Justin Fox has recently fired off another broadside in the war that has been raging among certain circles, decrying iniquities visited by incentive-based CEO compensation schemes on those deemed to be stakeholders: shareholders, employees, customers, even society at large, natch. Many commenters have noted the many perceived injustices that result from high CEO compensation, while others pointed out issues inherent in corporate governance because of the principle-agency problem. Fox in effect throws in the towel by claiming that boards have no capacity to control executive behavior and, furthermore, implying that whatever function they exert is nothing more than a fig leaf to conceal management self-interest.
Before we rush off to cry defeat in the face of all these contradictions, however, it would behoove us to reflect upon a few basic principles of business. First, and I know that this is controversial, but it is nonetheless a fact, almost by definition: there are no stakeholders in a corporation - only shareholders. Now, before you stop reading here and go searching for your pitchfork, consider instead that maximizing value to the shareholders is rarely possible amid employee misery, customer dissatisfaction or great social outrage. Once we, reluctantly, accept that maximizing shareholder value is a corporation's sole function, we can remove our blinkers to begin examining how boards can ensure its success.
It is undeniable that many public (and some private) corporation boards have failed to protect shareholders from the conflicts of interest inherent in agency relationships that they have with CEOs. However, it would behoove us to reflect that private-equity portfolio-company boards have quite well demonstrated a high degree of effectiveness in harnessing managements to benefit their owners.
The most important question that this dichotomy implies is: why have public corporation boards proved to be so much less effective in representing shareholder interests. The answer is, self-evidently, that buyout shops appoint directors whose incentives are solely tied to the value of the companies. By contrast, public company directors are hired not by the mass of shareholders, periodic proxy votes notwithstanding, but rather by the managements, to whom directors owe their allegiance, seats and compensation, so reinforcing the conflict of interest between owner and agent.
Conflicts of interest are, of course, not limited to the relationships among shareholders, managements and boards, but let us restrict ourselves to a manageable scope of topic. Of the remedies proposed to the conflict such as tying CEO compensation to return on equity or capital in preference to share value, restricting executive pay to arbitrary metrics, or corporate social responsibility initiatives, none have a realistic hope of effecting changes beyond just optics for the simple reason that it is the very boards whose allegiances are already so compromised who would be tasked to implement them.
More realistically than expecting boards to act against their own interests, we should instead be seeking to change their behavior by altering incentives. I hereby challenge both large shareholders and business regulators to consider how pubic boards might be made to function more like their private cousins.
Unfortunately, developments have rather been in the direction opposite to that of interests of shareholders. Anti-takeover devices that protect managements from corporate raiders who might otherwise take advantage of their folly have been allowed to stand. Rather than offering relief through rule-making or through legislation to reverse some of these management protections, instead we see a doubling down on protections for incumbents. Proxy vote rules continue to be governed almost entirely through bylaws, empowering managements at the expense of owners. Activist hedge funds have had some success in getting some companies to alter their strategies, but just as often they have failed.
As things stand today, it is really only up to the large shareholders to pool enough of their votes to install boards that protect their interests in preference to those of the managements and to lobby for rule-making for legislation to take shareholder interests more seriously. Let us then hope that we will enjoy the fruits of their labors in our lifetimes.
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