The Conference Board Governance Center Blog

Mar
27
2013

Rethinking ‘Shareholder Value’, the Purpose of the Corporation, and the Role of the Board

David H. Langstaff, President & CEO, TASC, Inc.; Chairman, Advisory Board, Aspen Institute Business & Society Program

Note from the Blog Editors: This post is an edited version of the keynote comments that Mr. Langstaff gave at the March, 2013 Kellogg School of Management/Aspen Institute Business and Society Conference on Rethinking Shareholder Value. The full text of the speech is available on the Aspen Institute Business & Society page. A video of Mr. Langstaff’s keynote is available on the conference website.

 

Introduction

This topic – rethinking ‘shareholder value’ and the purpose of the firm – is one which I have given a great deal of thought. It is almost where we need to start if we are to address some of the fundamental problems that are evident in society, and our capitalist system. I appreciate the opportunity to share my thoughts with you today, and hopefully, open a door to how we must move forward, and move the discussion from the theoretical to the practical, from ‘talk to action’.

I have titled my remarks ‘Tomorrow’s Corporation that We Need Today – Getting There from Here’. I will start by addressing why ‘purpose’ is so important, looking at it from a number of perspectives, and then will lay out actions that, if taken, could drive us forward. Before closing, I will touch on a couple counter-intuitive points which we need to consider if we are to have a constructive dialogue.

Purpose

The purpose of the firm: I believe that the lack of attention to this topic is one of the fundamental reasons why business finds itself near the bottom of the ‘trust’ scale in society today.

How we address a corporation’s purpose has far‐reaching implications; it is fundamental to the kind of political and economic system on which our society is based, and the values we choose to bind us together. A question on the table today is whether we – the business and financial community – can pull ourselves out of our self‐absorbed, self‐rationalizing pursuit of narrowly defined, short‐term self‐interest to realize that we all have a permanent interest in preserving the system that has contributed so much good to society and which provides us with the freedoms we now take for granted.

Today, corporate purpose is being held hostage by the myth of shareholder primacy. Society must decide whether it is to embrace a property, or solely economic view of the corporation, or a citizenship view. If we choose the property view – that the purpose of the corporation is for its shareholders – we are on a path to replay the ‘Tragedy of the Commons’ and we all will lose. Even more tragic, in the long run, we destroy our own motivations, beliefs and trust in each other and in our institutions. It becomes our own ‘Faustian’ bargain where we sacrifice our societal ‘soul’ for short‐term, yet unsustainable gratification of the few.

If we embrace the citizenship view, we can regain the path where business is a trusted and responsible member of society delivering for all its constituents, including its shareholders. This last point is important, for we cannot fall into the trap of thinking that the citizenship model is an anti‐shareholder model. Such a belief would be a huge mistake.

The great irony in the way this topic is debated is that in the long‐term, I would posit that both the property‐based and the citizenship‐based arguments converge in agreement. The real issues are the time-frame in which one measures success, the priorities driving near‐term decision‐making, and a more careful consideration of the rights of shareholders.

Moving Forward – the Role of Government

It is, in part, the role and responsibility of government to reflect, protect and enable the values of society.

Today, the government has three roles to play: first, it must demonstrate that it cannot be bought, and that it can rise above parochial self‐interest and begin to act more consistently and conscientiously in our shared national interest. The government must rebuild and re‐learn the trust we need to have in our government. Second, it must establish and enforce the laws required to protect the values of society. And third, it should introduce new regulations, policies and other measures to incentivize the different behavior we desire to see on the part of business.

To this latter point, I am not suggesting that the government try to curtail the market; instead it can co‐opt it and let market forces drive different behavior – because it makes economic and self-interest sense for such different behavior to occur. Market forces are powerful and cannot be ignored. Frankly, we cannot expect a groundswell of enlightened CEOs to make decisions that work against market forces. But, the government can introduce changes that redirect market forces and therefore influence a different kind of behavior.

Let me offer some examples:

  • An inversely progressive capital gains tax that starts high and declines to zero over time, thereby encouraging more patient capital by creating an economic incentive to hold investments for a longer period of time;
  • A transaction tax on the buying and selling of securities that would create an economic dis‐incentive to frequent trading and churning;
  • Differentiated voting rights among shareholders to favor those shareholders who have demonstrated a long‐term commitment to a company from those who are in and out of the stock on a more rapid basis;
  • An extension of the obligation of fiduciary duty to financial intermediaries; and
  • Modernizing our accounting system and required reporting metrics to reflect true costs of products and services, and to reflect the fact that our economy now includes companies that are knowledge‐based, rich in intellectual property, or people‐based rather than just the asset‐based businesses of earlier industrial ages on which our current system is based.

This last point is one of my ‘hot‐buttons’. If you start with the premise that more often than not you get what you measure, we ought to examine more carefully what we are measuring. It should be no surprise that we get what appears to be short‐term profitable behavior if we don’t have to measure or otherwise account for long‐term costs. While there are government agencies that weigh in on these issues (the SEC being an example), there are also non‐government institutions like the Federal Accounting Standards Board, or the Public Company Oversight Accounting Board that also have a role to play. And, let me suggest that this topic is one where business schools can play, as well, by challenging the adequacy of the systems we have today.

The cold reality is that we aren’t going to see ‘responsible’ long‐term behavior, and avoid long‐term harm if we choose to ignore long‐term costs and impacts. Similarly, why are we surprised at the judgments being made about investments if we teach students and financial analysts to ignore difficult‐to‐measure long‐term costs when performing a discounted cash flow analysis. Once again… we get what we measure.

Moving Forward – the Role of the Corporate Board of Directors

Let me turn to the role of the Board of Directors. Although boards don’t set the rules of the game, they do drive company performance by way of the expectations they set and the incentives they put in place at the individual company level.

Many boards have fallen into the trap of believing their primary role is one of ensuring compliance. This role, while necessary, is insufficient. Boards must spend more time looking forward, not backward; they must spend more time on matters of strategy and direction. By doing so, they open up both time and space for responsible decision‐making.

The role of the Board is to ensure that purpose, vision and core values are in place, and then to give the CEO and executive team the time and space to act responsibly. Boards must understand and support company strategies, confirm the metrics that will indicate both success and progress, and hold the CEOs accountable for performance. Boards also must help CEOs counter the short‐term pressures of the market, and ensure that companies do not make short‐term accommodating decisions that are not in its long‐term interest as responsible contributors to society. To date, boards have become too compliance‐oriented, are insufficiently grounded in company purpose, vision and strategy, and are too quick to buckle to the short‐term market pressures, thereby denying CEOs and executive teams the time and space necessary to run the company in a responsible fashion. Said another way, boards of directors must step up to the whole job, not just the easy part.

It is worth noting that if our aim is to find a better balance among short, medium and long‐term goals, and if we are committed to addressing more of the needs and expectations of multiple constituents, then boards of directors have an obligation to re‐examine executive compensation through this lens. I think we will find that the unconscionable levels of executive compensation at many companies can no longer be justified by what shareholders might approve under the property theory of the corporation.

There is an ironic parallel that I feel compelled to point out. A board is to the shareholder in our current corporate governance construct what our elected officials are to the voting public in our democratic republic. In the same way that James Madison envisioned our elected representatives serving as a buffer against the potential tyranny of a pure democracy, the board of directors needs to protect management against the tyranny of vocal, active short‐term oriented shareholders. Today, on this issue, neither our elected officials nor our boards of directors are performing the job required of them.

Revisiting Shareholder Primacy and the Short‐Term/Long‐Term Debate

Before closing, I want to offer a few more nuanced thoughts on the debate around the property v. citizenship view of the corporation, and the short‐term versus long‐term trade-off.

We may be creating the wrong dichotomy when we position the property theory against the citizenship theory. As a long‐term investor, your interests are aligned with society in that you want to see the continuation of a productive, healthy company that creates sustainable long‐term value. Such a long‐term investor has a seat at the table along with other stakeholders in the citizenship theory. All are united in their desires for sustainable long‐term value to trump short‐term, potentially damaging considerations. All see the corporate institution as a desirable ongoing member of society.

Similarly, the short‐term v. long‐term debate can be problematic in that, at some point, the long‐term we talk about today needs to be reflected in tomorrow’s short‐term. Said another way, prudent, long‐term decisions made today need to translate into economic value: higher productivity, greater market share, consistent new product innovation, higher quality offerings, lower cost of capital, lower employee turnover, etc. These results benefit not only investors, but also society’s sustaining interests. Clamoring for greater long‐term focus cannot be an excuse for continuing poor short‐term results. Further development of this idea takes us back to the need for greater transparency, and the question of metrics – whether we have a system of measurement that fails to reveal long‐term costs and implications, and therefore inappropriately biases decisions for the short‐term.

The real issue is how companies make decisions. Are they made with the long‐term interests of the company in mind, or are they made in a way that sub‐optimizes the creation of long‐term value due to short‐term market pressures or demands of short‐term investors? Consideration of this issue opens the door to the topic of executive compensation, and more fundamentally executive tenure, which, in turn, takes us back to the points raised in the discussion of the role of the board of directors.

Final Comments

I keep on my desk one of the statements of Confucius. It reads: ‘To know what is right and not to do it is the worst cowardice.’

I think it is right to put this discussion in a moral framework, and not just consider it in an economic context.

People across the United States, and around the world are saying today that things aren’t right… they aren’t fair. There are too many undeserved winners, and undeserving losers. We have come to accept so much money in politics that we politely call what is legalized corruption ‘lobbying’, and ‘campaign finance.’ We have become beaten down by forces that we claim we don’t control and which we believe are wrong. Yet, we accept them.

The fact is, we hide behind the notion that market forces act on their own, and how they act is not our fault. Market forces, in fact, are amoral – not immoral. It is we, the humans, who must bring a morality to our society. But, we should not fool ourselves into thinking that markets can be made moral. We must be the ones to say where the market can play, and where it must stop so that life is governed by other values. As Arthur Okun, the economic advisor to President Johnson, noted in his 1975 book, Equality and Efficiency: The Big Tradeoff, ‘Society needs to keep the market in its place… Given the chance, it would sweep away all other values, and establish a vending­ machine society.’ And, wasn’t it George Will who famously wrote many years ago that the welfare state is the price we pay for free market capitalism?

Society will push back, and insist on new laws and regulations that, if history is to be our guide, will likely be poorly thought through yet passed into law in an effort to protect what it considers important. The business environment will only become more difficult. Business has a choice: we have a powerful long‐term self‐interest to act before new restrictive rules are imposed, and re‐win the confidence of society. Or, we can simply wait and see what will be imposed. If we take the latter approach, I think we run a high risk of witnessing our modern day version of the ‘Tragedy of the Commons’ play out: each party acting in accordance with its own short‐term self‐interest, with no one taking responsibility for the Commons. As the Honorable Leo Strine, Chancellor of the Delaware Courts has noted, “we don’t have time to relearn the lessons of the 19th Century!

We need a ‘world view’ – a goal we share about the kind of society in which we want to live and be part. Arguably, this is what our elected officials should be addressing, and the laws and policies we have should reflect the values we share, the limits we believe need to be set for everyone, and the safety net we believe to be just. It is not clear to me that our politicians will or can agree on such a shared vision. In fact, it would appear that we are in a war of fundamentally different visions for the future, and what constitutes a just society.

Despite these obvious challenges, business should not get a free pass. I believe that every business should articulate clearly what it sees its role to be, and the contribution it will make to society. It can do this, of course, through a clear statement of purpose.

Similarly, if we shared a common world view, it would be easier for us to outline the role and behaviors of business in the society we seek to build. Absent a consensus, a business can articulate its chosen path, and the contributions it will make, in its vision.

I believe a clear purpose is an essential building block in the foundation of a more responsible capitalism. You can’t achieve your purpose in a quarter, or a year. It serves as a statement of why a company exists, and more fundamentally why a company merits having a corporate charter and receive the protections of society. Absent a world view of the kind of society we want to have, it is very company’s opportunity, and responsibility, to articulate the contribution it seeks to make to society and to the improvement of life on earth.

About the Guest Blogger:

David H. Langstaff, President and CEO, TASC, Inc.

David H. Langstaff, President and CEO, TASC, Inc.

David H. Langstaff is President and Chief Executive Officer of TASC, Inc., chairman of the Advisory Board for the Aspen Institute Business and Society policy program, trustee of the Committee for Economic Development, and chairman of This I Believe, Inc.

Before assuming the position of president and chief executive officer of TASC in March 2011, Langstaff had served as chairman of TASC’s board of directors since December 2009, when the company separated from Northrop Grumman Corporation. 

Previously, Langstaff was president, chief executive officer and director of Veridian Corporation, from its formation in 1997 until its sale to General Dynamics in 2003. Veridian was regarded as one of the preeminent companies in national and homeland security with a strong values based culture; its IPO was recognized by the Financial Times as one of the 10 best global IPOs in 2002. 

This post was originally delivered as the keynote address at the Kellogg School of Management/Aspen Institute Business and Society Conference, Rethinking ‘Shareholder Value’ and the Purpose of the Corporation,  on March 7, 2013.



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2 Responses to “Rethinking ‘Shareholder Value’, the Purpose of the Corporation, and the Role of the Board”

  1. This scholarly and well-thought-out piece has highlighted the long-standing debate on the purpose of a company. Interestingly, as rightly noted in the article, both the shareholder value approach and the stakeholder approach converge into one. This is so because shareholders of a company are in fact part of the company’s stakeholders.

    Nevertheless, a major challenge to the stakeholder approach is with tenure of the directors. This also makes long-term goals somewhat unattractive. In today’s corporate environment where expectations from companies are enormous, directors are now put under increased burden of retaining their seats. This is a major issue. Perhaps, there should be some re-thinking of corporate governance framework to accommodate these present-day challenges. Unfortunately, “Say-on-Pay” and yearly retirement of directors do not help solve the problem.

    There must be a way out. And this must be found and adopted!

  2. […] Rethinking ‘Shareholder Value,’ the Purpose of the Corporation, and the Role of the Board on The Conference Board Governance Center Blog, March 7, […]

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