What’s Wrong With Governance, Get Support
Article published on
September 21, 2009
The No. 1 problem with
corporate governance in the U.S. is pressure to focus on short-term results,
according to an Agenda survey of independent directors.
Those directors are
concerned that the debate over the causes of the financial crisis has
focused too much on a lack of shareholders’ rights. In fact, only 1% of
respondents to the survey, which
was conducted in July and included 294 independent directors, pointed to
lack of shareholder rights as the biggest problem in corporate governance.
Now, the Aspen Institute Business & Society Program’s Corporate Values
Strategy Group is trying to shift the debate to the problem of short-termism.
A new statement by the institute calls on
Congress to adopt a number of policies designed to improve the problem of
A diverse group of directors, executives, academics and investors signed the
statement, including the likes of Warren Buffett, The Vanguard Group founder
John Bogle, Duke Energy CEO Jim Rogers and former chairman of Goldman Sachs
While some observers say short-termism has been a problem for the past
decade or longer, it has become more prevalent in recent years due to lower
trading costs, the advent of technology, the increased use of derivative
products and the introduction of 401(k) plans.
The Aspen Institute first made waves in this area when it released a set of
principles in 2007 that called for an end to quarterly earnings guidance
from companies and aligning compensation incentives with an eye toward the
The latest advocacy is “taking it a step further,” says Lynn Stout, a law
professor at the University of California, Los Angeles and one of the
signatories to the latest statement. “It’s not enough to simply discourage
quarterly earnings guidance,” she says.
“This round of work is really saying, ‘OK, we need to look at whatever
leverage points exist in policy to shore up this direction,’” says Judy
Samuelson, executive director of the Business and Society Program at the
Aspen Institute. “Our focus at this point is Capitol Hill and the
administration.” She says the institute is using the networks of its
signatories to spread the word in Washington.
Hearings on this issue are expected soon in both the House and Senate,
several people involved say.
The Aspen Institute and its signatories want to revise the capital gains tax
provisions or implement an excise tax to reward long-term stock holdings;
remove limitations on capital loss deductibility for very long-term
holdings; and adopt minimum holding periods or time-based vesting in
exchange for more shareholder rights. The institute also advocates for
increased disclosure from investors and applying more enforcement of the
fiduciary duties of investor advisors — a topic of conversation at the SEC’s
investor advisory committee’s first meeting this summer.
The sentiment coming from the Aspen Institute is also supported by other
organizations. A recent report from a task force of the Corporate Governance
Committee of the ABA Section of Business Law, which was sent to members of
Congress and the SEC, recommended that policymakers encourage shareholder
interest in the long term through tax incentives and enhanced voting rights.
The obvious direction to take is reforming capital gains taxes, says Stout.
The current tax laws give preferential tax rates if investors hold stock for
a minimum of 12 months. “You can get a lower tax rate for short-term trading
than holding down a regular job,” she says.
The Aspen Institute has had success with its previous advocacy in this area.
Many companies have eliminated quarterly earnings guidance since the
organization’s initial call to do so. General Electric, for instance, said
it would stop the practice last December after missing and revising its
earnings guidance amid the recession.
But progress has stalled of late. A 2009 National Investor Relations
Institute survey shows 60% of respondents provide earnings guidance compared
to 64% in 2008. Analysts, naturally, want companies to continue issuing
guidance. In a recent survey conducted by MWW Group, 76% of 100 sell-side
analysts said they believed the stock market would penalize companies that
suspend earnings guidance in this economic environment.
There are even some voices calling for the continuation of earnings
guidance, saying it is in the best interest of management. “Abolishing
earning forecasts by issuers will not abolish the forecasts; it will only
mean analyst forecasts will be less informed,” says Hal Scott, a Harvard
professor and director of the Committee on Capital Markets Regulation, an
independent and nonpartisan research organization.
Scott’s committee commissioned a study released last week that concludes
that management forecasts actually provide better alignment of market
returns with long-term performance. Gregory Miller, a business professor at
the University of Michigan and author of the study, recommends that boards
become involved in creating a written policy for when and in what form
forecasts will be provided and how they relate to the company’s overall
Other Forces at Work
There are two main problems with the investing public, says William Sihler,
a business professor at University of Virginia and a director at Curtiss-Wright.
One is the problem of vote lending, which is when an investor borrows shares
to vote but has no underlying economic interest in the company. This is an
issue SEC chairwoman Mary Schapiro will likely look at as part of an overall
review of the proxy voting system. Sihler’s second concern is short-term
One solution to these problems is to give long-term institutional investors
greater voting power, he says. It can also be worth a company’s time and
effort to recruit the right kind of shareholders, he adds. To encourage
long-term stockholders you have to “cultivate institutions that are known to
be sympathetic with the idea you can show them what is happening,” he says.
Analysts can’t be ignored either. This means sending CEOs and CFOs on the
road to trade shows and spreading the message of the company’s long-term
AutoNation CEO Michael Jackson told McKinsey Quarterly recently that when he
took over eight years ago, he knew that to succeed he needed to attract a
new shareholder base that would be willing to sacrifice short-term profit
for long-term gain. “The investors I have now understand the business model,
and that’s been a huge plus. But it didn’t happen by itself,” he tells
Another possible solution is to give shareholders more rights in exchange
for time-weighted voting, says Stout. This is a concept that is embedded in
the SEC’s proxy access proposal, which the commission is expected to rule on
this fall. If shareholders want to have the right to exercise proxy access
they have to hold stock for at least one year. While many businesses would
like to see an even longer time period, the concept of encouraging longer
holding periods is a good one, says Stout.
However, some directors are less hopeful that anything can be done to break
the cycle of short-termism. Even if you try to recruit the right kind of
shareholders and change tax incentives to encourage more long-term
shareholders, management will be chasing numbers to meet their bonus target,
says Leigh Abrams, a director at Impac Mortgage Holdings and chairman and
former CEO of Drew Industries. “No matter how you boil it down, human nature
says, ‘What’s my bonus going to be next year?’” The best way to accomplish a
long-term mind-set at the company level is through having the right tone at
the top with your managers, he says.
Compensation committees can also work with management to identify metrics
with a longer-term horizon, suggests Barbara Allen, a director of RLI
Corporation and a veteran of several other boards. Those metrics can include
economic value-added (EVA) or ones focused on return, she says. “It may not
be obvious in the metrics that the rest of the world is focusing on and it
requires a lot of communication,” she says.
Meanwhile, Abrams cautions that it’s not always a bad thing to think in the
short term. “You’ve got to make sure today is all right,” he says. “You
better be able to make money right now.”