Brookings: Series - Corporate Purpose

Can Executive Compensation Reform Cure Short-Termism?

Andrew C.W. Lund and Gregg D. Polsky — Mon, 18 Mar 2013 00:00:00 -0400

There is an increasingly pervasive view among corporate governance observers that senior managers are too focused on short-term results at the expense of long-term interests. Concerns about “short-termism” have been expressed within the financial industry context and outside of it, but because of the recent financial crisis, much of the discussion has been directed at financial institutions. To combat short-termism, several commentators have advocated executive compensation reform to encourage senior managers to adopt a longer-term perspective. Yet these reforms will likely prove ineffective because of other significant pressures on managers to maintain current stock prices.

Paper highlights include:

A general overview short-termism and the causes and effect of overweighing short-term results relative to long-term consequences when making decisions.
Proposals to redesign compensation structures to combat short-termism.
Questioning the effectiveness of compensation proposals.
A look at the new corporate governance world.
An examination of changes to senior management job security.
Policy proposals for better options to mitigate short-termism.

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Authors

Andrew C.W. Lund
Gregg D. Polsky

Image Source: © Lisi Niesner / Reuters

Reimagining a Corporation’s Purpose in the Great Recession Era and Meeting Threats to Free Enterprise

Wed, 30 Jan 2013 14:00:00 -0500

Event Information

January 30, 2013
2:00 PM - 3:30 PM EST

Falk Auditorium
Brookings Institution
1775 Massachusetts Avenue, N.W.
Washington, DC 20036

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The current economic climate is obviously a difficult one for U.S. corporations: the economy is sluggish, the housing market has yet to fully rebound, consumer demand is down, and Wall Street’s relationship with Washington appears to have hit an all-time low. To add to these mounting difficulties, corporate America’s current focus appears to have shifted heavily toward maximizing shareholder profits and executive compensation at the expense of long-term corporate growth and business stakeholders, including employees, investors and communities. “Corporate short-termism” and profit by any means necessary are veritable threats to free enterprise and the health of the U.S. capital markets.

On January 30, as part of a series on corporate purpose, Brookings hosted a discussion on the substantial challenges modern-day corporations face as they struggle to rebound in an historically difficult economic environment, which is seemingly bound by different ethics than eras past. Moderated by Governance Studies Vice President Darrell West, a panel of experts explored how the short-term focus of shareholders and investors affects corporate behavior and government policy; how to encourage longer time horizons among shareholders and executives; how companies can best serve the interests of its stakeholders; and how corporate America can best meet the challenges presented by the Great Recession.

Reimagining a Corporation’s Purpose in the Great Recession Era and Meeting Threats to Free Enterprise

Wed, 30 Jan 2013 00:00:00 -0500

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January 30, 2013, 2:00 PM - 3:30 PM EST

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Wed, 30 Jan 2013 00:00:00 -0500

Is It Time to Reform Executive Compensation and Stock Option Grants?

Thu, 27 Sep 2012 10:00:00 -0400

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September 27, 2012
10:00 AM - 11:30 AM EDT

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

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In recent decades, executive compensation has increasingly shifted toward a model tied to stock option grants. As a result, many corporations fixate on short-term stock gains, harming the nation’s ability to innovate and build a long-term focused, sustainable economy. This trend in executive compensation raises the question of whether there are better ways to reward executives and make them more accountable to shareholders, stakeholders, and society.

On September 27, Governance Studies at Brookings hosted a forum on executive compensation practices and the links to economic vitality. A panel of experts discussed the changes in corporate pay since 1980 and how they have affected companies’ long-term viability, as well as possible solutions that would encourage executives to focus on long-term business goals and growth.

After the program, speakers took audience questions.

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Whose Capital; What Gains?: Why the U.S. Economy Needs to Change Incentives

Lawrence E. Mitchell — Tue, 10 Jul 2012 00:00:00 -0400

If we fail to change the incentive structures of American management and financial markets, our nation’s long-term economic well-being and, with it, our national security, will suffer, writes Lawrence Mitchell. The crisis was decades, and perhaps more than a century, in the making, and is the result of many different factors that can be found in the historical record.

In this new paper, Mitchell argues that common stock has almost never been a source of permanent capital in American industry. And, he writes, the sources of capital gains has also dramatically shifted from the 1950s, when Merton Miller and Franco Modigliani, developed their famous dividend irrelevance theory, from corporate profits in the form of retained earnings to future profits in the form of velocity-induced trading gains. While both of these propositions may seem counterintuitive, the latter will seem plainly wrong, at least to devotees of efficient market theory. But the empirical correctness of the former proposition underlies the contemporary theoretical weakness of the latter.

The net results are that shareholders, or managers on their behalf, are gambling with debtholders’ money, and that the future profits of American industry are being spent today. Both call into question the sustainability of American industry and the future wealth of the United States.

Mitchell makes a number of recommendations in this paper, incuding:

Build long-term investing into the initial investment decision by developing a sliding scale capital gains tax, with highly punitive taxation for short-term trading, diminishing over time to tax forgiveness for long-term holding.
Include returning to largely insider boards (outside directors tend to manage by stock price) and making appropriate accounting changes to rely more heavily on cash flow than income statement accounting.

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Whose Capital; What Gains?: Why the U.S. Economy Needs to Change Incentives

Authors

Lawrence E. Mitchell

Image Source: © Chip East / Reuters

The Problem of Corporate Purpose

Lynn A. Stout — Mon, 18 Jun 2012 00:00:00 -0400

In a new paper, Lynn A. Stout, questions the purpose of the modern public corporation. Is it to maximize shareholders’ wealth? Or are other goals, like serving customers or providing innovative products, valued in their own right?

Stout looks at the history of corporations and their attitude towards shareholder wealth and outlines how this relatively new notion of shareholder value thinking gets the law, economics and evidence wrong.

Stout explains that the current predominant view is that the purpose of corporations is to increase stock price, despite the fact that this shareholder value ideology is a relatively new development in the business culture. It is not supported by the traditional rules of American corporate law; is not consistent with the real economic structure of business corporations; and is not supported by the bulk of the empirical evidence on what makes corporations and economies work.

Indeed, there is good reason to suspect that focusing on “shareholder value” may in fact be a mistake for most business firms. This is because there is no single shareholder value—different shareholders have different needs and interests depending on their investing time frame, degrees of diversification and interests in other assets, and perspectives on corporate ethics and social responsibility. This ultimately harms most shareholders themselves—along with employees, customers, and communities.

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The Problem of Corporate Purpose

Authors

Lynn A. Stout

Image Source: © Lucas Jackson / Reuters

Mobilizing Ownership: An Agenda for Corporate Renewal

Stephen M. Davis — Fri, 01 Jun 2012 00:00:00 -0400

Editor's Note: This report was released in conjunction with an event at Brookings on The Modern Shareholder: How a Short-Term Focus is Harming U.S. Corporations.

With Barack Obama trying to paint Mitt Romney as the embodiment of ruthless capitalism, and Romney countering that the president suppresses free enterprise, Corporate America is center stage as never before in a modern US election campaign. Stephen Davis argues that in the haze of the presidential campaign season, both candidates may be missing promising policy ideas to stimulate growth and responsibility.

For as much effort as policymakers have spent modernizing corporate structures, they have devoted comparatively little attention to the institutional investors they count on to oversee the market, Davis writes. This paper explores a policy agenda that mirrors corporate governance reforms, designed to strengthen the capacity of institutional investors to act as long term owners.

Davis offers a formula for prudent stewardship in the broader capital market and “reforms that put the interests of citizen-investors first hold out the prospect of making better citizens of corporations.” Below are highlights:

Corporations should issue a disclosure statement which provides transparency of things like government arrangements and offers appropriate feedback channels.
Reforms to fiduciary duties in the capital markets by, for example, rediscovering the duty of impartiality or applying fiduciary duty to intermediaries.
Establishing public policy steps to US regulations of investment, which serve both corporations and savers. Davis writes that one important question has to be answered by policy experts first: “Who should mind the industry? Oversight of long-term savings has become a regulatory orphan.”

The benefits to correcting to the world of institutional investment are numerous, Davis writes, and carry the potential of giving corporate boardrooms both capital and a license to innovate, embrace appropriate risk, and address extra-financial drivers of value creation over the long term.

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Mobilizing Ownership: An Agenda for Corporate Renewal

Authors

Stephen M. Davis

Image Source: © Chip East / Reuters

The Modern Shareholder: How a Short-Term Focus is Harming U.S. Corporations

Fri, 01 Jun 2012 13:00:00 -0400

Event Information

June 1, 2012
1:00 PM - 2:30 PM EDT

Saul/Zilkha Rooms
Brookings Institution
1775 Massachusetts Avenue NW
Washington, DC 20036

The individuals and organizations who own shares in corporations have changed radically over the past 50 years. Today the household sector holds few direct shares in corporate equities – and a significant majority of stocks are owned by institutional investors, including mutual funds, pension and retirement funds, life insurance companies, and foreign entities. It is estimated that nearly 70 percent of American stock-trading arises from companies using high-frequency trading strategies that emphasize holding stocks for very short periods of time. As a result, many current shareholders lack a long-term time horizon and prefer short-term results. This new reality makes it difficult for corporate executives to pursue strategies based on long-term welfare and growth of a company.

On June 1, the Governance Studies program at Brookings hosted a forum focused on the social, economic and political ramifications of the changed nature of corporate shareholders. A panel of experts explored how the short-term focus of shareholders and investors affects corporate behavior and government policy, how to encourage longer time horizons among shareholders and executives, and how the financialization of America's corporations is affecting long-term development.

At the event, Stephen Davis released a paper, "Mobilizing Ownership: An Agenda for Corporate Renewal,” that explores a policy agenda that mirrors corporate governance reforms, designed to strengthen the capacity of institutional investors to act as long term owners.

Participants followed the conversation on Twitter using the hashtag #BILTD. After the program, speakers took audience questions.

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Participants

Moderator

Darrell West

Panelists

Stephen Davis

Executive Director, Millstein Center for Corporate Governance

Elliot Schwartz

Vice President and Director, Economic Studies

Bennett Freeman

Senior Vice President, Sustainability Research and Policy

Darrell West

Corporate Governance and Long-Term, “Patient” Capital

Wed, 14 Mar 2012 10:00:00 -0400

Event Information

March 14, 2012
10:00 AM - 11:30 AM EDT

Falk Auditorium
The Brookings Institution
1775 Massachusetts Ave., NW
Washington, DC

Not long ago, many American investors held that innovation took time to develop and that capital needed to be “patient” to realize a reasonable rate of return. Today, the converse is true: there is now great emphasis put on short-term monetary returns and the need for immediate gratification on capital investments.

On March 14, Governance Studies at Brookings hosted a discussion exploring how “impatient” capital can harm the economy by reducing incentives for innovation and shortening the time horizon for business managers. A panel of experts examined how policy and regulatory mechanisms should be structured to incentivize the business sector to refocus on longer-term time horizons and “patient” business practices.

After the program, panelists took questions from the audience. Participants followed the conversation on Twitter using the hashtag: #PatientCap.

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Participants

Moderator

Panelists

The Honorable Byron Dorgan

Former Senator (D-N.D.), U.S. Senate
Senior Fellow, Bipartisan Policy Center; Senior Policy Advisor, Arent Fox

Jack B. Jacobs

Justice
Supreme Court of Delaware

Lawrence E. Mitchell

Dean and Joseph C. Hostetler-Baker & Hostetler Professor
Case Western Reserve University School of Law

Judy Samuelson

Executive Director, Business and Society Program
The Aspen Institute

Corporations Need a Broader Purpose

Darrell M. West — Wed, 14 Dec 2011 10:00:00 -0500

Corporations have a long and varied history. Many of them were chartered and given special privileges in order to accomplish public purposes. This included things such as building roads, dams and canals. Even when companies were formed for private purposes, many corporate boards and management tended to focus on the long view of building great companies that would serve the long-term interests of shareholders and the nation.

Some observers, however, wonder if the current focus has shifted too much in favor of maximizing short-term shareholder profits. Many corporate leaders focus exclusively on quarterly profits and ignore broader constituencies such as employees, the community, and the nation and world as a whole.

To address this subject, we have launched a three-year project on the purpose of the corporation. As part of this effort, we will undertake research and hold quarterly forums on various aspects of corporate purpose. Our goal is to bring together leaders including lawmakers, corporate executives, university leaders, and representatives from the non-profit sector for discussions regarding the purpose of the corporation. Companies have special privileges and this raises several questions. What is the purpose of the firm? What benefits and obligations accrue to an enterprise as a result of incorporation? And what are the duties and responsibilities of corporate officers and directors?

In our opening forum on December 13, 2011, David Langstaff, the President and Chief Executive Officer for TASC, Inc., delivered a rousing keynote address where he argued that “business leaders need to step forth and be more actively engaged in finding the shared middle ground that we must find if we, together, are going to protect the Commons.” He worried whether our political and economic system could “pull ourselves out of our self-absorbed, myopic tailspin”.

Too many leaders, he complained, focus on short-termism and worry only about meeting the next quarterly financial target. Instead, he argued it is time for leaders to pursue a “virtuous cycle” whereby “business is granted a charter, given protection from liabilities in order to encourage it to take risks, offer employment, develop and distribute new offerings, and contribute to an improved quality of life and standard of living in society, for all its members.”

Langstaff’s speech was followed by an engaging conversation among three academic experts. Constance Bagley, the professor in the practice of law and management at Yale University, said many business schools have a tendency to focus on maximizing shareholder value and that we need a broader conception that includes shareholders, bondholders, and the community at large. She indicated we need better corporate disclosure rules so that companies disclose material circumstances that affect a variety of constituencies. Getting information out would help us deal with the “massive problem of externalities” that we currently face.

Tom Donaldson, the Mark Winkelman Professor at the Wharton School of the University of Pennsylvania, pointed to the Norway sovereign wealth fund as an example of financial investors who have a broader conception of corporate purpose that emphasizes societal values and socially responsible investment based on transparent principles. He argued that excessive systemic risk contributed to the global financial crisis and that it is “striking no one has gone to jail in the context of the financial crisis.”

Lynn Stout, the Paul Hastings Distinguished Professor of Corporate and Securities Law, said many law schools teach only about maximizing shareholder value and ignore broader conceptions of corporate purpose. She said this is driven by ideology coming from the University of Chicago and reflects a “mistaken view” of the law. She noted that congressional tax code changes have led companies to tie compensation to stock price performance and encouraged many business leaders to focus only on shareholders. She pointed out that we have a “hyperactive market” in which the average stock holding period is four months, compared to what was eight years during the 1960s.

The panel of experts was divided on what policy or legal changes were necessary to deal with current problems. Bagley argued that we need a “portfolio churn tax” to encourage longer-term stock holding. Among other proposals, she suggested that we need “patient capital” that does not churn stocks over short periods of time and that management should have incentives to hold stocks for at least six months so that investors don’t “act like day traders”.

In contrast, Donaldson argued there are “limits to what government can do” and regulations always are a “couple of steps behind innovation”. Stout said there was no silver bullet to deal with executive compensation issues, and that it was a mistake when the stock transfer tax was eliminated. She complained that many tax rules “favor Carl Icahn over diversified Moms and Pops.”

Authors

Darrell M. West

The Purpose of the Corporation

Tue, 13 Dec 2011 13:00:00 -0500

Event Information

December 13, 2011
1:00 PM - 3:00 PM EST

Falk Auditorium
The Brookings Institution
1775 Massachusetts Ave., NW
Washington, DC

Corporations hold tremendous amounts of private sector capital and have the power to bolster economic prosperity by investing in critical industries and communities. Since the inception of the corporation, policymakers have debated to what degree corporations should be held to a standard of social responsibility. This issue is particularly relevant given the fragile state of the American economy and public concerns regarding economic opportunity. What is the purpose of the corporation in today’s society and economy? How should we think about corporate obligations and responsibilities? How do companies affect society, commerce and government?

On December 13, Governance Studies at Brookings hosted the first in a series of lectures examining the corporation in American society. David Langstaff, CEO of TASC, delivered a keynote address exploring the role of the corporation in today’s economy and how that role may evolve in the future. Following his presentation, a panel of experts, moderated by Darrell West, vice president and director of Governance Studies, examined the purpose of the corporation as it relates to the current state of the economy and political climate.

After the program, speakers and panelists took audience questions.