Five years into the new millennium, a cloud of uncertainty hangs over Corporate America. The lackluster economy, the war in Iraq, public and private fiscal imbalances, the Sarbanes-Oxley Act — all this obscures the financial landscape, inhibiting new investment, and with it, innovation and growth.
In this atmosphere of doubt, senior financial executives bent on creating value may not find reassurance from the conventional wisdom. Fresh thinking is needed to clear the fog. With this in mind, CFO sought out academic experts whose research suggests new, if unconventional, ways to create value. The work of the five experts we interviewed — Margaret Blair, Richard Roll, Ivo Welch, Jeremy Stein, and Robert Howell — centers on classic corporate-finance topics, from capital allocation and structure to accounting, governance, and risk and return. While much of their research may be theoretical, their observations surely will help CFOs struggling to find a profitable way forward.
Empower the Directors
Vanderbilt University Law School
Along with a handful of other iconoclasts, Margaret Blair has long argued that corporate law requires directors to be fiduciaries for the corporation, not just for shareholders. In practice, this places all stakeholders on an equal footing. Had the markets recognized this, she says, the scandals that destroyed so much shareholder value at Enron and other companies might have been avoided.
But until the interests of employees, customers, suppliers, and taxpayers are fully acknowledged, Blair warns, scandal will not diminish (Sarbanes-Oxley notwithstanding). Why? Her logic goes like this: other stakeholders help create value and have contractual rights that cannot easily be ignored. So if managers reward shareholders at the expense of other stakeholders, “they won’t be able to enter into precommitments and irrevocable contracts that reassure the [stakeholders],” observes Blair. That would leave managers with fewer options, the most tempting of which may be to manipulate the stock price.
“For optimal wealth creation,” concludes Blair, “both sides” — shareholders and stakeholders — “need to yield their authority to a board of directors.”
But how is management to proceed in light of these competing interests? Make long-term decisions in the interest of the business, answers Blair, instead of focusing on the daily ups and downs of the stock price. A self-evident solution, of course, but by no means simple to implement, she admits. “You have to keep doing something new. If you don’t, you’re in a commodity business. And if you do, there is no formula.”
Understand Your Options
The Anderson School, UCLA
The most widely used method for estimating a company’s cost of equity — the capital asset pricing model (CAPM) — has long been criticized for its reliance on beta, a standardized measure of risk. Beta makes no allowance for company-specific risk, say critics, and that effectively rules out the possibility that individual managers add or destroy shareholder value. “We don’t really have a good risk-return model,” says Richard Roll.