How America Can Get the Patient Capital It Needs
A Commentary

In a business world beset by a nagging recession, precarious leverage levels, and stiffening competition, corporate governance doesn't exactly weigh heavily on the minds of most executives. Theoretically, it might be nice to improve the interaction among investors who provide capital, corporations that use it, and directors who oversee its use. But right now, there are more important things to do. Besides, shareholders who get too involved with corporate affairs can be irritating--as Time Warner Inc.'s managers, for example, learned last July, when they were forced to revise their $3 billion stock plan.

Yet corporate governance should move front and center. There is a strong, undeniable link between it and competitiveness--so it's good business to pay greater heed to shareholders. Fortunately, a growing number of enlightened capitalists understand that if the U. S. wants to compete more effectively against Japan and Germany--whose systems provide the more patient capital that allows long-term strategies--U. S. executives may have to agree to institutional changes. As Treasury Under Secretary Robert R. Glauber said on Oct. 3 at an Investor Responsibility Research Center governance conference: "Patience requires participation."

SHUT OUT. At the moment, the U. S. system holds executives accountable with a kind of rough justice. Since stockholders have little influence on management, they usually sell their shares when they're dissatisfied. The stock price falls. Managers react by taking action that will buttress the stock price in the short term but may sacrifice long-term returns. That way, they insulate themselves from the "market for corporate control"--or takeovers--and keep their jobs. They probably get paid better, too, thanks to programs that link pay to stock performance.

The system is pretty harsh on shareholders, too. They lack not only influence but also access to management. That hampers their ability to understand corporate aims, especially those that have no evident short-term payoff. Worse, investors have no easy way to discipline managers who make decisions that feather their own nests rather than boost a company's value. Boards, the supposed monitors, generally do not act against management unless it does something egregious.

To compensate for this added risk to their investment, "shareholders demand constant proof that their money is being invested wisely," says Michael T. Jacobs, a former Treasury official and author of a just published book called Short-Term America. They get it by watching stock-price movements for the expected high returns. The result: a higher cost of equity capital in the U. S. This damages the country's ability to compete with Japan or Germany, where equity owners have bigger stakes and more influence.

This adversarial relationship between the providers and users of capital is exacting a high cost on U. S. industry. How then can the system be changed to integrate shareholders into the governance process without harming the efficient allocation of capital?

Most attempts to fix this state of affairs have come from the big public pension funds--usually via the proxy process. They've lodged resolutions asking management to rescind poison pills, say, or institute confidential proxy voting. But except for getting management's attention, these efforts have largely failed. That's one reason one of the most activist shareholders, the $65 billion California Public Employees' Retirement System, has decided to change tactics: In 1992, instead of offering proxy resolutions, CalPERS will lobby for change with managers and directors of poorly performing companies in its portfolio.

The CalPERS path is worth following. But the situation demands more. Boards are the key to better governance, and investors, managers, and directors themselves need to focus on getting them up to snuff. Having "outside directors" isn't enough--they must be truly independent, active directors willing to communicate with shareholders. Boards should be pushed to convene more often, do more at meetings, and gather occasionally without the CEO.

Shareholders must also be able to monitor the performance of directors, changing them if necessary. That requires reform of the proxy system, which is now under review by the Securities & Exchange Commission. Companies should probably be asked to provide more data about directors. They should perhaps offer more than one choice for a board opening. They should definitely be required to allow voting for individual directors, rather than a slate, and to allow votes against a director, rather than the mere withholding of a vote. That would allow dissident investors to mount less costly challenges to management.

No one has a perfect plan to make shareholders more effective owners and managers more accountable. But it's good that some thinkers are now explaining the link between corporate governance and competitiveness. Once that's understood, Corporate America should be more willing to solve this pressing problem.