The perils of playing to quarterly expectations: focusing on the short term in order to please investors can be a destructive trap. Two consultants argue that longer-term goals for building value should set the agenda.

• Author: Favaro, Paul

As investors look for signs that corporate performance is finally rebounding, they are scrutinizing quarterly earnings announcements more than ever. The pressure on management to deliver a specific earnings per share (EPS) target seems to be at an all-time high. In the past nine months, shares of respected companies like Kraft Foods, The Kroger Co. and Target have dropped significantly after their managements announced they would miss quarterly earnings forecasts--if even by lust one cent (as was the case with both Target and Kroger). Themselves under fire, board directors have become increasingly impatient with CEOs who fall short of promised results, doubling the pressure on top executives to meet expectations.

Given these pressures, it's hard to resist the temptation to set short-term financial goals to meet analysts' quarterly estimates. However, giving in to this temptation can make matters worse. For starters, a focus on short-term targets often stands in the way of building the capabilities and making the investments required to increase a company's longer-term value. It can actually destroy value in the long run.

How can top management avoid these traps? By understanding what truly drives growth in intrinsic value and adopting a new approach to setting long- and short-term goals. The approach, which has helped companies like Lloyds TSB and Coca-Cola Co. sustain exceptional value growth over time, ensures that short- and long-term goals are in harmony with the drivers of value.

In our experience, this requires top managers to redefine their role: to deliver solid near-term results and create a more valuable business for the long run. To do so, the process of setting financial and operational goals must strike the right balance between short-term stretch and long-term sustainability.

Executives who set goals just to meet short-term EPS expectations typically assume that strong capital market performance is the result of delivering what the market wants. So, if investors anticipate 15 percent EPS growth in the quarter, these executives would expect 15 percent EPS growth to result in 15 percent share price growth. This, of course, assumes price-earnings multiples hold steady, which they do only if investors' long-term expectations don't change. More likely, though, is that P-E multiples will change as investors revise their outlook for long-term growth and returns, which suggests that delivering only in the near term is not sufficient to drive sustained value growth.

Consider California-based Network Associates. Early last year, the computer network security firm announced that it had topped fiscal fourth-quarter expectations. Yet its shares fell by about 17 percent that day and continued falling in the subsequent weeks. Why?

Despite exceeding analysts' short-term EPS estimates, the company found that its customers were delaying technology investments or eliminating significant parts of their IT budgets. This raised investor concerns about Network Associates' ability to sell some of its core corporate...