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What is the Numbers Trap?

Thoughts on value Talks that inspire Books we love

Excessive boardroom focus on number-crunching and cost management is coming at the expense of experimentation, innovation and top-line growth. In this fearful, post-Lehman age, finance directors, accountants and procurement officers have a great deal of power. Chief executives (especially former finance directors like me) should take note: it’s hard to imagine the future when your head is buried in a spreadsheet. – Sir Martin Sorrell, Founder and CEO, WPP

For business leaders the job is more challenging than ever before.  There’s pressure to control costs, but this isn’t sufficient – it’s cost and growth and managing risk and creating value.  This requires a change in mindset.

Trust in corporations is at an all time low and organisations are being called upon to develop more sustainable business models that connect to the needs of society and consider the value they contribute to society more completely.

The International Integrated Reporting Council (IIRC) reporting framework is intended to help restore public trust.  Mandatory for UK listed companies from 2014, integrated reporting requires that companies state how their strategy, governance, performance and prospects will lead to the creation of value over the short, medium and long term. This process results in communication about how all of a company’s resources will create value over time – most visibly through a periodic “integrated report”.

Business leaders are being called upon to reform capitalism by fighting “the tyranny of short-termism” by ignoring market pressures to maximise short-term results and by cultivating a share register of active, engaged asset owners that seek to create value through collaborating with the board of directors and management to optimise their value creation strategy over time.

But all the evidence is that “quarterly capitalism” is actually getting worse. Business leaders, whose incentives are linked to share price performance are challenged by asset-managers with a short-term focus, that increasingly set the market price.  They take a narrow view of a stock’s value that is unlikely to lead to efficient pricing and collectively leads to herd behaviour, excess volatility, and bubbles.

We call this state of affairs the “numbers trap” – leaders become so focused on the numbers that they lose sight of what creates value in the first place – people.

In turn, corporate boards and management make suboptimal decisions for creating long-term value. This undermines their ability to invest and grow and has far reaching consequences on GDP, unemployment and returns to savers and pensioners.  The typical response of many asset owners, to a failing corporate strategy or poor environmental, social, or governance practices is not to act like owners at all, but simply to sell the stock.

With neither business leaders or shareholders leading with the mindset of long-term wealth creation an “ownership vacuum” arises, allowing the interests of the small subset of shareholders who are the most short-term, opportunistic, undiversified, and asocial, to thrive.