There was a time when companies were both owned and managed by the same people, often by generation after generation of a single family. These owners/managers typically took a long-term view of how well their companies performed. Not only did they expect to own and manage their businesses for their entire working lives, they also expected to leave their businesses to their children, who would then assume the owner/manager role and responsibilities. The motives, interests, and actions of the owners/ managers all aligned with the long-term success of the company and concentrated on building enduring, intrinsic value. That value came from sustaining the business as a competitive enterprise that would generate cash over many years.
As companies grew and economies shifted, the dynamics of the owner/manager model changed dramatically. For many different reasons, ranging from the difficulties of managing increasingly complex businesses to simply a lack of interest by successive generations, companies began to hire professional managers. This created a distinct separation between the owners and management, which in turn created what is called the “agency” issue. With the owners no longer intimately involved in day-to-day business operations, they needed to ensure that the professional managers they hired—their agents—ran things for the benefit of both the owners and the enterprise as a whole. Boards of directors were created to serve this oversight function and to provide a system of checks and balances to ensure that management not only performed ethically and honestly but also focused on building long-term value for the owners.
The advent of the capital markets also dramatically changed the owner/manager model. Selling shares of stock in a company provided a way to attract money from investors who were neither the dynastic owners nor the professional managers. When “outsiders” began to share in the company’s ownership, their separation from managers became even more distinct and distant, requiring a more robust system of checks and balances to monitor the agency problem.
Over time, the combination of the agency issue and the dispersion of ownership created two major governance paradoxes for publicly traded companies:
- Shareholder identity is often misdefined. In today’s volatile market, the majority of shareholders are short-term investors, more interested in changes in share price than in long-term value creation. But higher share price is in the interest of all shareholders only when the increase is permanent and based on real earnings and sustainable growth. To fulfill their fiduciary responsibilities to all shareholders (past, present, and future), directors must take a longer-term view because only when stock price truly reflects real value do all shareholders, regardless of when they buy or sell their shares, benefit over time.
- The ability of investors to trade shares at will, moment by moment, puts individual shareholders in competition with each other. Only long-term growth in real enterprise value aligns the interests of shareholders. When shareholders compete as traders in the equity markets, their interests are nonaligned. This competition—the desire to buy low and to sell high—has inherently misaligned shareholders’ individual interests in the short term. When corporate executives and directors, who have inside information, buy and sell their shares with other investors, the misalignment becomes a grave governance issue.