31 March 2004
No Stock Market Discipline of Management
The Securities and Exchange Commission is considering adopting a rule that would make the Boards of Directors of regulated corporations into vehicles for shareholder control of management. The role of Boards in assuring proper governance of publicly-owned enterprises has historically been a consultative one. It has been their responsibility to diligently provide good judgment to corporations’ managements. Their nomination and selection, according to by-laws of each corporation, has often been assigned to management and major shareholders.
Ultimately, shareholder control over management has traditionally been exerted through the discipline of the stock market. Corporate Boards of Directors have helped management to anticipate those shareholders’ decisions to buy or sell the company’s stock. Management has generally benefited from their counsel. The relationship has been a symbiotic one, not adversarial.
Now, the government’s principal regulatory authority is moving towards enlisting Boards as instruments of its control over corporate managements. Why does the stock market no longer perform this function efficiently? Perhaps it has to do with the infection of the shareholding public with the greed that certain corporate executives have allowed to drive their operating decisions. Shareholders go along with executives who seem to be able to play the markets so as to maximize the value of their own shareholdings and options, even if it means ignoring the long-term health of those corporations.
Markets do not take a long view. While stock ownership is broader than ever, the dominance of funds managed by professionals has made trading the key skill determining their success. When stock ownership was primarily in the hands of individual investors, small and large, the long run return on individual stocks was more important. Now, it’s the long-run return on the portfolio of stocks held by mutual funds that compels individual investors. Thus, corporations have seen their attractiveness to investors change from bringing long-term returns to presenting good plays to traders. Profits and dividends have yielded the stage to capital gains as the platform on which traders and executives both earn their rewards.
The Securities and Exchange Commission is considering adopting a rule that would make the Boards of Directors of regulated corporations into vehicles for shareholder control of management. The role of Boards in assuring proper governance of publicly-owned enterprises has historically been a consultative one. It has been their responsibility to diligently provide good judgment to corporations’ managements. Their nomination and selection, according to by-laws of each corporation, has often been assigned to management and major shareholders.
Ultimately, shareholder control over management has traditionally been exerted through the discipline of the stock market. Corporate Boards of Directors have helped management to anticipate those shareholders’ decisions to buy or sell the company’s stock. Management has generally benefited from their counsel. The relationship has been a symbiotic one, not adversarial.
Now, the government’s principal regulatory authority is moving towards enlisting Boards as instruments of its control over corporate managements. Why does the stock market no longer perform this function efficiently? Perhaps it has to do with the infection of the shareholding public with the greed that certain corporate executives have allowed to drive their operating decisions. Shareholders go along with executives who seem to be able to play the markets so as to maximize the value of their own shareholdings and options, even if it means ignoring the long-term health of those corporations.
Markets do not take a long view. While stock ownership is broader than ever, the dominance of funds managed by professionals has made trading the key skill determining their success. When stock ownership was primarily in the hands of individual investors, small and large, the long run return on individual stocks was more important. Now, it’s the long-run return on the portfolio of stocks held by mutual funds that compels individual investors. Thus, corporations have seen their attractiveness to investors change from bringing long-term returns to presenting good plays to traders. Profits and dividends have yielded the stage to capital gains as the platform on which traders and executives both earn their rewards.
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