I was struggling for a title for this post, as it started out with a concept I call “dialing for dollars.” What do I mean by that? In publicly traded companies, at the end of every quarter, the accounting staff goes dialing for dollars. Each year, various departments or “responsibility centers” set up an estimate of their expenses for the year. These amounts are typically accrued over the course of the year as expense items. At the end of each quarter, the accountants call you if you have not spent the money accrued for that quarter or year-to-date.
Why do they do this? They are looking to reverse excess accruals into income for the quarter. The company is having difficulty meeting the expected Earnings Per Share performance for the quarter, so they are looking to make the number any legitimate way they can. When a company does not meet their short-term expectations, even by a penny or two, the capital markets may reduce their share price. Yet, this unhealthy focus is usually harmful to longer term success, as it shortens the focus of the leadership. It makes leaders more like managers and usually waters down risk taking, as you don’t want to not meet your goals.
I have a friend in retail company who summed it up this way. He said “we step over quarters to pick up nickels around here.” Investments are often not made if the results are not profitable in the same fiscal year. Think about that for a second. You may have a great idea for the company that will produce profitable results either through revenue gain or expense reduction, but if it is not “accretive to earnings” (meaning adds to earnings) in the same year, it may not get done. So, the company would rather step over a quarter that will be earned next year for a nickel today.
The key reason is most incentive plans are short term in nature. Coupling that with impatient investors who read analysts’ expectations, leaders do not have the time to overcome an error that hurts earnings and causes them to miss estimates. They become more pensive and take fewer risks. This is one reason so many companies are sitting on cash these days as a leader does not want to invest poorly. When you hear their reasons, you have to take them with a grain of salt and a healthy does of skepticism. The CEO might say I am not investing because of uncertainty in the economy, because of Obamacare, or because of regulations. Excuse making like this has gone on for years and is largely poor-mouthing gamesmanship. The leaders do this, so when they achieve success, they can appear to have overcome obstacles.
Yet, I digress. The focus on short-term profits hinders progress toward long term goals. This happens not just in publicly traded companies, but in other enterprises as well. A good example is investing for a cleaner energy future. The profits in “drill baby drill” are huge for fossil fuel companies, so they are riding that horse for as long as they can. However, that is not the best answer long term, as the cost of not moving more quickly to alternative energy will outweigh the short-term benefits these companies gain now.
One of the hardest parts of this equation is the costs and profits are not always borne by the same entities. Developers want to get in, make their money and get out. Their typical modus operandi is to leave the problems for someone else. Fracking is a great example, where the fracking company makes a huge profit and the land owner makes a nice nest egg, but the problems are left for the community at large through less usable water, poisoned water, air quality concerns, and landscape degradation. We are only beginning to see the negative results of fracking which will be a gift that keeps on giving in a negative way.
So, we need leaders to be leaders and look longer term. How can we create sustainable earnings? How can we be good community citizens and help the lives of everyone? How can we make money without harming others? If we allow them to continue focusing on short-term, the long term problems will not get solved. And, then it will cost more money to fix things. Eventually, someone will have to pay the fiddler while we dance to the music today.