What is the purpose and structure of the modern corporation, and what are the consequences when management takes a short-term approach to meeting corporate goals?
. In a recent article, Boston Globe reporter Leon Neyfakh captured the debate surrounding the “future of the American corporation—what its purpose is, how it should be run, and whom it should be engineered to benefit.” The article describes how shareholder-guided corporations often fail to adequately serve other stakeholders such as employees, customers, the environment, and local community. Nayfakh also notes the failures of shareholder supremacy and the harms inflicted on others, even shareholders themselves. He writes: “Countless others made short-sighted decisions intended to goose earnings, keep investors happy, and enrich themselves—all without regard for the long-term health of their companies.” Shareholders, according to Neyfakh, have also been harmed by the status quo and are increasingly advocating for greater representation on boards of directors.
There are other strong voices in the debate about the structure and purpose of corporations such as Harvard Law School professor Lucian Bebhuk. He argues that there are significant barriers to greater shareholder activism that stem from the near-absolute power of the board and CEO. Bebchuk favors empowering shareholders to make “rules of the game” decisions about the structure of the corporate ballot set by by-laws. Bebchuk explains that these decisions are unlikely to occur because boards and CEOs accrue private benefits from having control over the corporate ballot such as job security, higher pay, and other perks. This problem of board capture also manifests itself in the exorbitant pay of many CEOs which some have referred to as the “smoking gun” of managerial opportunism and other corporate governance failures.
While the stakeholder model may appear to be a better alternative to the shareholder primacy model, there are unique challenges to detecting and eliminating managerial opportunism under a stakeholder model. If CEO performance is currently quantified in share price and compared to peers, what performance metrics would complement the creation of shareholder value? How would these different metrics be balanced? The inclusion of alternative metrics creates room for CEOs to justify even more egregious pay packages. For example, if a CEO serves the local community and workers well but delivers weak financial results, how much should the CEO be paid? Even under the shareholder model, CEOs are able to justify vast compensation packages to boards and shareholders. During economic downturns, CEOs are paid for performance in spite of various headwinds and obstacles. Insider opportunism is clearly prevalent in the shareholder model and might even be more insidious and frequent in the stakeholder model.
These challenging questions suggest that the stakeholder model might be more vulnerable to insider opportunism than the shareholder model. As Jonathan Macy and Geoffery Miller warn “constituency statutes do not benefit the interests or groups that they ostensibly are intended to benefit. Rather, such statutes benefit a well-organized, highly influential special-interest group, namely the top managers of large, publicly held corporations who wish to terminate the market for corporate control.”
Together, these issues represent an essential point of focus for corporations, politicians, and citizens alike. Accordingly, the Rules Change team will provide coverage on issues of corporate governance as they continue to unfold.