Legendary counsel to corporate insiders Martin Lipton spoke to the NYSE and CEO Peer Forum about "The Future of the Board of Directors" and his remarks are now available on Harvard's Corporate Forum on Corporate Governance and Finance website.
Lipton continues to show his deftness at redefining the questions to fit his answers. He says that boards worked better in the days before we put so much emphasis on independent directors.
At the same time as we have set these stringent expectations for performance and personal qualifications, we have allowed the playing field on which the board of directors performs to tilt in favor of shareholders who seek short-term profits rather than long-term growth. To quote the title of a brilliant speech Vice Chancellor Leo Strine of the Delaware Court of Chancery gave at Stanford University last month, One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed For The Long Term Unless Their Powerful Electorates Also Act And Think Long Term?
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The combined effect of the agency theory, Sarbanes-Oxley, the stock exchange governance rules, SEC regulations, the Institutional Shareholder Services Company (ISS) and the Council of Institutional Investors (CII) pressure and the corporate governance provisions of the pending financial industry regulation bill is to exalt short-term shareholder interests over that of all the other stakeholders—and of the American economy and the American public. The assumption that empowering shareholders and promoting their interests will lead to better performance and more efficient management of corporations, and that shareholder interests are therefore aligned with those of other stakeholders, is contradicted by the short-term trading objectives of many of the major institutional investors and hedge funds. It was the taking of undue risks in an effort to meet the short-term profits demands of shareholders that was a root cause of the financial crisis.
It is disingenuous at best for the creator of the poison pill to suggest that shareholders who seek short-term profits are the ones with the power. And it is preposterous to blame the victims by making shareholders the cause of the financial crisis.
Who is he talking about? The largest shareholders in the world are the corporations themselves, through their pension funds. The CEOs, as fiduciaries of those funds, are entirely responsible for their investment strategy and pension funds are the ultimate long-term investor. As Pogo said, "We have met the enemy and he is us." If CEOs want long-term shareholders, they should start with themselves. And then there were those other shareholders, the Wall Street firms themselves, who preside over the largest pools of investment capital. They subordinated their interests as shareholders to their interests as executives, perpetuating and benefiting from perverse incentive compensation. Because their boards let them get away with it.
The shareholders' responsibility in the financial meltdown was not a short-sighted and self-destructive focus on short-term returns. It was negligent oversight of the perverse incentives in the compensation schemes that led to the over-investment in sub-prime mortgages and its derivatives and of the boards that approved them.
Lipton asks us to
recognize that the purpose of corporate governance must be to encourage management and directors to develop policies and procedures that enable them to best perform their duties (and meet our expectations), while not putting them in a straight jacket that dampens risk-taking and discourages investing for long-term growth and true value creation.
No argument there. But the best way to reach that goal is not to entrench management but to make sure that those who deploy capital are accountable to those who provide it.
Nell Minow -Editor
