ALEX EDMANS: The 20th century firm competed predominantly according to cost efficiency. Companies achieved success by mass-producing standardized products more cheaply than their rivals. For example, Henry Ford is credited as saying that “any customer can have a car painted any color that he wants so long as it is black”. Tangible assets, such as factories and machines, were key to productive efficiency.  The modern firm is different. Consumers view quality and customization as increasingly important compared with price. To deliver on these dimensions, a company must have superior intangible assets, such as human capital and innovative capability. How can a CFO ensure that he or she builds for the future?  1. Look Beyond the Quantitative, and Look To the Qualitative. Investment costs money. Thus, it’s easier to justify if its fruits are immediately visible, as with tangible investments. Investors can see if a firm has bought a factory, and thus know that if its cash position is low, it’s due to investment. But if a firm invests in its corporate culture, this isn’t immediately visible, so investors may interpret the resulting low cash position as stemming from poor managerial quality. If CFOs only make investments with quantitative payoffs, they’ll neglect the qualitative dimensions that are critical for future success. There is ample evidence that intangibles are important. One of my papers showed that firms with high employee satisfaction, as measured by inclusion in the “100 Best Companies to Work for in America,” outperformed their peers by 2% to 3% a year over a 26-year period. Another conclusion: It’s satisfaction that causes performance, not the other way round.  2. Shift Attention from the Short Term to the Long Term. Since they aren’t immediately visible, intangible assets take a long time to pay off. I find that the stock market takes four to five years before it fully incorporates the benefits of employee satisfaction. Thus, if CFOs favor projects with short payback periods, they will shirk on some of the most valuable investments.  3. Avoid Providing Earnings Guidance. Providing guidance on likely quarterly earnings numbers increases transparency, but also means that the market holds firms accountable to their forecasts. Thus, companies will focus on meeting short-term targets, rather than pursuing long-term value. Google refrains from providing guidance, to allow it to focus on the future. In some countries, companies have the discretion to go further and choose not to report quarterly earnings at all. Unilever has stopped doing so, to attract shareholders who look beyond the next quarter.  4. Focus on the Structure, not Level of Pay. A key challenge is for managers to pay enough to retain their best staff, without eating too much into company profits. However, at least as important as the level of pay is the structure—in particular, the horizon over which bonuses are paid out. Paying bonuses, or making promotion decisions, according to short-term profit will encourage workers to focus on the short-term. Even if their actions have negative long-term consequences, the workers hope to have cashed out their bonus or been promoted into a new role.  5. Communicate Intangibles to Investors. Firms are required to disclose financial numbers in their annual reports, but they can also choose to report qualitative dimensions of their performance, such as corporate social responsibility and employee training initiatives. They can also seek independent third-party verification of their intangible assets, for example by applying to be considered for the Best Companies lists. Knowing that these intangibles will be reported, managers will have greater incentives to invest in them to begin with.  Alex Edmans (@aedmans) is professor of finance at London Business School. His TEDx talk on employee satisfaction and stock returns is at http://bit.ly/tedxcsr.
Corporate finance has changed significantly in the past few years, from the way companies handle risk, cash flow, and even their earnings calls.