That brings us back to the original problem that resurfaced when options failed:
Reinstilling Dynamism: What Will It Take?
For a remarkably innovative economy, very little innovation has occurred in the fundamental form of structuring and running public enterprises over the past 100 years or so. Most of the attention of policymakers, academics, and business executives has focused on “perfecting” the form of the public corporation. But, in so doing, they have lost track of its original purpose, and that it still remains plagued by structural problems, specifically the agency problem.
Recent controversies should lead us to go beyond a debate as to how to “perfect” the model further. We ought to have a much more active debate about new forms of enterprise ownership. We need to bring the same level of innovation to corporate forms that we have to financial instruments. That will require that executives, board members, and policymakers revisit some of their assumptions as to the status and evolution of public companies.
- The costs of being public. Business leaders, regulators, and politicians must make the mounting direct and indirect costs of being a publicly held enterprise a focus of discussion. Over the last several decades, public companies have become magnets for costs imposed by regulation and legislation. The accretion of those costs reflects the importance society places on public ownership and their centrality to our national life. But we must acknowledge an unintended consequence—a growing unattractiveness to being public—and consider how to prevent those costs from getting out of hand.
- Reporting on risks, not just results. The degree to which large numbers of individual investors took on risks they did not understand constitutes one of the revelations of the last several years. That many of them did so in order to fund their retirement represents an enduring tragedy. In retrospect, it is hard to imagine why any individual investor might have held shares in Enron, a company incurring risks of such complexity that it has required forensic accountants to fully understand them. While new reporting requirements will enhance the timeliness and integrity of financial reporting, they do little to speak to the fundamental problem shareholders confront in understanding public companies—evaluating the risk/return trade-offs that underlie any company’s strategy.
- Rethinking executive compensation by rethinking tax treatments. Many factors contributed to the adoption of option programs by so many companies. The reasonably favorable tax treatment options receive contributed significantly. Compensation committees face a dilemma in granting compensation in the form of equity that creates immediate tax liabilities for the executives in question. It makes little sense to give someone a tranche of equity in order to help ameliorate the agency problem, only to have them sell 55% of the award in order to meet their cumulative tax obligations. By deferring gains, options provided an elegant solution to the friction that occurs on the intersection of the corporate and personal tax codes. We have special tax treatments to solve anomalies related to partnerships, real estate transactions, etc. Why not extend that logic to executive compensation?
- Reducing the barriers to exit from public status. Executives, lawyers, and policymakers have invested incalculable hours refining the process through which companies become public. Few individuals, other than corporate raiders and private equity investors, have spent time considering how to make exiting public status efficient if not convenient. But, the aversion private equity firms have for transactions involving privatizing companies suggests that sufficiently material and costly barriers exist in the process of bidding for a company as to scare off even the most sophisticated investors. Companies in capital markets purgatory need to have their path out of that unfortunate state eased.
- Eliminate dated restrictions on financial holdings. When one studies the literature on corporation strategy and compares it to actual performance, an anomaly emerges. The literature says that highly diversified companies will systematically underperform focused corporations. But, when one asks even casual students of corporate America to name the best-managed large companies, they invariably get the same answers: General Electric and Berkshire Hathaway. Those companies share several things in common, one of which is that both remain unrepentantly diversified, defying strategy pundits. Perhaps more important, they speak to the effectiveness of professionally managed holding companies, as does the success of private equity investors like Clayton, Dubilier & Rice, and Thomas H. Lee. Holding companies of various types provide professional governance motivated by an owner’s or principal’s motives—a combination that helps defuse the agency dilemma. In the early 20th century, trust-busting administrations and financial regulators moved aggressively to inhibit the growth of such holdings and the ability of banks to invest directly in and maintain substantial stakes in unrelated commercial enterprises. While the underlying concerns motivating those actions were appropriate to that time and place, those barriers deserve reconsideration. Relaxing certain restrictions should stimulate new types of vehicles, less vulnerable to problems of agency and less afflicted with the direct and indirect cost of public ownership status.