The Owner vs. The Boss
Who controls the corporation? Most economists and investors would say "the shareholders." Even proponents of stakeholder theory agree that shareholders should have a significant say in how a firm conducts itself. In 2005 Jean-Paul Page wrote an excellent little book entitled Corporate Governance and Value Creation for the CFA Research Institute. It's a think piece on the role of corporations in society, written from first principles ("corporate governance begins with power") and a deep awareness of the contending schools of thought in the field. After much deliberation Page concludes that this should be the first commandment of corporate governance:
The ultimate power in a company must rest with its shareholders.
It's not hard to come up with an illustration for why this must be so:
Let's say you own an apartment building, and have hired a management company to run it. You're planning to sell the building in a year or so, so you decide to only do cosmetic maintenance. You authorize minimal repairs, but instruct the manager to put off major issues, if possible, for the next owner to deal with. Seeing this, the management company decides to hold back a portion of the rent payments you receive and 1) gives itself a raise and 2) begins managing the property as if they, not you, were the owner.
What would you do in this situation?
It is not an academic or hypothetical example. It is an almost exact description of what is happening in corporate America today. Enthused by the prospects of a sale (to private equity, perhaps), and pressured by performance-driven compensation structures, shareholders are becoming more short term-oriented than ever. As discussed many times here, time horizons have shortened to microscopic levels - the average turnover on the New York Stock Exchange is 100%, suggesting the average investor is looking out about one-year. Since many shares never trade (think of all that low cost-basis stock in bank trust accounts), the de facto time horizon for a given trade is even shorter than that. People don't own stocks anymore, they rent them.
And the managers hired to run the business are increasingly treating the owners like tenants. Let me rephrase the story I just told you:
Let's say you manage an apartment building for an absentee landlord. Inattentive, fickle, and unsophisticated, this person is trying to sell the building for a quick profit. You've been authorized to do only cosmetic maintenance - putting off major issues for the next owner to deal with. After thinking it over, you decide to hold back a portion of the rent payments you receive and 1) give yourself a raise (you need to get more money up front - who knows what the next owner will think of you?) and 2) begin managing the property from a longer-term perspective (the owner may not care if the building falls down the day after the sale, but you do).
In the latest Business Week, Clayton Christensen and Scott Anthony present the clearest defense I have seen of management's perspective ("Put Investors in Their Place"). "Why," they ask, should management "pander to people who now hold shares, on average, less than 10 months? Should managers really regard such investors, whose investment horizons are shorter than the most nearsighted of managers, as stakeholders whose value they ought to maximize?"
Well, game on. The battle for control of the corporation is now clearly out in the open. Large pools of equity capital, sophisticated investment banks, and leading management consultants are offering alternatives to the longstanding model of public ownership of U.S. corporations. If that model cannot be fixed, and soon, society will face a significant loss of corporate transparency and accountability, as companies are taken private. Christensen and Anthony point out that companies in Asia, such as Tata (India) and Li & Fung (Hong Kong) are doing exceptionally well without the help of day traders and corporate governance activists.
Christensen and Anthony argue that this will come with social benefits. Their script for managers reads: "Our responsibility is to maximize the long-term value of this company. We will therefore act in the interest of those whose interests coincide with our long-term prospects, namely employees, customers, the communities in which our employees live, and the minority of investors who plan to hold our securities for several years."
It is a noble goal. But the choice is not a simple one. Should social investors be prepared to sign away Page's "ultimate power" to get the social benefits (which, after all, are just a promise)? Or is it time to start looking for a new management company?
