Substituting expert judgment for business judgment
I’ve been reading too much about some fundamentally misguided corporate governance notions from Cornell Law School professor Lynn Stout.
Maybe it’s the author of the piece trying to make something out of nothing, but the article reads as if Prof. Stout simply knows what’s best for corporations, individual shareholders, and institutional investors. While it’s not uncommon to see academics pronounce superior judgment, Prof. Stout acknowledges the power of the board to control a corporation. A misstatement of law then intrudes, and this is where the article turns south in terms of quality: the board’s fiduciary duty to shareholders (a phrase not even mentioned in the article) to exercise their business judgment is transformed, without support, into an obligation to create short-term increases in the stock price. Beyond being incorrect (that’s not what the law says at all except in the general scenario where the board has determined to sell the company and is then obligated to search for the highest price), there’s no real proof that that’s even what management and boards are doing in the first place. (That’s about four long posts’ worth of explanation foreshadowed right there.)
Instead, what this article really does is communicate Prof. Stout’s opinions about practices she doesn’t like.
- She says that tying executive compensation to share performance is bad; executives should get bonuses instead.
- She thinks that hedge funds (a convenient and irrelevant foil) engage in lots of “zero-sum” trading.
She thinks that too many investors have a short-term perspective.
Separate from the notion that there are plenty of companies that take different approaches to these issues is the idea that Prof. Stout can certainly buy corporate control in the market and make long-term decisions instead. If that’s all it takes, she should make outsized returns.
As with many academics, the solution is too quickly “you do as I say” rather than “let me do what I say and see what happens.” For each of these described problems, there are counter-examples and reasons for doing business a certain way. Google’s founders, in one well-known example, structured the company’s cap table to preserve their ability, consistent with their fiduciary duties under state law, to make long-term decisions that might have negative short-term consequences. Private equity funds take companies off the public market when investors disfavor short-term negative results as a price for long-term investments.
If compensating executives differently is so easy and so obviously “right” that boards should be prevented from any other system (and there have been bonus structures in the past, obviously), then perhaps the way to actually prove this theory is by doing compensation consulting and basing the fee on results. I wonder whether Prof. Stout would reject stock-based compensation to share in any value increase to the company. Money plays no favorites; the market will respond to the results.
Nothing about the concept of shareholder value dictates any particular executive compensation scheme; nothing about fiduciary duties requires boards to focus on quarterly results. Whether some do, perhaps even unwisely, has little to say about the wisdom of requiring boards to act in any specific way.
(Conflicts of interest: Rick went to Cornell Law, Class of 1997. Mike went to Cornell’s Johnson Graduate School of Management, Class of 1999.)