The S&P 500 crashed another 7.5 percent today, bringing U.S. stocks, adjusted for inflation, back to where they were in mid-1996. Investors are apparently not sold on the idea that managers of U.S. corporations are going to pay them a healthy share of profits. What would it take to restore investor confidence in the U.S. market? How about governance reform?
Right now the shareholders of a public company are at the mercy of management. Without an expensive proxy fight, the shareholders cannot nominate or vote for their own representatives on the Board of Directors. The CEO nominates a slate of golfing buddies to serve on the Board, while he or she will in turn serve on their boards. Lately it seems that the typical CEO’s golfing buddies have decided on very generous compensation for the CEO, often amount to a substantial share of the company’s profits. The golfing buddies have also decided that the public shareholders should be diluted by stock options granted to top executives and that the price on those options should be reset every time the company’s stock takes a dive (probably there is a lot of option price resetting going on right now! Wouldn’t want your CEO to lose incentive).
If current trends continue, the CEO and the rest of the executive team will eventually have salaries that consume 100 percent of a public company’s profits and they will collect half ownership of the company via stock options every few years. Who would want to invest in that? Not sophisticated investors, it turns out. Big universities such as Harvard and Yale have reduced their exposure to U.S. public companies down to about 15 percent. Instead of buying a forestry company and watching the managers steal the trees, they’ve chosen to own forests directly. Given the laziness of university administrators, it should have been a wake-up call to the SEC that something needed to change when Harvard preferred to run its own forests.
Corporations are supposed to operate for the benefit of shareholders. The only way that this can happen is if a majority of Directors are nominated by and selected by shareholders. It may have been the case that social mores in the 1950s constrained CEO-nominated Boards from paying their friend $50 million per year, but those mores are apparently gone and the present structure in which management regulates itself serves only to facilitate large-scale looting by management.