Institutional investors can do more to further corporate governance reform. As a major engine of funding in the world capital market, they can flex considerable financial muscle. Ira Millstein, the Senior Associate Dean for Corporate Governance at the Yale School of Management for whom the Millstein Center for Corporate Governance and Performance is named, explained to a crowd of Yale students and faculty on February 28 that there is an underlying problem of short-termism, which may be ameliorated through governance reforms.
Millstein spoke at the center’s first lunch series lecture. He said that most businesspeople would assert that they feel pressured to meet expectations about quarterly results, or face analysts' complaints about "performance" – stock market performance – and director restlessness about their "leadership." It is human nature to respond to such pressure by managing performance in that direction – the short-term.
The key to changing this trend, Millstein asserted, is a consensus among all the players that long-term strategies are, in the end, best for companies and the economy. Long-term strategies include investment in research and development, and the risk-taking that has provided for dynamic growth in so many sectors. But these strategies often require foregoing the maximization of short-term results, which, in turn, requires boards willing to support managers in creating and executing long-term strategies. To do so, boards must be willing to risk negative stock market reactions until the strategies are understood, and also resist the blandishments of private equity funds which see the possibilities of growth and profit not being appreciated in the market. These are not subjects for easy execution, Millstein stated, but can be accomplished if thought through carefully.
Turning to a blackboard diagram of the players in the capital markets, Millstein asserted that institutional investors, with their major holdings of public companies, were best positioned to affect the short-term trend. They could do so by electing directors who were likely to be long-term oriented, by investing in private pools of capital managed by persons dedicated to improving the long-term performance of the corporations they invest in, and by subsequently monitoring the performance of such pools, namely private equity and venture capital funds. Again, Millstein acknowledged, these ideas are easily asserted but difficult, though surely not impossible, to effectuate.
Millstein then briefly described some of the many and complex reasons why this was not happening. First, in the U.S., shareholders have limited ability to directly elect board members. Lack of majority voting, no right to access to the proxy for director elections, limited removal rights, broker voting, and other issues have left the board largely self-perpetuating, although reform is slowly coming. Another set of problems relates to a host of obvious and not-so-obvious conflicts in how institutions use the voting rights they have. This, Millstein asserted, is the subject of many articles in the academic and popular press which so far have caused little change. Questions remain about whether the institutions use voting power to benefit themselves, portfolio companies, or beneficiaries. He reminded the audience that the institutional investors have a fiduciary duty exclusively to the beneficiaries.
Millstein pointed out that much has to be done in the way of reform in the area of shareholder rights and institutional conflicts in order for the institutions to take their rightful place in electing directors who can, and will, take a longer-term view of corporate performance and support managers who can execute the necessary strategies.
The complex subjects of this lecture will be the subject of future articles by Millstein, the subject of research projects supported by the Center, and be considered in the course he will be giving next fall at the School of Management.