It has become a reality in American business today that businesses are run on a quarter by quarter basis. Earnings and profits must be secured for those critical quarters, or the analysts won't like your stock, and its price will plummet. And this, the stock price, has become the holy grail of corporate management.

The roots of the stock market come from the idea that an individual can purchase part of a larger corporation, effectively becoming a part owner. This means that the management of the corporation does, and should, have some responsibility to this new owner. This is actually mandated by law, and in fact, the shareholder has the right to sue management for not acting in the interest of the shareholder. Modern corporate management has interpreted this as a responsibility to maximize the stock price of their corporation.

Why does working for the shareholder mean increasing the stock price? Because there is no concept of long term ownership in the stock market today. It is easy of a shareholder (consumer) to switch their investment portfolio quickly. They have very little loyalty to a specific corporation, they are just concerned with how much money they will make selling the shares in the future. This makes the market very speculative. Because of this very short term perspective, this shareholder does not care about other benefits such as dividends that a company can provide. In fact, this type of owner is more of a 'day trader' than an investor.

While this is a significant portion of investors, I don't believe that it is the largest. With many pension plans disappearing from corporate offerings many people have their entire retirement investment riding in 401K accounts. Many times these accounts are funded heavily with the corporate stock. These investors are much more concerned about the long term profitability of the corporation than they are about the immediate quarterly results. Why aren't their concerns figured into the corporate strategy? There is no easy, candy coated, way to articulate how long term planning should work. Because it isn't easily evaluated and ranked, it isn't valued in a 'scientific' (numbers based) culture.

This problem also steams from the way that executive management compensation packages are structured. To over simplify slightly, they usually have a salary component and a stock option based bonus component. The salary is usually insubstantial relative to the bonus even to the point of having Steve Jobs pull the PR stunt of having a $1 per year salary. This means, that an executive of a major corporation can count his wealth directly by looking at the stock price of their company. Why wouldn't they want to maximize it? Who cares about long term stability or profitability?

At the end of this rant it is important to look towards the future and see what actions should be considered for fixing this problem.

  • Legal precedence for not maximizing the stock price. Because it is a legal issue that management is required to work for the shareholders, it must be decided in court whether this means maximizing the stock price. The only way to determine this is to have someone sue, and have the case get decided in court.
  • Restructuring of executive compensation. While it is important for a board to want to compensate an executive based on the quality of his work, this can not be entirely based on the stock price. I would recommend making part of this related to the dividend that the corporation gives to it's stock holders. Also, I think that there needs to be some long term accountability -- perhaps with long term stock options that are not dependent on employment. But, saying that their is one solution is ludicrous, the package must be determined and evaluated by the board for the specific metrics that they are concerned about for the company, stock price cannot be the only one.
  • Chairman of the board must not be an executive. In recent years it has become popular to have the title "Chairman and CEO". I believe that this should be illegal. By having the group which oversees the executives of the corporation contain members of those who are being overseen is obviously a conflict of interest. This restricts the accountability of the executives and limits the impact of dissenting members of the board can have on a run away executive

Will these things happen? Perhaps, perhaps not. I think that the it will require some government work, and also some will require public outrage. Probably the only thing that will cause this is a threat to business from abroad -- which, perhaps, isn't that far away.


posted Sep 25, 2004 | permanent link