Schumer's Shareholder Bill Misses the Mark

Schumer's Shareholder Bill Misses the Mark. By Martin Lipton, Jay W Lorsch and Theodore N Mirvis
Corporate managers need to be able to take the long view.
WSJ, May 12, 2009

This week New York Sen. Chuck Schumer is expected to introduce the Shareholder Bill of Rights Act of 2009. The stated goal of the legislation -- "to prioritize the long-term health of firms and their shareholders" -- is commendable.

The trouble is that its provisions actually encourage the opposite. In its current form, the bill would require annual votes by stockholders on executive compensation. It would grant stockholders a new right to include their own director nominees in the corporation's proxy statement. The bill would put an end to staggered boards at all companies (the traditional option of electing one-third of the board each year). And it would require that all directors receive a majority of votes cast to be elected. Public companies would be forced to split the CEO and board chair positions.

Excessive stockholder power is precisely what caused the short-term fixation that led to the current financial crisis. As stockholder power increased over the last 20 years, our stock markets also became increasingly institutionalized. The real investors are mostly professional money managers who are focused on the short term.

It is these shareholders who pushed companies to generate returns at levels that were not sustainable. They also made sure high returns were tied to management compensation. The pressure to produce unrealistic profit fueled increased risk-taking. And as the government relaxed checks on excessive risk-taking (or, at a minimum, didn't respond with increased prudential regulation), stockholder demands for ever higher returns grew still further. It was a vicious cycle.

Thoughtful observers of corporate governance have recognized the direct causal relationship between the financial meltdown and the short-term focus that drove reckless risk-taking.

One key observer, the International Corporate Governance Network, issued a statement about the global financial crisis on Nov. 10, 2008. It spelled out the problem of shareholder power: "[i]t is true that shareholders sometimes encouraged companies, including investment banks, to ramp up short-term returns through leverage." It further declared that "[i]nstitutional shareholders must recognize their responsibility to generate long term value on behalf of their beneficiaries, the savers and pensioners for whom they are ultimately working." It recommended that pension funds and others seeking to hire fund managers "should insist that fund managers put sufficient resources into governance that delivers long term value."

If government really wants to encourage stability and profitability, the Schumer bill must call for measures that would promote the long-term value perspective. Providing long-term shareholders a greater number of votes per share should become a permissible option. Quinquennial rather than annual or triennial elections of corporate board members should be considered. Institutions should discontinue the practice of compensating fund managers based on quarterly performance. And corporations should follow the lead of General Electric by discontinuing the practice of issuing quarterly earnings.

The stockholder-centric view of the current Schumer bill simply cannot be the cure for the disease it spawned. Though the short-term focus benefited shareholders for a time, when the meltdown happened shareholders weren't the only people hit. Employees who devoted their lives to building stockholder value felt the pain acutely. Communities, suppliers and creditors -- indeed, the whole range of constituencies who support the creation and maintenance of stock value -- were impacted. They have a legitimate stake in this debate.

Let's use the opportunity for fresh thinking that this crisis presents and restore the ability of boards and managers to run America's companies for our long-term best interest. Hopefully, the astounding losses we have witnessed over the past months will steer us back to responsibility.

Messrs. Lipton and Mirvis are partners of the New York law firm Wachtell, Lipton, Rosen and Katz. Mr. Lorsch is a professor at Harvard Business School.