THE ERROR AT THE HEART OF CORPORATE LEADERSHIPAll we can say is that companies with a long- term orientation tend
to perform better than similar but short- term- focused fi rms. Even
so, the correlation we uncovered between behaviors that typify a
longer- term approach and superior historical performance deliver a
message that’s hard to ignore.
To construct our Corporate Horizon Index, we identifi ed fi ve fi nan-
cial indicators, selected because they matched up with fi ve hypothe-
ses we had developed about the ways in which long- and short- term
companies might diff er. These indicators and hypotheses were:
- Investment. The ratio of capex to depreciation. We assume
long- term companies will invest more and more- consistently
than other companies. - Earnings quality. Accruals as a share of revenue. Our belief
is that the earnings of long- term companies will rely less on
accounting decisions and more on underlying cash fl ow than
other companies. - Margin growth. Diff erence between earnings growth and
revenue growth. We assume that long- term companies are
less likely to grow their margins unsustainably in order to hit
near- term targets. - Earnings growth. Diff erence between earnings- per- share
(EPS) growth and true earnings growth. We hypothesize
that long- term companies will focus less on things like Wall
Street’s obsession with earnings- per- share, which can be
infl uenced by actions such as share repurchases, and more
on the absolute rise or fall of reported earnings. - Quarterly targeting. Incidence of beating or missing EPS
targets by less than two cents. We assume long- term com-
panies are more likely to miss earnings targets by small
amounts (when they easily could have taken action to
hit them) and less likely to hit earnings targets by small
amounts (where doing so would divert resources from
other business needs).