Short-term incentives motivate short-term behavior. Corporate boards can drive long-term performance by making changes to remuneration that encourage long-term behavior by executives while avoiding common pitfalls. Similarly, investors can support long-term executive remuneration plans through their votes and engagement.

Financial incentives motivate behavior—indeed, financial incentives may work too well. Executive pay is focused on a short time horizon—with recent data pegging average duration of executive compensation plans for CEOs of MSCI All Country World Index (ACWI) constituents at 1.7 years. [1] This short-term focus can have far-reaching consequences, yet setting out to make remuneration longer-term is no simple task.

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Ample evidence shows that when executives consistently make decisions and investments with long-term objectives in mind, their companies generate more shareholder value, create more jobs, and contribute more to economic growth than do peer companies that focus on the short term. Addressing the interests of employees, customers, and other stakeholders also brings about better long-term performance. The future, it seems, should belong to leaders who have a long-term orientation and accept the importance of treating various stakeholders fairly.

Nevertheless, our research shows that behavior geared toward short-term benefits has risen in recent years. In a recent survey conducted by FCLTGlobal and McKinsey, executives say they continue to feel pressure from shareholders and directors to meet their near-term earnings targets at the expense of strategies designed for the long term. Managers say they believe their CEOs would redirect capital and other resources, such as talent, away from strategic initiatives just to meet short-term financial goals.

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Executive Summary

Effective long-term capital allocation is fundamental for innovating and creating value; investment in research and development (R&D) fuels this growth. Successful R&D can be transformational for an organization and for broader society. But while worldwide spending on R&D has slowly increased, R&D returns have been declining. What’s driving this decline? Emerging evidence suggests a short-term mindset lies at the heart of this puzzle.

R&D spending, especially long-horizon R&D project spending, faces a unique set of short-term pressures relative to other types of long-term investment. When facing short-term financial pressures, behavioral biases including manager risk aversion and uncertainty around forecasting potential future returns (among other things) lead to a tendency among management teams to cut long-horizon projects first. The declining tenure of managers, the lack of innovation-linked metrics in incentive compensation plans, the typically asymmetric return profile of long-horizon projects, and an investment community that often ignores the potential impact of long-horizon innovation spending in a company’s valuation analysis all contribute to this problem.

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Executive Summary

Effective long-term capital allocation is fundamental for innovating and creating value; investment in research and development (R&D) fuels this growth. Successful R&D can be transformational for an organization and for broader society. But while worldwide spending on R&D has slowly increased, R&D returns have been declining. What’s driving this decline? Emerging evidence suggests a short-term mindset lies at the heart of this puzzle.

R&D spending, especially long-horizon R&D project spending, faces a unique set of short-term pressures relative to other types of long-term investment. When facing short-term financial pressures, behavioral biases including manager risk aversion and uncertainty around forecasting potential future returns (among other things) lead to a tendency among management teams to cut long-horizon projects first. The declining tenure of managers, the lack of innovation-linked metrics in incentive compensation plans, the typically asymmetric return profile of long-horizon projects, and an investment community that often ignores the potential impact of long-horizon innovation spending in a company’s valuation analysis all contribute to this problem.

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Executive Summary

Operating at the nexus of short-term performance pressures and the behaviors that promote long-term value creation within the firm, the chief financial officer (CFO) has a unique ability to drive long-term value creation for the organization. Among their growing set of responsibilities, CFOs and their teams report company financial results, communicate with and field questions from investors, secure financing to fund corporate strategies, and act as a strategic resource for the chief executive officer (CEO) and board of directors.

CFOs need to manage legitimate short-term performance pressures and, at the same time, advocate for capital allocation decisions with long-term benefits, even if potential contributions to corporate earnings are years in the future. CFOs are essential to driving long-term behaviors and are in a unique position to make a meaningful difference. According to one leading academic, “There’s a huge opportunity for CFOs to focus firms on what truly matters.”

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