The Short-Term Pressures That Affect the Companies Operating in Britain - Literature review Example

The short-term pressures that affect the companies operating in Britain Introduction Different studies arrived at the conclusions that different owners of companies will have and will pursue different investment focus areas and horizons. The differences mentioned are often, likely, to alter the corporate performance and the actions implemented by different companies. One example among these studies is that by Koh and Hsu (2005), where they pointed out that transient and long-term targeting companies, identify with different earnings management models, and that the different models hold the potential to change the operational outlook of either companies. For instance, short-term investors are more likely to prefer share repurchases, but at the same avoid dividends, which are likely to weaken the governance models adopted; such differences can lead to higher managerial compensation levels (Clay, 2000). Other studies like Bushee (1998) support the same idea, by emphasizing that the short term focus and the high frequency of trading among institutional investors is likely to compel managers to overlook long-term investment systems like research and development (R&D), so as to focus all managerial efforts towards the realization of current revenue or earnings targets. There is evidence of that the short-term focus of managerial staffs can adversely affect value, as many managers will appear to engage in short-term programs that may be destructive to the long term success of the company. The value creating activities that are, mostly, hampered by the short-term inclination of managers include advertising, R & D, delaying the launch of a new program and maintenance. The delays are made in an effort to continue pursuing the short-term performance targets set by the stakeholders of the company. Additionally, Lijeblom and Vaihekoski (2009) arrived at the conclusion that the ownership structures of different companies influence the investment behaviours adopted in the short and the long term. Corporate governance mechanisms are set to eliminate the problems related to agency, which often comes up between the management of a company and its owners (Keown et al., 2004). For this reason, it is important to explore the time horizons of the shareholders of a given company, prior to the setting of the incentive model to be adopted by the management, including the management compensation model used by the company. In the case of the individual investor, the situation is relatively different, as it should be a priority to explore their focus and the behaviours expected from the company, taking note that many companies are, usually, controlled by an institutional owner, government or an activist. These control agents are influential than the management of companies (Briggs, 2007). Building on this context, this paper will explore the causes of short-term performance pressures for the companies operating in Britain, and the extent to which the situation affects the different companies. The Causes of Short-term Performance Pressures in Britain Demirag and Tylecote (1996), through a study done on UK engineering companies, found that the CEO’s of different companies did not admit the reality of short-term pressure in their companies. However, an R & D director of one of the companies and the divisional chief executive of another consented that their divisions were operating under short-term pressure. The case was different for the managers of the Scandinavian and British companies covered by the company, as they reported that the companies operated under short-term pressure. However, it is important to take note that the study was administered during the time of a recession, which gives the idea that the financial restrictions adopted during crisis could have been interpreted by the managers as short-term pressure variables (Demirag and Tylecote, 1996). The short-term pressures reported by the managers of the companies covered by the study reported one or all of the following indicators that the companies were operating under short-term pressure. One recent case in the UK was that of Neil Woodford, who had to bow to pressure to the extent of quitting the leadership of Invesco; he quit the position following the heavy criticisms arising from the emphasis on short-term investing (Smith and Foley, 2013). The departure of Woodford gave the issue more attention, as the fund manager had over the years complained about investing for the short term. In support of the debate, dignitaries like Prince Charles joined in the debate, insisting that the emphasis offered to quarterly capitalism was not fit for development (Smith and Foley, 2013). The variables reported by the different managers included pay restrictions; the managers reported that the different CEO’s of the companies studied, in some way, demonstrated a considerable performance element. The common thread between the performance elements was that there was the practice of profit-based bonuses in the pay models in place. The second variable identified by the managers was that there was setting of performance targets and performance measurement, where short-term targets had been set so that the managers could use them as markers of improvements in profitability of cash flow. The third variable reported by the managers was that there were elements of the inadequacy of investing in the advancement or funding the research and development (R & D) departments of the companies. The uniqueness of the different sources of short-term pressure came from the fact that none of the variables arose directly from the formal model used by the company. That fact could explain the reason why the executive managers covered by the study were not aware of the different short-term performance bottlenecks (Demirag and Tylecote, 1996). However, according to the study by Demirag and Tylecote (1996), eliminating these elements of short-term pressure among British companies is very complex, noting that the short-term pressure created by bonuses is one administrative area, which is instrumental in improving the financial success of different companies. Further, budgets and targets must be set by all companies, as they act the indicators of performance; which makes the elimination of short-term pressure a very complicated process (Demirag and Tylecote, 1996). This is the case, because determining the level at which the budgets allocated are too low or the targets set for the managers become too high is predominantly a matter of debate, where there may not be any generalized views. There is also the dilemma of the levels of central funding that are sufficient, noting that R & D directors and company managers will always need more funding for the advancement of their departments. Capital-market related pressures The management of capital within capital markets is cited as one of the factors that lead to the short-term pressures experienced by managerial personnel. Among British companies, it is commonly agreed that the short-term pressures experienced by managers comes from their concerns about improving the share prices of their companies (Demirag, 1995). The managerial levels of concern regarding the improvement of the share prices of their shares is largely determined by their levels of fears about the possibility of a take-over attempt, and also whether they would like to create a new revenue channel through an acquisition or another form of organic growth. The short-term pressures of managers are compounded by the pressure that mounts from the demands of investors or the financial institutions that hold major stakes in their companies, which threatens the wellbeing of their company, in the case that their share prices do not improve (Demirag, 1995). In the light of this challenge, (EY, 2013) reported that UK workers are operating under intense pressure regarding the delivery of outcomes in the short-term. The situation is particularly acute for managers and the directors of UK companies, who are subjected to more short-term pressure to deliver upon the set targets, irrespective of the financial implications of the financial crisis. The survey administered among many board members, managers and the executives from UK companies showed that the unending short-term pressure to perform had made about 7 percent of the workers and the managers of the UK to report financial manipulation (EY, 2013). In the same light, John Stuart, the head of EY in UK reported that the short-term pressure and other pressures experienced by workers are compelling them to engage in fraudulent activities. In the past, institutional investors have shown more inclination towards exiting companies, compared to the situation of voicing the issues affecting the performance of these companies. Instead of working together with the management, these institutional investors resolve to threats about withdrawing, which pressure the management and the boards of directors to adopt short-term success seeking behaviors (Hribar, Jenkins and Johnson, 2006). The threats of institutional investors can take different forms, including the possibility of a hostile take over, voting against the different teams (managers and board members), the dismissal of the management by the owners or changing managerial policies (Demirag, 1995). Frank and Mayers (1990) made the observation that, during past decades like the 1980s, institutional investors have used both institutional exits and take-over cases to cause the exemplary dismissal of executives in Britain. Demirag (1995) states that the institutional market is predominated by pension funds, similar to the case of many companies in the UK. Taking into account that some of these institutional investors, particularly pension funds operate under short-term pressure conditions, it appears relatively justified for them to exert short-term pressure on the companies that benefit from their financing (Klein and Zur, 2009). Ownership-related pressures From one end of ownership, a family-owned company in the UK is more likely to act in a more patient manner, towards its managers, in the short and the long term (Maury and Pajuste, 2005). This ownership type will adopt a more long-term focus, similar to the case of municipal and government owned companies and cooperatives. The rationales behind their long-term outlook include the fact that these types of companies are more likely to hold a variety of objectives, in addition to the objective of maximizing profits. Some of these rationales include those of sustaining the stable and broad supply of goods and services, maintaining the competitiveness of business, maintaining competitive fees and prices in the long term, environmental considerations and employment creation, which are less likely to be substituted with the short-term goal of profit maximization (Bohren et al., 2004). The long-term outlook of these companies can also be traced to the fact that their ownerships are usually more stable. For example, the threats of a corporate takeover are forceful enough to pressure the management, to the extent of adopting short-term changes that can maximize profits (Bohren et al., 2004). Graham et al. (2006) compared publicly owned companies to those that are privately owned, and arrived at the conclusion that publicly owned companies are more likely to subject the management to more short-term pressure. This difference is the result of the fact that publicly owned companies will have more ownership ventures; particularly those owned by short-term investors like activist owners and mutual funds (Gitman, 2008). The findings of the survey by Graham et al. (2006), it was found that the institutional investors were the major ownership groups that subjected the management of companies under the pressure to perform and show results in the shortest time possible. This conclusion was made from the information collected from the managers of the companies covered by the study, who reported that the institutional investors were constantly pushing them towards the adoption of short-term behaviors. One source of pressure cited by these managers as a pressure for the adoption of short term behaviors was the view held by many of the managers that compensating fund managers was a major cause for the adoption of short-term focus (Graham et al., 2006). This is mainly the case because fund managers are depending on their funds perform; their performance is compared to that of peer managers. In real market situations, a “band wagon” effect can come into effect, in a case where all the funds begin to sell out, the stocks of companies that are not meeting their income targets. This situation shows that a widely-owned company, particularly one with majority institutional investors is more likely to operate under higher short-term pressure to perform (Graham et al., 2006). Apart from real and marginal ownership, firms in the UK face the pressure to adopt a short-term outlook by the interests of other stakeholders. Some of the influential stakeholders that can exert pressure for the adoption of short-term behaviors include financial analysts, through their work of producing services for investors (Van Horne and Wachowicz, 2009). Other stakeholders that lead to the adoption of short-term behaviors include unions, workers, the media and politicians. In the UK, the companies that are under the limelight of public interest, including municipal and state-owned companies are more vulnerable to the adoption of short term behaviors, due to the pressure mounting from the public and other agents, pushing them to improve performance of profit maximization. In the case of municipal and state-owned companies, short-term pressure can be exerted by the media, workers and their unions and politicians (Neate et al., 2013). In the UK, one of the companies facing a lot of pressure from politicians and the public is the Royal Mail, following the controversial floatation of its shares on the market. The company was also under the spotlight following a reduction in profits, following the reduction in the delivery of letters from 63 million in 2011/12 to 58 million in 2012/13; the company was under the pressure to invest in parcel delivery, so as to recover its profitability (Neate et al., 2013). Other factors controlling the degree of pressure for the adoption of short-term behaviors include the corporate governance models of the firm and managerial labor markets. One example of the variables under this cluster includes the management compensation models adopted by a company (Groot, 1998). Graham et al. (2006) reported that three-fourths of the respondents of the study held the view that a manager’s concern over their external reputation is among the factors underlying the desire to meet their earnings benchmark. The managers’ desire to realize the targeted earnings seems to be highly driven by their career projections, more than they could be driven by the motivation of compensation. Managerial Teams Initiated Short-term Pressures Demireg (1995a) discussed that different evidence-based studies show that the research and development officers of British companies report that short-term pressures start with the dynamics of capital markets; R & D officials are compelled to reduce the expenditure channeled towards the department. The short-term pressure exerted from the capital markets varies from one area to another, which is was evident from the fact that Demireg (1995a) only reported that about 53.5 percent of informants reported the acute impact of biasness against channeling funds towards research and development for long term success; instead, they channeled finances towards product development. However, the informants of the study reported that the shareholders and the analysts exerting pressure on the budgets allocated to R & D do not take into account, the value and the quality of proposed research and development projects. There is also a proportion of research and development (R & D) directors that express the sentiments that the pressure forcing them to reduce the budgetary allocation channeled towards R & D are relatively different. The views of these R & D officials include that the pressure for short-term profit maximization, so as to improve the satisfaction of shareholders, by financing the projects that are likely to foster profitability. The views of the finance directors of UK companies have not been uniform, as some report that short-terminism does not exist, while others believe that it exists among fund managers and institutional analysts. The views of finance directors appear to balance those of research and development officials, which could be explained using the differences in their official backgrounds and interests. For example, some of the managerial staffs covered by the study reported preference for R & D projects that are short-term in nature, as compared to those that are predominantly long term (Demireg, 1995a). The diversity of the views of the different managerial groups covered by the study shows that a majority of R & D officials regard and view capital markets as being short-termist, unlike the other group. On the other hand, the institutional shareholders and the investment analysts covered by the study showed a lack of education on the long-term outlook of the British industry as a whole, which could explain the differences in their views. Personal Position about Short-term Pressures among UK Companies In reflection to the discussion of the short-term pressure experienced by the managerial staffs of UK companies, it became evident that a number of factors fuel the pressure felt by the managers and the board members of UK companies. The wide array of factors shows that short-term pressures are a reality among UK companies, and are a major hindrance to the returns that yield from research and development (Faccio and Lang, 2002). From the discovery of these different variables from a wide variety of resources and authorities, it is conclusive that short-term performance is a non-escapable reality in the UK, and the situation needs to be addressed, so as to improve the outcomes of the UK market, among other variables. Conclusion Different companies in the UK adopt different investment horizons and focus, and the effects of some include the increased reporting of short-term pressures to report outcomes. The factors that can be attributed to the increasing levels of short-term pressure in the UK include the ownership patterns of companies, where institutional ownership is the major contributor to high levels of short-term pressure. Other factors contributing to short-term pressures among the management and the board members of UK companies include the reward structures adopted by different companies, the pressure from capital markets and the manipulation of the administration by managers. 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