PART ONE
WHEN GROWTH STALLS
There is a great delusion that companies, even large and mature companies, can keep increasing their earnings year-over-year. Most investors expect it, managers buy into it, and governments rely on it. But as is becoming increasingly clear, growth is not eternal. It does stall, and when it does, the past actions of management in creating the illusion of growth are devastating.
This obviously matters to corporate boards, and this book is about what they can do to prevent this situation. But first, in the chapters in Part One, we will take stock of why and how slowing growth leads to damaging leadership actions that ensnare companies in the growth curse.
CHAPTER ONE
THE GROWTH CONUNDRUM
Crises in corporate governance come in many shapes and sizes. Regardless of whether they are triggered by weak risk management practices, failing strategies, or outright fraud, the root cause of many of these governance troubles is ultimately the same—stalling growth. And as companies mature, this type of slowdown in growth will be a fact of life.
Yet stalling growth seems to be anathema to most CEOs and executive managers. Otherwise, how do you explain why they continue to commit to delivering unrealistic short-term growth—by which we mean bottom-line, net income growth—in the face of what they know to be challenging underlying conditions? Why do corporate leaders in large mature companies seem intent on squeezing every last drop out of their core business in an effort to deliver short-term growth (when these businesses have clearly plateaued) rather than investing in new growth businesses for the longer term? Why is the pretense of continued growth seemingly preferable to issuing a profit warning, especially when missed consecutive quarterly growth forecasts lead management, investors, analysts, the media, and even boards to panic? And why do boards continue to approve strategies designed to favor short-term expediency over longer-term sustainability?
It would be easy to answer these questions by pointing out the obvious: Many influential investors have come to expect (and indeed demand) short-term quarterly growth, and so CEOs and senior executives focus much of their energy on trying to meet this expectation, with the implicit support of their boards. Corporate leaders are afraid of missing quarterly targets; if growth forecasts are lowered or missed, investors don't react well. A company's share price falls on such news, and both the CEO and board are seen to have failed in their fiduciary duty to shareholders. In addition, being pegged to the share price and growth targets, the remuneration of the company's leaders will be adversely affected. So, is it all about loss of esteem and personal financial gain, then? Well, not quite. The growth imperative is highly ingrained in us as humans and cannot be explained away solely by the four Ps—power, prestige, pay, and perks—of a select few.
The pursuit of growth has been vital at both the individual and broader economic levels for human development. It is vital to human inquiry, learning, and creativity. At the individual level, physiological growth aside, humans strive for growth and improvement —whether in education, athletic prowess, artistic and creative skills, wisdom, or spiritually. We grow and improve as parents, in the hobbies and leisure activities we pursue, in the economic security we seek for ourselves and our families, and in our careers. And this career growth imperative is even stronger in many corporate leaders whose success has been based on them continually realizing (and exceeding) their business units' and company's growth objectives.
The orthodoxy of continual and strong corporate growth, which CEOs and senior executives have been imbued with, has in many ways translated into a force for good at the broader economic level, where increased gross domestic product has had an astonishing impact, lifting billions of people out of abject poverty: Since 1950, we have seen the average life expectancy across the world increase by 60 percent to age 72.8.1 Over the same period, literacy rates increased from just over 50 percent to 87 percent.2
But despite the benefits, historically, the pursuit of growth has always had its murkier side—think of colonialism, territorial wars, and the exploitation of natural resources and people on a grand scale. And in recent decades, the relentless commitment to achieving short-term corporate growth based on meeting quarterly targets can be associated with a new set of problems:
A chimera—A focus on short-term quarterly growth rarely delivers sustainable growth but more often the illusion of growth. Leaders can be so fixated on short-termism that meeting quarterly targets becomes sacrosanct at the cost of their own integrity as well as ethical business practice. As we will discuss in detail in chapter 3, delivering the illusion of growth is achieved in a variety of ways, from accounting sleights of hand to outright accounting fraud, as well as by employing handy mechanisms such as share buybacks and waves of acquisitions. Whatever the method, this is not real sustainable growth.
Value destruction—Far from creating value, the scourge of short-termism actually has a detrimental effect on companies in the medium to long term and ultimately hurts shareholders, too (which does not bode well for anyone with investments or a pension fund). A 2017 study by the McKinsey Global Institute of 615 listed companies in the United States, conducted over a 15-year period starting from 2001, found that companies that were managed for the long term (defined as those making consistent investments even in difficult times, whose earnings reflected cash flow not accounting decisions, and those less likely to grow margins to meet short-term targets) outperformed their short-term-oriented peers on many levels. Over the period studied, the revenue of long-term companies was almost 50 percent higher while their net income was, on average, 36 percent higher than the firms with a short-term focus. Additionally, their market capitalization grew more, their shareholder returns were higher, and they created significantly more jobs.3 This, of course, begs the question: Exactly who benefits from short-termism? Clearly, the executives who enrich themselves while hollowing out the companies they work for benefit. But while the shareholders who put so much pressure on executives to meet quarterly targets gain in the near term, over the relatively short period of 15 years, they are shown to lose out.
Hidden external costs of growth—In general, the external costs of corporate activity (environmental damage, pollution, waste, water and land use, for instance) are not accounted for—although since German sports brand PUMA published the world's first environmental profit and loss in 2011, a small number of companies are beginning to put a financial figure on the environmental costs of their business activities. For companies focused on short-termism, the very idea of stepping up to acknowledge the cost of externalities is anathema, and so the hidden costs of their growth are unlikely to be divulged. In addition, when two common behaviors of short-term-focused companies are taken into account—a lack of investment and "gaming the system"—this points even more strongly to growth being at the cost of the environment and society. Just think back to the Volkswagen emissions scandal and the fact that executives chose to install software that could cheat emissions tests on diesel cars in order to sell more cars, regardless of the damage these engines would have on people's health and the environment more widely.
Despite the ultimate futility of short-termism, the day of reckoning has yet to come. And in the meantime, many boards sit back and allow the circus of conflating corporate progress with increased quarterly results to continue unabated.
