Senior risk executives have privately been concerned for some time over the sharemarket’s infatuation with short term earnings. Now, high profile figures are joining in the debate. Michael Chaney, chairman of National Australia Bank, recently summed up Australian business’s obsession with improving short term profits at the expense of long term stability.

The Group of 100, which represents the chief financial officers of Australia’s 100 largest listed firms, is also concerned. Its president, Tom Honan, who is also CFO at Compushare, said recently that companies must be aware of the pervasive effects of ‘short-termism’ and focus attention on long term objectives. He added that the health of the private sector is dependent on long term planning and execution of corporate and investment strategies.

“This contrasts with the pre-occupation of some in the investment community with the short-term performance of companies often induced by their rewards systems that focus on a short period of performance measurement — for example, quarterly,” he said. “In turn this leads to concerns that an excessive focus on short-term performance is creating a climate of risk aversion and focus on delivering short-term performance to meet expectations, this will tend to shift focus away from long-term sustainable value creation for shareholders.”

The prudential regulator is also concerned. Brandon Khoo, general manager of the Australian Prudential Regulation Authority’s specialised institutions division, recently warned firms not to relax risk management practices for the sake of growth and to avoid cutting investment in risk management functions.

“It is important to also recognise that as the world changes, so do the demands on risk management,” he said. “Even if risk management budgets and staff headcounts do not decline, there may well be a need to increase resources just to stand still. Certainly, any institution that is not investing significantly in risk management in the current environment may be falling behind its more forward-looking peers.”

Khoo added that it is now common to read that upon appointment of a new CEO or an annual results presentation, a company announces major short term cost cutting. While this is clearly aimed at shareholders, obviously a key group, the consequences of short term cost cutting do not become clear for some time into the future.

“ADIs [authorised deposit-taking institutions] of course have an additional obligation to depositors, and as the prudential regulator, APRA has an expectation that ADIs will be cognisant of this,” Khoo said. “As the prudential regulator, it is our role to ensure that ADIs understand this obligation otherwise it may be necessary for APRA to mandate a level of protection that it feels is appropriate. In particular, I make the point that we would not want to see cost cutting jeopardise key risk management or oversight areas as that could potentially increase the risk to depositors.”

The G100 suggested that regular communication to shareholders should focus on how companies are building long term shareholder value and the way in which current performance reflects progress towards achieving those objectives. Honan added that employee bonus and compensation schemes should be designed to reward progress towards achieving long term goals and avoid rewarding short-term out-performance.

The fallout from the National Australia Bank foreign exchange options scandal showed in acute detail how short-term performance-related bonus schemes can severely impact, and in some cases override, risk management policies and procedures.

Khoo added that focusing solely on earnings per share (EPS) can be a dangerous and short-sighted policy. “In the corporate sector in Australia, short term EPS seems to have become a significant driver,” he said. “This desire to improve upon previous years’ results needs to be tempered with reality. For ADIs, in a slowing market for housing credit, how realistic is it to be looking to maintain or improve on previous years’ results? What compromises will need to be made to achieve this? As I mentioned previously, looking to maintain results of previous years in a slowing market may be a very ambitious target.”

Stuart Fagg is the Editor of Risk Management magazine, Lawyers Weekly’s sister publication.