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American business must be free to manage long term.

American business must be free to manage long term

Let me advance this proposition: the managers of American business will forfeit any chance they have to succeed in the world marketplace unless they make it their overriding mission to manage for the long term. They will achieve this only if they also work to create the kind of ownership that will allow them to run their companies for the long haul.

We all know what American management is up against today. We all know what kinds of inroads that the Europeans, the Japanese, and now the Koreans are making into our markets - both domestically and internationally.

Just one example: television sets. Twenty years ago, there were 18 U.S.-owned companies and zero non-U.S.-owned companies making TV sets for the American market. Today, there are 17 non-U.S.-owned companies and just two U.S.-owned companies producing TV sets for sale here.

Why is U.S. business losing ground? Many people believe it's because too many American executives are yielding to pressures to manage short term.

Business Month magazine recently did a survey of CEOs and found that a resounding 86 percent believe that business is generally too short-term oriented. Forty percent - two out of five - even admit that their own companies are managing too short term.

Only 4 percent believe companies are doing a good job of competing in foreign markets. And just 6 percent think companies are planning effectively for the future. What are almost universally identified as the culprits for short-term management are the demands created by Wall Street's insatiable desire for short-term gratification.

Today's market and today's financial entrepreneurs seem to have made short-term thinking into a kind of religion. In the heat of today's biggest transactions, time horizons get crushed down as tight as matter in a black hole. The operative interval for some of the legal or investment banking superstars in these deals may be the two or three weeks that it takes them to walk away with a fee as large as $20 million. In the corporate world, the most extreme example of short-term thinking is the management buyout, or LBO. Of course, LBOs themselves often spring from the immediate pressure of a takeover threat.

For the owners of the gone-private enterprise, an LBO holds out the chance for significant financial enrichment, especially if the enterprise is later able to become a "born-again" public company with a nifty stock price.

But, to do an LBO, the enterprise needs to take on a mountain of debt - often high-yield. Interest payments are staggering. The obsession of management becomes, therefore, to maximize cash flow.

The argument is, of course, that this extreme leveraging creates intense positive pressures for performance. Fat is pared away. Perks disappear. Efficiency is king. The company becomes a lean, mean cash machine.

You can listen to people on both sides of the question debate whether LBOs are good or bad for America. But one way to think about LBOs is to compare a company to the body of an athlete. An enterprise that's run for the long term is like an athlete who gets a balanced diet of nutrients, sufficient rest, and proper exercise. These are what the athlete needs to go the distance.

On the other hand, look at an athlete who is training the wrong way, for short-term, peak performance. He's constantly working out, at a considerable risk of injury, and he's not getting enough rest. This athlete's receiving steroids, which may bulk up his muscles and boost performance - but they also take their toll on his body. In order to add a mental "high," he may be taking amphetamines or cocaine, which will hurt his future health even further.

There's something about the most highly leveraged LBOs - those that have to steal from tomorrow to survive today - that's like this hyped-up athlete.

On the other side of the coin, there are plenty of companies and industries that have bucked the short-term trend and made notable successes out of managing for the long term. The automobile industry and the pharmaceutical industry are two cases in point. But some companies in commodities-style businesses have also set commendable examples of long-term management under almost impossible conditions. Asarco, the metals producer, is one such company.

One of the most heroic examples of long-term management you'll find is Cummins Engine, a little $3 billion company in Columbus, Indiana. Cummins, in effect, "bet the company" on a daring strategy to protect its market from foreign competition. And it's still around to tell the tale.

Of course, case histories are nice. But what about the awful pressure corporate executives feel in their guts for short-term earnings improvement?

These pressures are with top executives every day. The question is, how can they break the short-term cycle and free themselves to manage long term?

It's well known that the long-term competitiveness of American business is of particular interest to the Bush Administration. A number of policy initiatives have been suggested, both from inside and outside the Administration. Some are already getting the attention of Congress, and a lot of them make sense.

A second policy suggestion is that the government become partners with business in order to attain the technological progress the nation needs to become a worldwide contender. Many observers believe this kind of government/industry cooperation has been a big factor indeed in non-U.S. competitors getting a jump on us.

Where the financial executive fits in

But what can executives themselves do? Donald Frey, the former chief executive of Bell and Howell, hit upon the key ingredient in a Fortune magazine essay when he used the phrase, "patient capital" He discussed how "patient Japanese capital" - provided by investors who are willing to stick it out for the long term - has paid off for that country's industrial machine.

Where does one find patient capital in this country? One of the best places may be in a company's offices and factories. Ownership of stock by employees is probably the most patient capital that could be found anywhere.

Employees who own company stock will often stay with their company investment because they know they have the possibility of realizing appreciation and increased dividends if they can help the company perform well. In any kind of proxy vote, or a contest for control of the company, these employee shareholders tend to support management.

Employee stock ownership plans (ESOPs), which were hot a few years ago and then dropped out of the limelight, are coming back. There are three good reasons for putting in an ESOP, or expanding an existing one. First, stock ownership can be a forceful motivator for employees - and a way to build their loyalty and company feeling of "family." Second, ESOPs offer companies and their lenders some significant tax advantages. And, third, a federal court decision on the Polaroid-Diamond Shamrock bid now gives ESOPs a possible new role as a hindrance to an unwanted takeover. Beginning an ESOP, or enlarging an existing one, is something any number of companies might do well to investigate.

But the company that adopts an ESOP still has institutional owners of its shares. And these owners often represent the most impatient kind of capital. For example, the turnover rate of many pension fund equity portfolios today is better than 70 percent a year. And for some other institutional portfolios, turnover rates of 200 percent are not unusual.

On the other hand, many U.S. institutional investors have turnover rates that are much lower. Thus, the corporation that seeks to free itself from some of the pressures of short-term-oriented institutions can and should seek out the more patient capital available from institutional investors who will stay with it for the long pull.

One suggestion is to invite such an institution to take a substantial long-term position in your company. In return for its agreeing to go the distance with you, you offer the institution representation on your board.

Certainly this idea is not without risk. You'd want to take the time to establish a relationship of trust with that kind of shareholder before proceeding.

The other constraint - from the large shareholder's point of view - is that being on your board and having almost constant access to insider information would greatly limit his ability to trade in your stock. But, if he's come in as a long-term investor, that shouldn't present much of a roadblock.

A corporation might also consider launching a broader-scale campaign to attract longer-term institutional owners. There are databases available today that enable one to identify institutional investors according to how frequently they turn over their portfolios.

To give such an effort the best chance of success, one more step is advised. Tune up your database so you can pinpoint the institutions whose criteria for investments are in line with your company's unique characteristics. The idea is to go with the institutions you like and the institutions that like you.

But getting the names of the institutions off the database is the easy part. It's the follow-through that's critical. First, contact the target institutions, to see if they have a potential interest in your company as an investment. Or ask an experienced outside consultant to make these initial contacts.

Once a threshold interest is established, a program of direct, one-on-one visits with the institutions needs to be arranged for the CFO or the investor relations director.

The goal of this program is to stimulate demand from long-term holders, who will buy stock from the "weaker hands" - the short-term holders. Because once they've bought those shares, chances are high that they'll hold onto them.

For this effort to work, company management really must be committed to the long term - and your company must have legitimate long-term prospects. If it doesn't, the institutions will see through this tactic and stay away.

Traditionally, investor communications programs have emphasized communications with sell-side analysts. The sell-siders then go out and sell the company's stock to whatever institution will pay them a commission. The company has nothing to say about it. My point is that the company should. What I'm proposing is that you select the institutions, rather than letting the institutions select you.

Also, take a look at your company's investor communications materials: the annual and quarterly reports, the 10-K, the presentations to security analysts, and the analysts' fact book.

Is your company presenting its message to satisfy the interests of its investor audience in only short-term performance? If it is, you're pandering. And if your company is letting the short-term boys call the tune on how you communicate, are you also willing to let them tell you how to manage?

I submit that a company is more likely to attract the kinds of investors it wants if it presents itself as the kind of company those long-term investors are interested in. In other words, take the lead. Make it clear in all communications that you're a company that's in it for the duration - that you have long-term goals and a long-term strategy for achieving those goals. It's likely that the institutions that buy into this management approach may also want to buy into your stock.

A pension

management plan

The top executives of public companies are in a unique position. On one hand, they're running companies whose stocks are bought and sold by the most powerful institutional investors - pension funds. At the same time, most of them also have outside pension fund managers working for them, managing their pension money.

So financial executives like you have a lot to say about what kinds of thinking pension funds bring to the managing of your portfolio. The instructions you give these pension managers, plus the way you review their performance, will have a lot to do with whether or not they invest for the long term.

At least one company CEO has grabbed the bull by the horns and changed the way in which his company supervises outside pension managers. This is Hicks Waldron of Avon.

Two years ago, Waldron took the short-term pressure off Avon's pension managers by changing their performance evaluations from quarterly to every three years. He also told them to keep a company's long-term view in mind when they vote a proxy, and he began reviewing each manager's proxy votes on shareholder resolutions.

How did the pension managers react?

"Our managers by and large love it," Waldron said. "It takes the heat off them."

Waldron said that by going public with his change in evaluating pension managers he hoped to encourage other CEOs and the investment community to follow his lead. In many ways it's an inspiring idea, because if a cross-section of public-company executives with pension oversight responsibilities got together with a cross-section of pension fund managers they would find they all want the same thing.

The assumption is that the pension fund overseers would be happy to relax the period over which they review pension fund performance - if they knew that pension fund managers in general would also agree to take a more long-term view in buying and holding stocks - including the overseer's own company stock.

My conversations with people in the pension field indicate that they may be receptive to this idea. A first step would be to identify an organization that would be willing to promote this idea. Its initial objective would be to develop a statement of principles for pension fund management, promulgate it widely, and get a majority of corporations and pension fund management firms to sign onto it.

Two cautions, however: it must be clear that such an effort is not intended as an anti-takeover move for public companies. And a pension manager's fiduciary responsibility cannot be perceived as being compromised in any way. If the effort falls into either of these two traps, it will not fly.

In closing, let me say that I'm absolutely serious about this idea. I believe it can work. Despite my own short-term pressures, I am ready to roll up my sleeves and work with anybody who wishes to pursue this thought further. I'll contribute whatever time, energy, and ideas I can to make it happen.

PHOTO : The "Chester Ferry," made of wood

PHOTO : Part of a set of toy soldiers in the Royal Marine Drum Corps, England
COPYRIGHT 1989 Financial Executives International
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Copyright 1989, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:Management Strategy
Author:Raynolds, Edward O.
Publication:Financial Executive
Date:Nov 1, 1989
Previous Article:How to plan your global tax strategy for the 1990s.
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