How CEOs Can Forge a New Kind of Shareholder Value
(Bloomberg Opinion) -- The Business Roundtable, the organization for chief executive officers of large U.S. corporations, got a lot of attention last month with its revised “Statement on the Purpose of a Corporation.” The document, signed by 181 CEOs, calls for companies to serve all stakeholders by delivering value to customers, investing in employees, dealing fairly with suppliers, supporting the communities in which companies operate and protecting the environment. It also offers a vague commitment to “generate long-term value for shareholders.”
Many commentators in the media, as well as prominent politicians, greeted the Roundtable statement as a significant shift from shareholder primacy to a new governance structure with a deepened commitment to corporate social responsibility. However, there is good reason to question this, because of what the Roundtable statement does not tell us.
The statement does not tell us, for example, how companies should allocate resources when they face the inevitable trade-offs between the interests of different stakeholders. Incorporating the interests of stakeholders is indispensable for delivering long-term shareholder value, but it is impossible to satisfy all stakeholders simultaneously. Further, it is nearly impossible to hold CEOs accountable for their decisions in the absence of consistent and transparent guidelines for making them.
Consider the basic decision of setting the price for a product. In the short run, lower prices benefit customers (better value) and suppliers (increased demand), but could be costly for employees (less wage growth) and shareholders (lower profit). Higher prices may be good for employees and shareholders in the short run, but bad for customers and suppliers. Companies that charge too much will lose customers. Companies that charge too little will have happy customers today but may be unable to afford the investments necessary to serve the customers of tomorrow. A company puts its long-term viability at risk if any one stakeholder receives too much, or too little, for an extended period.
The challenge for management is to find the sweet spot that delivers value for both shareholders and other stakeholders. This is precisely the job of the approach to allocating resources that I introduced in the 1980s, first in the Harvard Business Review and then in my book "Creating Shareholder Value." In a nutshell, a company creates shareholder value when the present value of the cash flows it generates over time exceeds the dollars it invests to produce those cash flows. If this is the criterion by which the Roundtable expects companies to “generate long-term value for shareholders,” then its statement would simply be an endorsement of this economically sound approach to long-term value creation.
If the Roundtable supports investing in socially motivated initiatives at the expense of long-term value, that would be another matter. CEOs would be accountable to neither shareholders nor other stakeholders — a recipe for risking the long-term health of the company. Social purpose without value creation is unsustainable and does not serve the firm’s stakeholders.
Suppose the Roundtable statement instead intends to commit its CEOs to invest only in socially-motivated initiatives that promise long-term value creation. In that case, we can best describe the Roundtable’s shift as away from a focus on Wall Street quarterly earnings expectations toward a commitment to create long-term shareholder value through the support of all of the firm’s stakeholders. But again, the Roundtable’s CEOs don’t tell us.
Another important matter about which they are silent is compensation. Most CEO compensation packages fail to incentivize long-term value creation. They typically include annual performance bonuses, three-year incentive plans, stock options and restricted stock grants. Annual and three-year plans are based largely on earnings-related metrics that encourage short-term behavior. Similarly, three-year plans that reward CEOs for achieving total shareholder return targets relative to competitors are too short for most business cycles.
Most stock option plans also fail the long-term value-creation test because holding periods of three or four years or less can encourage CEOs to focus on short-term earnings, exercise their options early and cash out shares. Further, CEOs profit from any increase in the company’s stock price and are therefore rewarded handsomely even if the company’s shares earn a return below that of Treasury notes.
Restricted stock units, a significant component of today’s CEO compensation, are essentially options with an exercise price of zero, which encourages risk-averse CEOs to play it safe. In an effort to blunt the criticism that restricted stock plans are a giveaway, many companies require CEOs and senior executives to achieve short-term earnings, revenue or return-on-capital targets to receive them, which can be counterproductive.
The Business Roundtable’s message that corporations should become more stakeholder-inclusive and socially responsive is significant and timely. Regrettably, it offers no specifics on how companies should allocate resources, on whether it supports corporate investments in socially motivated initiatives that do not create long-term value, or on how to align incentive compensation with long-term value. Until the Roundtable addresses these issues, corporate boards, senior executives, investors and government regulators can only speculate about the statement’s true significance.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Alfred Rappaport is the Leonard Spacek Professor Emeritus at Northwestern University’s Kellogg School of Management. He is the author of "Creating Shareholder Value: A Guide for Managers and Investors" and "Saving Capitalism from Short-Termism."
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