Senator Charles Schumer’s plan to enact a “Shareholder Bill of Rights” and the Securities and Exchange Commission’s shareholder access proposal[...] is an issue that has almost nothing to do with the financial collapse, and threatens, in the long run, to hobble the corporate governance system that built American industry. ... putting pressure on corporate managers to increase short-term stock prices at the expense of long-term business health. Doing business that way puts jobs and sustainable industry at risk, now and in the future.
Senator Charles Schumer’s plan to enact a “Shareholder Bill of Rights” and the Securities and Exchange Commission’s shareholder access proposal show the harm that can come from crisis lawmaking. These proposals are misplaced populist attempts to regulate quickly amid the disarray. But shareholder rights is an issue that had almost nothing to do with the financial collapse, and threatens, in the long run, to hobble the corporate governance system that built American industry.
In the first place, shareholders are hardly an oppressed class. The beneficiaries of shareholder access rules will be the pension funds and mutual funds who hold billions of dollars of corporate stock. True, they hold it on behalf of ordinary Americans, but the managers of these funds have their own interests that often conflict with those of their beneficiaries. Managers thrive by increasing their portfolios’ value. That is a hard thing to do and it takes time. So for years fund managers have increased their pay by putting pressure on corporate managers to increase short-term stock prices at the expense of long-term business health. Doing business that way puts jobs and sustainable industry at risk, now and in the future.
For example, managers responded to the pressure by using their retained earnings to engage in large stock buybacks. In the three years to September 2007, companies in the S&P 500 used more money to buy back stock than to invest in production. With retained earnings gone, all that was left to finance production was debt. When the credit markets collapsed, these corporations could not borrow, and thus could not produce. Are boards and managers to blame? Sure. But so are the big shareholders who have been pushing management for this kind of behaviour for years. They are more the problem than the solution. Enhancing their voting rights will only make things worse.
Another flaw in these approaches is the assumption that these institutions somehow are investors. They are not. They are traders. In recent years, annual turnover on the New York Stock Exchange has topped 120 per cent, compared with historical rates averaging in the teens and twenties before 1980. Mutual fund turnover has reached 110 per cent, and pension funds, whose investment horizons should theoretically be forever, have had turnovers in the 90 per cent range. These rates hardly suggest a long-term perspective; they show that even our pension funds engage in extensive speculation. It is true that the SEC and Schumer proposals both demand a holding period before a shareholder is allowed to nominate directors, but no requirement that it hold the stock after the vote. This creates incentives for institutions to strong-arm management to increase share prices and then sell out as soon as they are done, regardless of the long-term effects on the business.
Do we really want speculators telling corporate boards how to manage their businesses? Those who say “yes” want to increase short-term management pressure and thus share prices, regardless of the corporate mutilation this induces. They do not seem to care that their profits come at the expense of future generations’ economic well-being. But if our goal is to give expert managers the time necessary to create long-term, sustainable, and innovative businesses, the answer is a clear “no”.
These misguided proposals also rely on the notion that a corporation is a democracy. Whatever the corporation is, it is assuredly not a democracy. As the great business historian, Alfred Chandler, demonstrated, the American corporation has succeeded in large part because it is a wonderfully constructed bureaucracy. Bureaucracies do not work when they are operated by town meeting. It is worth remembering that the golden era of US business occurred at a time when the shareholder vote was considered meaningless. We should also remember that the nations with whom we compete for business all recognise the importance of centralised management and bureaucracy to corporate success and economic growth.
The proposals are fighting the last war. Inattentive boards of non-financial companies may have been a big factor in the corporate scandals at the start of the century. But it is hyperbolic to suggest, as the Schumer bill does, that this had anything significant to do with the current recession. The Schumer bill and the SEC proposal only exacerbate the problem by chaining boards to the ball of stock prices – which helped to cause those scandals in the first place.
Shareholders do need protection from inattentive and irresponsible boards, but it would be far more effective to strengthen the rules that regulate sloth and theft than to risk choking the engine of real economic production. Managers, not shareholders, are expert at running our businesses. Shareholder rights are simply wrong.
The writer, a law professor at George Washington University, is author of ‘The Speculation Economy: How Finance Triumphed Over Industry’
Copyright The Financial Times Limited 2009
Protect industry from predatory speculators
