Sunday, June 18, 2017

Apparent Gains in Corporate Governance Accountability as the U.S. Economy Shifts

In 2016, Sacred Heart University purchased G.E.’s headquarters in Fairfield, Connecticut for $31.5 million. Gone were the Persian rugs and lavish artwork. The property acquired included the “Guest House,” the company’s 28-room hotel “to serve visiting executives and others, with no expense spared on the parquet floors, wood-burning fireplaces and a Steinway piano.”[1] Jack Welsh oversaw the ornate construction, leading to the obvious question of just what his sense of fiduciary duty to the company’s stockholders was. An artificial distinction between managers—only some being styled “executives”—was doubtless behind the luxuriant excess only for those certain employees “in the club.” From the standpoints of a board and its stockholders, “executives,” managers, and other employees are all employees. Why then should some of them be associated with luxury while they are at work? Historically, the aristocratic luxuriated precisely because those people didn’t have to work, and more importantly, they viewed work (and even their own money) as not worthy of much attention—there being finer things in life. “Executive” employees are not aristocratic, for they labor even when they could live off their accumulated wealth and pursue loftier aims, such as aiding humanity, furthering knowledge, or engaging in the arts with an eye toward advancing civilization. Bill Gates got this memo; Warren Buffett did not.

The presence of extremely rich people in the executive ranks of large corporations interferes, I submit, with the accountability that corporate governance is designed to deliver for stockholders. Lavish business expenses run counter to such governance and the very notion of a corporation as the stockholders’ combined wealth.  In the era of American industrialization, the huge profits in the industrial sector gave cover to managers such as Jack Welsh, who felt free to exploit the obvious conflict of interest in spending lavishly for the upper-echelon managers themselves, as if the company were their own country club rather than a business. Doubtless managers themselves assumed that paid country-club memberships were necessary to get and even retain (well qualified?) fellow “executives.” The underlying conflict of interest was somehow invisible to sycophantic boards and even large stockholders who looked the other way. In the succeeding high-tech era, the same obliviousness has surely existed in that sector in spite of the rise of activist stockholders.

To be sure, indications can be found that suggest more activist pressure. Even as stockholder activists’ assets were increasing from 1997 to 2015, the number of publically traded U.S. companies decreased from 7,507 to 3,766.[2] Meanwhile, the activists were getting more, well, active, and they were finding it easier to win board seats as fewer companies staggered their elections over three-year cycles. More than 300 U.S. companies were targeted in 2015, up from about 100 in 2010.[3] Boards were better positioned, at least formally, to hold C.E.O.s accountable as the percentage of joint C.E.O.-Chair positions decreased. “In 2001, more than half of new C.E.O.s also assumed the position of chairman when they took over. By 2016, only 10 percent occupied both roles.”[4]

Yet the actual impact from activist stockholders may have only been in decreasing the average tenure of the C.E.O’s. Boards were “still willing to dole out huge golden parachutes to C.E.O.’s, even if they fail.”[5] Furthermore, even though G.E.’s swanky executive suites went from 44,000 square feet in Fairfield to 7,800 square feet in Boston, C.E.O.s of high-tech companies were under less activist scrutiny in spending from soaring profits and stock prices.[6] A study looking at shareholder proposals from 2003 through 2015 concludes that “managers often seek to avoid the implementation of legitimate shareholder interests.”[7] In 2017, the U.S. House of Representatives passed the Financial Choice Act, a deregulatory bill that would require a shareholder to own at least 1% of a company’s shares for three years to get a proposal on a proxy ballot. At the time, a stockholder needed to own only $2,000 worth of stock for at least a year. Clearly, the power of activist stockholders was quite far away from Congress, whereas that of corporate managements was very close by.

Even the increased power of activists to pressure the firing of a C.E.O. of an underperforming blue chip company may actually be a manifestation of frustration over stagnant revenue and profits in the sagging industrial sector; the real question, still unanswered in 2017, is whether activist stockholders would ever go after the lavish spending of “executives” of profitable companies. Even those managements, such as of Amazon, Apple, Google, and Facebook were obliged even in their hay-day by the legal doctrine of fiduciary duty to not be profligate, and to authorize spending for legitimate business reasons because cost management is in the stockowners’ financial interest. This interest, rather than those of “executives,” is legally hegemonic, rather than to be dismissed or even rebuffed. Luxury, in other words, does not go with the work inside a corporation, but, rather, with the ownership of wealth, even if some of the employees are themselves extremely rich. Their independence and association of themselves with luxury does not fit with the corporate model, especially as concerned the ability of corporate governance to exert accountability in the interests of stockholders. As for the apparent strengthening of corporate governance in the industrial sector, the alleged improvement may actually have been a function of a major sectoral shift within the American economy. It is only natural that the old guard would be frustrated at the shift, so what looks like better accountability may only be infighting. To gauge real accountability, we would need to look at the newly hegemonic sector: Are the “executives” in it taking liberties at their stockholders’ expense?  

[1] Nelson D. Schwartz, “The Decline of the Baronial C.E.O.,” The New York Times, June 17, 2017.
[2] Ibid.
[3] Ibid.
[4] Ibid.
[5] Ibid.
[6] Ibid.
[7] Gretchen Morgenson, “Meet the Legislation Designed to Stifle Shareholders,” The New York Times, June 16, 2017.