« The future of corporate governance »

« Large corporations can and should play a significant role in how we deal with social and environmental issues. To do this, however, they need to focus on building long-term value for all stakeholders rather than focusing on delivering short-term returns to shareholders.

When managers and board of directors of widely held, stock-market listed corporations look at the financial and governance landscape, what do they see?

• A widespread belief (at least in Anglo-Saxon countries) that boards of directors have a legal responsibility to act solely in the interest of shareholders and that shareholder value creation is their sacred duty
• A ritual of quarterly meetings with financially driven analysts, all about meeting expectations for earnings per share and growth in revenues
• Speculators of all sorts who can, and do, play nasty games with the company’s stock (short-selling, total return swaps, puts and calls, etc.) or its public debt (credit derivative swaps, etc.)
• The looming possibility of being targeted by “activist” hedge funds, if the company fails to meet financial expectations and create shareholder value
• The monitoring of their corporate governance and executive compensation by proxy advisors with considerable influence on the election of board members
• High turnover of shareholding, with a median holding time of under two years for institutional investors and an overall average holding period of less than a year as a result of high-speed trading, etc.
• Executive compensation systems, which in spite of all efforts are still considered by many as aberrant and based on measures that reward short-term performance

Senior executives may well believe in the need to broaden the horizon and the goals of the corporation. But the diktats of financial markets and typical executive compensation linked to stock price will convince them of the wisdom of a rising stock price and ever-growing earnings per share. All other stated goals become secondary, lip service or good public relations.

Until some pretty fundamental changes are made to this system, widely held, listed corporations will not, cannot really, pursue long-term strategies beneficial to all stakeholders, and society at large.

Some changes: who owns the company?

An important change, or rather a clarification, relates to the fundamental question: to whom are company directors and managers accountable?

The pat answer, of course, is shareholders. But this shareholder primacy is largely a myth.

Legal statutes and precedents in several countries, including Canada, the United Kingdom and several states of the United States, establish that boards have to make decisions “in the long-term interest of the company” (Canada) and “that the directors must exercise their business judgment and decide what is in the corporation’s long-term interests” (USA). Company law in the United Kingdom is even more explicit, stating that company directors “must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole.”

Indeed, boards of directors in many countries actually have a legal authority they rarely exercise or are frightened to use: to act in the long-term interest of the company and its various stakeholders.

Corporate citizenship

Several other measures would likely change the pernicious dynamics just described. For instance, in all decent societies, newcomers must wait a period of time before acquiring full citizenship and the right to vote. Tourists, for example, don’t vote. Why not institute a form of corporate citizenship whereby shareholders acquire the right to vote only after one year of ownership and “tourist shareholders” do not get to vote?

Why do institutional investors continue to be hostile towards dual-class shares, a capital structure in companies such as Berkshire-Hathaway, Google, Facebook, The New York Times and Netflix? This form of ownership, when structured in a way that protects minority shareholders, provides continuity of control for entrepreneurs, protects long-term planning and makes the company impervious to short-term financial games.

Alternatively, why not allow companies to limit, through their charter, the percentage of votes which may be exercised, irrespective of the percentage of shares owned. For instance, Nestlé, operating under Swiss corporate law, has limited voting rights to 5%.

Why not give corporations the possibility to calibrate dividends according to holding period, as is possible under French corporate law? What if governments were to set tax on capital gains on a sliding scale, decreasing as holding periods increase?

Compensation

The forms and levels of executive compensation have often turned management into well-paid servants of shareholders addicted to stock price rushes.

Why not eliminate executive compensation directly linked to share prices? At the very least, let’s eliminate yearly grants of options and restricted shares as well as the weakest link of the whole system: setting compensation on the basis of what a set of comparator companies pay their own executives.

Large companies should attend to the needs of several constituencies, including investors. But that will not happen, really happen, unless changes are brought to the sort of financial capitalism which has come to dominate the economic functioning of societies. »