Investor Capitalism Prevailed: Now What for Long-Termism?
By Michael Useem

Institutional investors need to continue pushing for board leadership.

It has been a quiet revolution.

In the old days, circa 1950, small holders, our parents and their parents, owned most of America’s largest publicly traded companies. Now, some 70 years later, they have been replaced by the great institutional holders, Blackrock, Fidelity, State Street and Vanguard among the most prominent.

With trillions of dollars under management and index funds at the core, they now dominate the ownership of virtually all listed companies. One apples-to-oranges but still instructive comparison: the $5 trillion-plus at each of the largest holders exceeds the GDP of almost all countries, including Germany, India and Russia.

Fortunately, that concentration of economic power has come with governance responsibility. Through ratings, proxies and good sense, institutional investors have compelled directors to junk their poison pills, compensate executives with options over cash, institute “lead directors” and sovereign committees, and make boards more workable, less ceremonial.

The age of investor capitalism — professional owners calling the shots instead of senior managers keeping control — has triumphed. We’re not gloating over the American way, but a victory dance might be in order.

Yet, if institutional investors stop there, they will have gone only half the distance, provoking a revolution without ensuring that their efforts have led to better managed companies for the long-term, not just short-term returns.

Thankfully, many institutional owners in recent years have allied with company directors to finish the job, empowering the latter with a roadmap for co-leading the enterprise.

And as boards become more engaged and exercise greater leadership, directors can and often do bring more long-term thinking into the enterprise.

A detailed study of scientific innovation in large pharmaceutical companies, for instance, found that empowered directors with scientific expertise actively advised company researchers on their long-term discovery agendas, and also that these directors then brought the firm’s innovation challenges into the boardroom for deliberation and guidance (tinyurl.com/empowereddirectors).

Engaged directors, in other words, are proactively shaping their company’s innovation strategy in addition to monitoring it.

And since the major institutions, especially those with indexed funds, have become large and enduring holders in virtually all publicly-traded companies, they have added their voices for long-term thinking and sustained returns by all.

Blackrock CEO Larry Fink has urged, for instance, that “corporate leaders’ duty of care and loyalty is … to the company and its long-term owners,” and they should “resist the pressure of short-term shareholders to extract value from the company if it would compromise value creation for long-term owners.”

As company directors have emerged as corporate leaders over the past decades, they must also embrace the long-term clarion call.

Genuine leadership, including a working partnership with the chief executive for setting strategy, building capability, and preventing catastrophe is critical.

Exceptions still abound: corporate governance at Wells Fargo remains a work in progress, according to the Federal Reserve and the board itself, but the trend line is otherwise remarkable. Boards are becoming more a high-performing team, less a collection of disparate individuals.

Executives, of course, still run the enterprise, but in the emergent model, directors are coming to lead it as well.

Focusing on directors of Fortune 500 firms, researchers asked what happens when several directors have significant ownership stakes in the firm but lack big business leadership (tinyurl.com/directorownership). Directors fell in this category if they held substantial company stock but had not founded a Fortune 500 company or served as a CEO or director of one. As the number of such “SOLE” directors — those with “significant ownership but low expertise” — increased on a board, company value decreased. Investors acted on the point: When SOLE directors left a board, investors drove up the share value.

Consistent with the research-informed thesis that directors should add value to a board when experienced in business leadership, another study of publicly held U.S. companies examined share prices after the unexpected death of a non-executive director.

Researchers found that when directors had served seven to 18 years — enough time to learn the business but not too much to resist change in the business — their sudden loss led to a share price decline, and for good reason (tinyurl.com/directorshareprice). When companies have more directors in that optimal 7- to 18-year experience range, they more tightly link their executives’ pay to the company’s performance.

To give the moment a fresh label, director leadership is now rising on the back of the earlier triumph of investor capitalism, and we are writing a new constitution for it. No surprise then that the great debates of the era revolve more around optimizing the board’s leadership of the company and less around investor influence on the company.

Though investor activism might seem a throwback, much of its present thrust is less about making boards accountable to owners and more about bringing new direction to the company, as recently seen at DuPont and its merger with Dow Chemical. It is now less an issue of investor authority than of director strategy.

For thriving in this new epoch of director leadership, here is a brief checklist to help identify whether your governing board is now well led, a high-performing team that not only oversees compliance but also adds real value to the business.

Does your board include:

• a non-executive chair or lead director who effectively organizes and guides the board;

• directors who bring business experience and strategic thinking to the boardroom;

• a culture and camaraderie among its members;

• a strong governance and nominating committee;

• a working partnership with top management;

• and a commitment to lead, not just monitor, the enterprise?

 If your board is near six for six, your directors are ready to lead in an age of long-termism.

Michael Useem is professor of management and faculty director of the Leadership Center at the Wharton School, University of Pennsylvania, and author of Investor Capitalism: How Money Managers are Changing the Face of Corporate America (Harper Collins), and co-author with Dennis Carey and Ram Charan of Boards That Lead: When to Take Charge, When to Partner, and When to Stay Out of the Way (Harvard Business Review Press).

 


Issue: 
2019 Annual Report

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