Rethinking The Relationship Between Capital And Management

Was getting rid of GM CEO Rick Wagoner a good idea? Will capping executive bonuses at Wall Street banks do any good, or just make us feel good? Will all the efforts to make the government more transparent actually matter if we don’t understand what we're looking at? Is our news media the equivalent of training wheels - something to hold us up until we can begin to see for ourselves - or are they more like bifocals - something we'll need to use the rest of our lives?

If we were all doctors, and the country was our patient, we would listen patiently at the outrage and disgust over Wall Street and the pity and regrets over the plight of the auto industry, take the nation's vital signs, review the symptoms of the citizenry, and prescribe a remedy. In this case, the proper medical protocol would call for alleviating the symptoms, if possible, while making an attempt to address the root cause of the problem.

Corporate governance would be our culprit in this case. It may sound innocuous, or tedious, the way some remedies your doctor prescribes may sound to you, but if you don't take the time to understand how power is wielded in a modern corporation, complaining about the fat cat salaries the media is spotlighting on TV these days is quite simply a waste of time. But we're human, so we yell at the TV anyway.

"U.S. restrictions on shareholder rights reflect the fact that U.S. companies are less controlled than non-U.S. companies by dominant shareholders. The U. S. has traditionally believed that directors are best placed to protect widely fragmented shareholder interests, e.g., long-term investors versus speculators, retail versus institutional, and large positions versus small."

Hal Scott
A Global Perspective On Corporate Governance

All of the power of a corporation stems from the way it governs itself - from the way its bylaws, rules and regulations determine who has what say so in how the company is run. The number one fallacy about public companies that permeates popular culture is shareholder rights. Shareholders, according to popular lore, wield the power to elect officers, board members, and other representatives. It is also widely believed that a majority of shareholders who band together can dictate the direction of the company.

These things have not been true for a very long time.

The most amazing thing about a public company is the way a man can walk in the front door on his first day with absolutely nothing in his briefcase, and walk out a few years later with so many millions he would need a caravan of Brink's Armored trucks to carry them if he received his golden parachute or severance pay in cash.

Why is this?

Because if you took a look at the balance of power between the shareholders (known in finance 101 as "the owners") and the C-level executives (known in finance 101 as "the managers"), you will find, in just about every public corporation in this country, that the people who have the least amount of skin in the game - "the managers" - have the most amount of power.

Think about it. If you owned a private business, lock stock and barrel, a business that was large enough for you to hire someone else to run it for you in an executive capacity while you went fishing, would you let him set his own salary? Would you smile dutifully when he requested large bonuses in the form of options on equity in your firm every year, staggered in size and date in such a way that the first award would literally fund the actual outright purchase of equity in your company without your manager putting up one dime of his own money? Would you jump and down with glee and turn handstands when he lost money for the year, happily hand over a fat bonus of cash and equity in your business to him, and then tell him you’re thinking about improving his contract in order to "retain his services?"

Probably not, because every dollar you pay your executive manager is subtracted directly from your bottom line. When we talk about "real money", as opposed to the "play money" that corporations use, the picture becomes clearer in a hurry. But the money corporations use isn’t play money. It's as real as if it came out of the cash register at a mom and pop store.

My old roommate from years and years ago was a computer trainer. He made pretty good money back in the 90's showing people how to use software. But he struggled to stay on a budget. So he came up with a method that helped to rein in his spending. After putting aside money for rent, telephone (remember when there was ONE telephone bill per household, and you had to wait your turn to use the phone), monthly bills and savings, he would withdraw all of his spending money in cash. He'd sit the stack of bills on our glass topped dining table and think about how it was going to be spent. He believed that handling the actual money was a visual deterrent - watching the money go through his fingers, he said, was enough to make him reconsider how much he was about to spend on many an occasion.

Rolling the cash equivalent of a CEO's pay into shareholder meetings in wheelbarrows and dumping it on the floor in front of him would be a nice grandstanding ploy that might be a little embarrassing for the recipient, but it really wouldn’t help the shareholders much. What would help shareholders would be a return to the kind of basic corporate bylaws and rules that made shareholder rights take precedence over the rights of management. Can it be done?

In practically every instance that a shareholder proposal is broached, Super Corporations get their general counsels or outside counsels to issue a statement, one that normally contains language - "Super Corporation strongly urges the SEC to reject the shareholder proposal" – that denounces and rejects any overtures by shareholders to make it easier for them to have a voice in company matters. Combine that position with a slate of directors that most shareholders have never heard of, but the CEO has, and you have an entity that in effect answers only to itself, even as it sits atop a pile of other people's money.

We could go the English one better, and break out the windows of every bank on Wall Street, but after they are replaced, none of these board members will be any more sympathetic to us, or any more inclined to hoist their CEO's on a petard when necessary, or any less disposed to approve lavish pay packages whether the company earnings win, lose, or draw. The men who have signed off on the CEO pay bubble for the last thirty years are the directors, men and women who are supposed to be acting in your best interests. Men and women who are supposed to be the grown-ups in the room when your CEO throws a tantrum, or threatens to go home and take the shareholders ball with him if he doesn't get what he wants. Guess who they get their advice from when they need to make a decision? Guess who briefs them when the company has a problem? The guy with the ball - the ball that the shareholders own and the company's creditors have liens on.

If we go back to the analogy about being the owner of a private business, and take a look and one more item, we might get an idea of how to change this equation in the future. As a private business owner, the people you answer to are your bankers and your creditors. People you OWE money can influence you to do things as a business owner that you don't really want to do, just to get to continue to borrow money from your banker, or keep your longer term debt holders at bay. Common stock may be an outdated way to invest in a company. Bond holders and convertible debenture owners have much more leverage with Super Corporations than shareholders do.

This may not be the answer - I'm just thinking out loud here - but it is clear that what we have now only really works for the best interests of a few people. I'm tired of yelling at my TV too. Let's use this crisis as a way to rethink the relationship between capital and management for the new millennium.