partner heavily involved in corporate governance and audit committee matters. Father of two. Avid marathon runner.