The economic cataclysm has shaken the most fervent believers in the invisible hand, from Judge Richard Posner to Former Federal Reserve Chairman Alan Greenspan, leading many of them—and most of the American public—to support a fundamental shift in the regulatory framework controlling our financial markets. Sen. Christopher Dodd, D-Conn., has introduced his financial reform bill, and there’s vigorous discussion about regulating everything from CEO compensation to use of corporate funds for political advertising to appropriate capital and leverage ratios.
But those who have pushed hard for this regulatory vigor must not blind themselves to one critical fact. While new regulation may have meaningful results, it also encourages us to ignore a more potent, and necessary, approach to remedying the markets’ structural problems: Shareholders must start exercising the latent power they have always had. By focusing almost exclusively on regulation, we are failing to take advantage of the fundamental power shareholders have had but have abdicated. It is akin to voters focusing on the need for campaign finance reform, railing against lobbyists, and then continuing to re-elect politicians who are too cozy with lobbyists. While we demand regulation and government activism to control Wall Street, we shareholders are ducking our own responsibility: We own the corporations whose behavior we disdain, yet we fail to use our power to control them.
Ownership trumps regulation—or litigation—as a means for controlling corporate behavior. We cannot regulate (or litigate) our way out of corporate failure.
Corporate governance should be viewed as a chain—the critical links are the CEO, the board, the management, and the shareholders. (Three other important links—attorneys, investment bankers, and accountants—have been bought and paid for by management over the past two decades and so rarely exercise any independent judgment.) It is only the negligence of shareholders that has permitted corporate power to flow upstream to the board and CEOs.
Now is the time to end this shareholder abdication. How? It would be cat herding to enlist all individual shareholders in the battle, but it will not be difficult to involve the shareholders who matter most, traditionally passive institutional investors—large mutual funds and pension funds. Here, politics is our friend. State treasurers and comptrollers are elected to use their power as overseers of enormous public pension funds in the interest of the pensioners they represent. In theory, this duty requires them to adopt the long-term perspective that has been so lacking in management in recent years and requires that they assert their power as shareholders to bring CEO behavior into alignment with the interests of shareholders.
These comptrollers and mutual fund managers can easily act—individually or in unison—to solve the worst problems in corporate governance. For example, how do shareholders restrain corporations from spending dollars on political campaigns in ways that may or may not reflect the interests of shareholders? Treasurers or comptrollers could insist that companies obtain prior shareholder approval before using corporate dollars for political or issue advertising.
Major shareholders could also easily fix the problem of overcompensation. There are countless remedies, but just the following would be a significant start: The pay of the top 10 employees must be approved by shareholders and must be directly tied to metrics or performance; no stock grants can have trigger prices reset without express shareholder approval; no options can vest before five years. These could all be mandated by shareholder resolution. Comptrollers and treasurers could insist that these rules be adopted in every corporation they hold stock in.
Shareholders can also examine the leverage ratios and general risk management of the corporations they own. They can warn management that the true risk holders will no longer tolerate the asymmetry which led management to adopt high-risk investment strategies that destroyed huge shareholder equity but gave management higher compensation.
We have recently used our passion for regulation as an excuse to get lazy about our obligations as owners. Continuing to cede the prerogatives of ownership to management will merely recreate the crises of the past two years. In a different era, Marx called for workers of the world to unite. Today, the best way to insure reform and protection of our economy is to rally to a new clarion call: Shareholders of the world, unite—take back your power!
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