Now I turn to the second question: Whom do Boards represent?
Shareholders — but which shareholders: the current ones, past ones or future ones? Most public companies experience a high volume of trading activity in their shares each day, with most of their outstanding shares theoretically changing hands every 30 to 120 days.
With the exception of large institutional investors who invest in the companies comprising the most popular stock indexes, most investors, including many institutional investors and traders at the leading investment banks and hedge funds, rarely have a long-term horizon for any particular investment. For these investors, the quality of corporate governance and the level and structure of executive compensation are largely irrelevant until there is a major financial crisis.
Momentum and fads matter much more. During the dot-com frenzy in the 1990s, most investors knew little about the companies in which they invested. When we look at the valuations of companies today, such as Tesla, Snap, Beyond Meat, Dropbox, Lyft, Uber, Amazon, and many others, we see that investors might be repeating the same pattern and mistakes. Who says history doesn’t repeat itself?
Why worry about past shareholders who no longer are shareholders today? Unless of course, directors discover, after the fact, that some historic financial information might have been deliberately misleading, which might have led to some past shareholders making the wrong decisions and incurring financial losses as a consequence.
In such circumstances, directors are forced to make a trade-off between past and present shareholders. Disclosing such information might lead to individual or class action suits against the company, and as a result, current shareholders might be faced with a diminution in the value of their equity in the company. If directors disclose such information, will they be fulfilling their fiduciary duties?
What about future shareholders? In other words, should directors choose courses of action that maximize the value of the company’s equity in the short run, or should they be concerned about maximizing the long-term value of the company?
Theoretically there should be no difference, and thus there should be no trade-off between the interests of present and future shareholders. According to finance and economic theory, if all strategic decisions factor in the values, both positive and negative, of all future options created and/or destroyed by strategies currently being evaluated, then a series of annual decisions that maximize the equity value of the company in the short run also should maximize the value of the company in the long run.
However, how many Boards of Directors understand this principal, let alone practice it? Do directors consider every possible future implication of drastic payroll, marketing or R&D cuts when they are trying to improve the short-run profitability of their companies? Did the Boards of Nortel, and other high-tech companies, map out all future options created or eliminated as they acquired other companies and expanded employment levels during the go-go days in the 1990s? Resource companies repeated the same mistakes during the past 12 years as commodity prices rose sharply. No industry has a monopoly on lemming-type behavior.
Consider all of the initiatives announced by GM during the few years prior to its bankruptcy in 2008 to try and improve its competitive position and financial performance. GM killed the electric car, only to bring it back as a possible savior for the company, and it is being beaten badly by an upstart — Tesla Motors, created by an outsider to the industry.
How should trade-offs among different groups of shareholders be made? Good corporate governance requires an answer to this question.