More Dialogue About the Role of Shareholders in Corporations

News Brief
October 5, 2012

By Cydney Posner

The debate about "shareholder value" and the role of shareholders in corporations continues.  (See the July 2, 2012 and October 11, 2011 News Briefs for further background.)  In this piece from the NYT, Down With Shareholder Value, Joe Nocera argues that, over time,  the focus on "shareholder value" has had none-too-pretty results. He considers the pressure to boost short-term earnings – and the executive compensation that depends on them – to be part of the impetus for the financial crisis, as ‘financial institutions took on far too much risk in search of easy profits that would lead to a higher stock price.  Now, though, it feels as if we are at the dawn of a new movement — one aimed at overturning the hegemony of shareholder value…..One of [various academics'] arguments is that the calls for increased shareholder democracy are misguided; shareholders, they write, simply aren't particularly well-suited to be ‘corporate bosses.' They are too diffuse, and too short-term-oriented, especially now that high-frequency trading dominates the market. Indeed, despite the increased emphasis on shareholders the past few decades, companies haven't gotten noticeably better. A second argument, though, is that the central idea that led us to elevate shareholders above all others is off-base. According to the reigning academic theory, shareholders are ‘principals' and management serves as their ‘agent.' Thus, it is the job of the principals to keep the agents in line. But, said [one academic], ‘The more you treat executives that way, the more they are going to act like mercenaries, and the more they get away from seeing themselves as stewards of an organization with lasting value. Look at almost any company that has lasted…. It is inevitably because executives see themselves as trying to move the organization forward, and not because they are incented by their pay package to maximize the share price.' " These academics tend to see corporations serving a larger function as part of society, including providing goods and services, providing employment and paying taxes. Looking for signs that the new movement may be taking root, Nocera points to a WSJ story about "Marissa Mayer, the new chief executive at Yahoo, ordered that the stock ticker be removed from the company's internal home page. ‘I want you thinking about users,' she told employees…."

However, this article from Compliance Week,The Misconceptions Behind the New 'Blame Shareholders' Viewpoint, as its title suggests, takes quite a different view.  The authors argue that shareholders should not be viewed as a "new public enemy," and that efforts by academics and others to attribute short-termism in corporate America and the scandals of the financial sector to the shareholder-value movement are misguided:  "As corporate governance experts and long-time shareowner advocates, our first reaction is to shake our heads. Shareowners' rights caused a reduction in our standard of living? Or poor customer service by insurance companies? Or the fall of Lehman Brothers?  Clearly, these are ridiculous claims, but further reading suggests there's a bit more going on here. " The academics who denounce insidious characteristics such as "short-term thinking, an executive compensation system that rewards transitory or illusory and non-sustainable performance, and lack of corporate responsibility to the wider economy" are not wrong to criticize those characteristics, they argue, just wrong to attribute blame to the shareholders. While "it's true that the average holding period of a U.S. company has dropped precipitously from an estimated seven years in 1940 to about seven months today[,]… averages by definition crush a wide variety of investing styles into one number. In the past few years, we have seen a meteoric rise in high-frequency trading; firms that employ such methods (we refuse to call them ‘investors') have holding periods closer to seven seconds. The result, according to [academic] research… is a shareholder base that is as layered as a wedding cake, with frothy high-frequency traders layered atop a mass of more traditional investors with more traditional holding periods. [The author of the study] finds that the average holding duration … of traditional investors has remained remarkably steady over the years. In fact, contrary to popular myth, it appears to have increased slightly, even as daily turnover has skyrocketed."  Although CFOs, corporate secretaries and investor relations personnel, as well as institutional shareholders, seem to recognize that many shareholders hold their stock for the long term, "somehow corporate boards and C-suites say they have no option but to kowtow to the perceived short-termism of the market, inferring from short-term stock price movements either validation or criticism of their latest corporate strategic plan or announcement. The reality is that price is driven by in-and-out traders over the short term, not by that steady list of top long-term owners—the company's most important owners—who may not trade the company's stock for months. By focusing on daily stock price, companies empower the short-term traders and ignore loyal long-term owners."  The authors contend instead that a better tactic might "be to communicate directly to the longer-term holders, who vote the majority of the proxies and have multi-year time horizons…."

Similarly, the authors suggest that the problem with executive pay is not the result of shareholder pressure, but rather the development of "executive compensation plans that rewarded short-term growth at the expense of prudence and sustainability as a contributing factor (along with lax regulation, structural changes in the banking system, and a host of others)." It was "a simplistic application of pay-for-performance that incentivized bankers to take unacceptable short-term risks." While some argue that "the rise of the shareholder-value movement … was the ‘tipping point' in creating the financial crisis.... To [the authors], that seems a bit like blaming the victim: What of the compensation consultants who created those structures, the compensation committees that granted them, or the executives who negotiated for them and cashed the checks. Certainly, shareowners did not put a gun to those heads and say ‘please pay them boatloads of money to blow up our investments.' In fact, most of the investigations that identified executive compensation as a contributing factor to the financial crisis suggested increasing, not decreasing, shareowner power. And, interestingly, say-on-pay seems to be the one aspect of the Dodd-Frank legislative package that most think is working well, on balance. It has increased the conversation between the shareowner and corporate community, largely in a respectful and constructive manner."

The authors recognize that the shareowner community is not "free of blame. Institutions allow unreformed short-term corporate raiders to dress themselves in the colors of investor advocates, and even occasionally employ them and cheer them on, rather than denounce them." However, the authors contend that the new movement has the "potential to demonize shareowners at exactly the time when engagement and constructive dialogue behind the scenes are gaining traction. And that would be a shame for all."