Within weeks of that famous drive Bernie Ebbers made to a federal prison in Louisiana, I attended a conference in Salt Lake City, where the keynote speaker was Dr. Stewart Myers, expert on corporate governance.
Corporate governance is the whole area of finance that looks at how to keep CEOs’ hands out of the cookie jars and on the right side of the law. Whenever you have managers running a company they don’t fully own, you set yourself up for a problem. Ownership motivates employees to work hard to increase revenue and to watch costs carefully to lower expenses. It also encourages them to behave in ways which lead to long, healthy lives for the company.
I am the sole owner of my company. When I sign up a new account, that extra revenue flows directly to my pocket. When I mess up a sheet of embossed stationary, I cut into my pay. You can bet I watch expenses closely. The decisions I make about my company have a direct and profound effect on my own bottom line. I don’t want to mess it up.
When public companies award stock options, they are trying to align the interests of the managers with those of the shareholders. The idea is that making managers owners of the company will make them pay attention to the health and well-being of the company. Now, even this is creating problems, as managers manipulate earnings and company announcements and even change options dating. It seems that anything less than full ownership leads to a potential for cheating.
From Enron to WorldCom to HealthSouth, bad behavior among managers has been rampant. It led to a crisis of faith in our markets, and regulators scrambled to find ways to adjust our federal corporate governance rules. That’s how Sarbanes Oxley came to be. It was Congress’ attempt to make managers of public companies behave. The problem is that it is very costly and cumbersome. Some companies are going private just to get away from the burden of compliance. Myers contends that there are parts of the new law which are downright silly. In our attempt to correct a problem, we have gone overboard and have still missed the point.
From my first finance class through my graduate doctoral program, we’ve all known the focus of corporate finance. In all decisions, the goal is to maximize shareholder value. Right? Wrong, according to Myers.
Whenever human capital is involved, the goal of corporate finance should be to maximize corporate wealth. The more a company depends on hired hands to make the company “go,” the more important it is to consider the well-being of those workers. While outside shareholders can tell managers what NOT to do, it is impossible to tell them what TO do.
Shareholders must give over the day-to-day operations of the company to a manager and his employees. When that happens, the self-interest of the manager matters, and that’s where problems occur.
Maximizing corporate wealth means you must appeal to a manager’s self-interest. You must find ways to motivate employees, so that they produce good results for the company. Along the way, you will do things which extend the life of the company, thereby granting job security to workers.
The idea is that what is good for the worker is good for the company and vice versa. Such a system would lead to better healthcare coverage for employees, despite the added costs.
It would also lead to a more relaxed work environment and better vacation packages. Happy workers are more productive workers. Of course, there is a tipping point. The trick is finding that balance.
When you maximize corporate wealth, you must insure the health of the company, but you understand that this is tied to the health and well-being of the employees. Good corporate governance is an attempt to align the interests of the insiders (the employees) with those of the outsiders (the shareholders).
If the objective of managers is to maximize corporate wealth, there will be “no Chinese wall” between corporate finance and corporate governance, according to Myers. It will all be the same. A good system would not require cumbersome laws to ensure good behavior. Managers, acting in their own self-interest, would also be acting in the best interests of the shareholders… IF it’s done right.
And what about public versus private ownership? According to Myers, public ownership is better for those companies in the mature stage who are experiencing moderate growth. The disbursed ownership of a public company can effectively motivate managers. Young, high-growth companies, though, are more suited for private ownership. These companies must sacrifice short-term earnings, as they invest in the future. Inside managers are less likely to give up their own raises for the future of the company. Older companies are also better suited for private ownership. In this case, the best choice may be to dissolve the company or sell it to another entity. Inside managers are more interested in keeping the gravy train going.
Myers emphasized that “good governance is not necessarily associated with good performance.” Because Wall Street is focused on short-term results, managers often make choices to boost short-term performance. Good governance is focused on the long-term health of the company.
All this means that WorldCom may have been better off remaining a private company. If they had stayed out of the public arena, they would not have been tempted to play fast and loose with their earnings to keep the stock price propped up. They would have faced their business troubles head on. A small group of private owners may have been able to reign in Sullivan and Ebbers… maybe. That’s a lot of maybes.
Doling out prison sentences to wayward CEOs and enacting laws to curb bad behavior can work, but only if the overseers are paying attention. It’s like the authoritarian parent, who can make sure Junior behaves, as long as they are standing over him with a big stick. The real trick in finance is to find ways to instill good behavior by making good choices beneficial to everyone.
Maybe, instead of Sarbanes Oxley, we just need a few good child psychologists.
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