A New Governance Model IS Needed — But Not a Stakeholder Model
A Look At A High Performance Hard Driving Entrepreneurial Model
On Monday August 19, 2019 the Business Roundtable (BRT) issued a statement on their proposed new governance model for corporations. This new model, in essence, is a “Stakeholder Model” designed to replace the purported “Shareholder Value Maximization Model.” I published an article in LinkedIn in response to this statement by the BRT. This article adds some additional commentary.
The BRT got one thing right and two things wrong: What they got right is that a new public company governance model is needed. What they got wrong is the claim that the current model is a “Shareholder Value Maximization Model” and that it should be replaced by a “Stakeholder Model.”
A little over a year ago I had a book published entitled Governance Arbitrage: Blowing Up the Public Company Governance Model to Maximize Long-Term Shareholder Value that also addressed the public company governance model and the importance of replacing it — but, with a more entrepreneurial model. In short, the thesis for this book was and is that boards at public companies are hidden, undervalued and underperforming assets and that this is the result of the current (pre BRT announcement) public company governance model.
One of my core arguments in the book was (and is) that the current public company governance model is not a shareholder value maximization model. Instead, this model is a compliance focused, risk avoidance model with, in most cases, directors who do not understand the value creation process and that is guided by an obsession with quarterly earnings. To qualify, a quarterly earnings obsession, contrary to those who do not grasp value creation, is, in and of itself, decidedly not shareholder value maximization. (An aggressive short term focus in the context the longer term initiatives of a fully diligenced and fully developed Value Maximization Plan would be indicative of a shareholder value maximization model).
Whereas the BRT is now “committing” to a new “Stakeholder Model” of corporate governance, my new model prescription is at the opposite end of the spectrum. In short what I have proposed is a robust, entrepreneurial model with competence (related to the value creation requirements of the company) the only director selection criteria and a governing objective of optimizing capital allocation and maximizing company performance and long-term shareholder value. In other words, this is not a model that is designed to dilute accountability but to enhance it. It is not a model about being confused as to which constituent is the most important in a given situation but one that is designed to develop the full potential of the company being governed. This is a governance model that is significantly superior in regard to developing competitive companies at a time when the greatest challenge to U.S. competitiveness since the rise of Japan and Germany in the late 1970’s is on the horizon.
The following chart provides a high level comparison of the current public company governance model, the BRT stakeholder model and the value maximization model from my book. The various descriptions in the BRT stakeholder model column assume a full implementation of a stakeholder model, i.e. full “equality” for all “stakeholders.”
(1) McKinsey & Company, Improving Board Governance August 2013 Global Survey
In my previous article, I discussed the very real and serious issues of accountability that can and will arise with a “Stakeholder Model.” An article entitled “What Companies Are For” in the August 24 edition of The Economist addresses the same issue and also zeroes in on “Dynamism” stating, “The second problem is dynamism. Collective capitalism [stakeholder model] leans away from change. In a dynamic system firms have to forsake at least some stakeholders: a number need to shrink in order to reallocate capital and workers from obsolete industries to new ones. If, say, climate change is to be tackled, oil firms will face huge job cuts. Fans of the corporate giants of the managerial era in the 1960s often forget that at&t ripped off consumers and that General Motors made out-of-date, unsafe cars. Both firms embodied social values that, even at the time, were uptight. They were sheltered partly because they performed broader social goals, whether jobs-for-life, world-class science or supporting the fabric of Detroit. The way to make capitalism work better for all is not to limit accountability and dynamism, but to enhance them both [Emphasis Added]. This requires that the purpose of companies should be set by their owners, not executives or campaigners.”
I believe that The Economist article nailed it. You do not make capitalism better by a shift to a model of equality. You do it by making capitalism even more vibrant and more demanding. In that regard, the preceding paragraph raises the critical question: Which of the 3 governance models in the chart is most oriented toward and suited for accountability and dynamism? Or said another way, if you are an investor or have a retirement plan, either a 401(k) or pension, which governance model is likely to create the greatest value over the longer term?