VALUE MAXIMIZATION AND STAKEHOLDER THEORY: COMPATIBLE OR NOT?

Complicating the current corporate governance controversy is a major disagreement about the fundamental purpose of the corporation. There are two main views on what should constitute the principal goal of the firm. Most economists tend to endorse value maximization—that is, maximization of the value of the firm's debt plus equity—or a version of value maximization known as “value‐based management” (VBM) that aims to maximize shareholder value. The main challenger is “stakeholder theory,” which argues that the corporation exists to benefit not just investors but all its major constituencies—employees, customers, suppliers, the local community, and the federal government, as well as shareholders. Thus, whereas the success of a corporation under VBM could be assessed simply by its long‐run return to shareholders, under stakeholder theory a company's success would be judged by taking account of its contributions to all its stakeholders. Using statistical analysis of various measures of corporate success in satisfying non‐investor stakeholders, the author investigates whether a broader focus on multiple stakeholders is necessarily inconsistent with the pursuit of long‐term shareholder value. His main findings in fact suggest just the opposite—namely, that long‐term value creation appears to be a necessary condition for maintaining corporate investment in stakeholder relationships. More specifically, the author's study shows that companies with higher levels of value creation tend to have stronger reputations for treating stakeholders well while companies that create little value end up shortchanging not just their shareholders but all their constituencies. For profitable companies that have previously failed to devote the optimal level of resources to their non‐investor stakeholders, the message of this article is that investing in stakeholders can add value—and, in fact, it pays for companies to spend an additional dollar on stakeholder relationships as long as the present value of the expected (long‐run) return is at least a dollar.     

The Pragmatic Theory of the Firm

Four key ideas provide the foundation for the pragmatic theory of the firm, which is expecially useful for managements and boards in developing an understanding of how companies create long‐term value for the benefit of all stakeholders. First, and a necessary point of departure, is clarity about the purpose of the firm. Maximizing shareholder value is viewed not as the social purpose of the firm, but as a consequence of a company's effectiveness in carrying out a purpose that recognizes the benefits of success to all key corporate stakeholders. Second, a company's knowledge‐building proficiency, in relation to that of its competitors, is viewed as the primary determinant of its long‐term performance. Nurturing and sustaining a knowledge‐building culture facilitates the discovery of obsolete assumptions and early adaptation to a changing environment. Third, the theory avoids “compartmentalizing” a company's activities into silos by treating the firm as a holistic system. A key component of the theory that quantifies corporate performance is the life‐cycle framework in which economic returns exhibit “competitive fade” over the long term. This holistic way of thinking provides insights about intangible assets and other sources of excess shareholder returns. Fourth, managing corporate risk should focus on identifying and removing all major obstacles to achieving the firm's purpose. Such obstacles can lead to value destruction through, for example, unethical behavior and all forms of shortsighted failure to recognize and make the most of opportunities to increase long‐run productivity and value. This theory of the firm is pragmatic in the sense that it aims to produce insights about a company's (or business unit's) performance that can improve management's decisions, especially in allocating capital and other corporate resources. The author uses John Deere's life‐cycle track record over the past 60 years to illustrate a successful application of the theory.     

Far Beyond the Quarterly Call: CECP's First CEO‐Investor Forum

The authors begin by describing how the existing structure of corporateshareholder communications encourages short‐term planning and performance evaluation horizons. Then, after summarizing the substantial evidence that corporate management, boards, and investors are concerned about the failure of current corporate‐shareholder communications to reflect longer‐run corporate investment and its expected payoffs, the article holds up the long‐run plans presented by the CEOs of five large public U.S. companies (and the CFO of IBM) at the first ever CECP CEOInvestor Forum as providing a promising model for the future. Such presentations are also evaluated against a set of criteria the authors propose for assessing the effectiveness of those presentations—criteria that were developed through extensive investor and CEO feedback. The article concludes by discussing the three main programs that make up CECP's Strategic Investor Initiative to further the development of such longterm plans. One program is focused on identifying different kinds of investors, with the aim of helping management attract longer‐term shareholders. A second program is designed to improve the ways companies communicate with their non‐investor stakeholder groups, with particular emphasis on The Statement of Material Audiences and its role in identifying the critical stakeholders and their contributions to the long‐run success of the company. Third and last is the development of a common language and tool‐kit for longterm plans, with the aim of bringing about the broad adoption of longterm plans as a mainstream element in corporate‐shareholder communications.     

Risk Management,Corporate Governance,and the Search for Long-Term Investors

This discussion explores a number of ways that more effective risk management, corporate governance, and communication with investors can help companies increase their effciency and long-run value. According to one of the panelists, recent surveys of corporate directors suggest that companies should devote more time and attention to three issues—strategy, risk management, and succession planning—and that strategy and risk are the “flipsides of the same coin.” As the panelist argues, “You can't talk about strategy without talking about what risks you're going to take—and what risks you decide to take has to depend on the core competencies that drive the corporate strategy.” In addition to making risk management a critical part of corporate strategy, another notable recommendation is to communicate a company's strategy and business plan as clearly as possible to investors, with the aim of attracting more sophisticated, long-term shareholders. Contrary to popular belief, such a group may well include some hedge funds and other activist shareholders. According to a newly released report on shareholder activism (produced and cited by another panelist), corporate boards should work harder to identify and engage the “largest 10 shareholders in the organization,” with the ultimate goal of cultivating a shareholder base that buys into the company's strategy.     

Identifying and Attracting the "right" Investors: Evidence on the Behavior of Institutional Investors

This article summarizes the findings of research the author has conducted over the past seven years that aims to answer a number of questions about institutional investors: Are there significant differences among institutional investors in time horizon and other trading practices that would enable such investors to be classified into types on the basis of their observable behavior? Assuming the answer to the first is yes, do corporate managers respond differently to the pressures created by different types of investors– and, by implication, are certain kinds of investors more desirable from corporate management's point of view? What kinds of companies tend to attract each type of investor, and how does a company's disclosure policy affect that process? The author's approach identifies three categories of institutional investors: (1) “transient” institutions, which exhibit high portfolio turnover and own small stakes in portfolio companies; (2) “dedicated” holders, which provide stable ownership and take large positions in individual firms; and (3) “quasi‐indexers,” which also trade infrequently but own small stakes (similar to an index strategy). As might be expected, the disproportionate presence of transient institutions in a company's investor base appears to intensify pressure for short‐term performance while also resulting in excess volatility in the stock price. Also not surprising, transient investors are attracted to companies with investor relations activities geared toward forward‐looking information and “news events,” like management earnings forecasts, that constitute trading opportunities for such investors. By contrast, quasi‐indexers and dedicated institutions are largely insensitive to shortterm performance and their presence is associated with lower stock price volatility. The research also suggests that companies that focus their disclosure activities on historical information as opposed to earnings forecasts tend to attract quasi‐indexers instead of transient investors. In sum, the author's research suggests that changes in disclosure practices have the potential to shift the composition of a firm's investor base away from transient investors and toward more patient capital. By removing some of the external pressures for short‐term performance, such a shift could encourage managers to establish a culture based on long‐run value maximization.     

Bridging Sustainability and Finance: The Value Driver Adjustment Approach

Even though most large corporations view sustainability considerations and concerns as having the potential to affect their revenue and profits, and studies have shown that sustainability can affect stock returns, investors and corporate managers continue to struggle to incorporate such concerns into their financial decision‐making. As a consequence, the valuation effects of sustainability issues are not fully reflected in either the valuation of companies by investors or in capital investment decisions by corporate managers. The author argues that sustainability can be integrated into both of these kinds of financial decision‐making by linking it to business models, competitive positions, and value drivers using what the author calls a “value‐driver adjustment” (VDA) approach. The basic idea is simple: material sustainability issues affect business models and competitive positions, which in turn affect the company's value drivers—notably, sales, margins, and capital. The VDA approach explicitly considers these linkages by taking three steps: (1) identifying a company's material sustainability issues; (2) analyzing how these issues are expected to affect the company's business model and competitive position; and (3) quantifying the effects of such changes in business model and competitive position on the company's value drivers, including its cost of capital. In the first part of the article, the author provides an investor perspective that shows how sustainability can be integrated into investment decisions by asset managers. There he explains how and why ESG integration has so far failed to become mainstream, and what needs to be done to make it successful. The second part of this article takes the corporate perspective and shows how sustainability can be linked to value drivers using much the same ingredients as in asset management, but slightly different tools that can help corporate managers incorporate sustainability concerns into strategy and operations, including the finance function. And in closing, the author brings together corporate and investor perspectives while showing how sustainability programs can be used to make the relationship between companies and their shareholders both stronger and longer‐lasting.     

VALUE MAXIMIZATION, STAKEHOLDER THEORY, AND THE CORPORATE OBJECTIVE FUNCTION

This paper examines the role of the corporate objective function in corporate productivity and efficiency, social welfare, and the accountability of managers and directors. The author argues that because it is logically impossible to maximize in more than one dimension, purposeful behavior requires a single‐valued objective function. Two hundred years of work in economics and finance implies that, in the absence of externalities and monopoly, social welfare is maximized when each firm in an economy maximizes its total market value. The main contender to value maximization as the corporate objective is stakeholder theory, which argues that managers should make decisions so as to take account of the interests of all stakeholders in a firm, including not only financial claimants, but also employees, customers, communities, and governmental officials. Because the advocates of stakeholder theory refuse to specify how to make the necessary tradeoffs among these competing interests, they leave managers with a theory that makes it impossible for them to make purposeful decisions. With no clear way to keep score, stakeholder theory effectively makes managers unaccountable for their actions (which helps explain the theory's popularity among many managers). But if value creation is the overarching corporate goal, the process of creating value involves much more than simply holding up value maximization as the organizational objective. As a statement of corporate purpose or vision, value maximization is not likely to tap into the energy and enthusiasm of employees and managers. Thus, in addition to setting up value maximization as the corporate scorecard, top management must provide a corporate vision, strategy, and tactics that will unite all the firm's constituencies in its efforts to compete and add value for investors. In clarifying the proper relation between value maximization and stakeholder theory, the author introduces a somewhat new corporate objective called “enlightened value maximization.” Enlightened value maximization uses much of the structure of stakeholder theory—notably the need to consider the interests of all corporate stakeholders—while continuing to posit maximization of long‐run firm value as the criterion for making the necessary tradeoffs among stakeholders. The paper comes to similar conclusions about the Balanced Scorecard, which is described as the managerial equivalent of stakeholder theory. Although the Balanced Scorecard can add value by helping managers better understand the drivers of shareholder value, it should not be used as a performance measurement and incentive compensation system because it fails to provide a single valued score, a clear way of distinguishing superior from substandard performance.     

Beyond Financial Reporting An Integrated Approach to Disclosure

A company's market value is a key determinant of its future success, affecting its ability to raise capital, recruit and retain key employees, and make strategic acquisitions. Confident, well‐informed investors are necessary for achieving and maintaining accurate valuation of a company's stock. But standard disclosure practice has left many companies releasing a great deal of data while conveying only limited understanding to outsiders. This article presents the outline of an integrated approach to corporate disclosure in which each of the three major elements–required financial reports, supplemental disclosure, and interactions with investors and intermediaries–are consistent and mutually reinforcing. Such an approach begins with required reports that refiect as closely as possible the economic reality of a company's business. But if GAAP income statements and balance sheets are often useful for communicating current and past performance, they are not designed to convey management's strategic vision and the company's prospects for creating value. To achieve and maintain accurate valuation, management must supplement mandated financial reporting with voluntary communication that highlights value drivers and helps investors understand both the company's strategic goals and management's progress in meeting those goals. Finally, management must interact with investors and capital market intermediaries in ways that provide them with a clear and compelling picture of the company's prospects, which should help both analysts and institutional investors become more effective monitors of the firm's performance. Through consistent communication that goes well beyond the sell side's focus on quarterly earnings per share, management will discover that it has the power to set the agenda for how the company's performance is evaluated by the market. In the process, companies are also likely to find that their investors (and analysts) are more patient than they thought, while their operating managers feel less pressure to take shortsighted steps to boost EPS. Both of these expected benefits of an integrated disclosure policy should end up increasing a company's value.     

Corporate Governance and the Cost of Capital: Evidence from Australian Companies

The authors examine a sample of large Australian companies over a 10‐year period with the aim of analyzing the role that firm‐level corporate governance mechanisms such as insider ownership and independent boards play in explaining a company's cost of capital. The Australian corporate system offers a unique environment for assessing the impact of corporate governance mechanisms. Australian companies have board structures and mechanisms that are similar in design to Anglo‐Saxon boards while offering a striking contrast to those of German and Japanese boards. At the same time, however, the Australian market for corporate control is much less active as a corrective mechanism against management entrenchment than its U.S. and U.K. counterparts, making the role of internal governance mechanisms potentially more important in Australia than elsewhere. The authors report that greater insider ownership, the presence of institutional blockholders, and independent boards are all associated with reductions in the perceived risk of a firm, thereby leading investors to demand lower rates of return on capital. In so doing, the study provides evidence of the important role of corporate governance in increasing corporate values.     

Loyalty‐Shares: Rewarding Long‐term Investors

In the face of growing concern about investors' excessive focus on quarterly earnings, recent research has found new evidence of the benefits of a committed long‐term shareholder base, whether in terms of higher profitability, R&D investment, greater integration of ESG factors, or a reduced cost of capital. In light of this evidence, this article takes up the challenge of proposing a market solution to this problem. Although much has already been done in the financial industry to lengthen the outlook of executives by imposing longer vesting periods for stock options, a significant fraction of institutional shareholders continues to have a short‐term orientation. The authors propose that companies try to attract a more long‐term‐oriented shareholder base by modifying the form of the common share contract to include a special reward for buy‐and‐hold investors. The type of contract proposed—called a “loyalty share”—is a call‐warrant attached to each share that is exercisable at a specified time‐horizon—say, three years—and exercise price, but is nontransferable and hence has value only if the share is held for the entire length of the specified “loyalty period.” Such a reward is expected to encourage a longer‐term valuation outlook, since those shareholders seeking the loyalty reward are likely to be those who are most confident about the company's ability to increase its value through the expiration of the loyalty period.     

Session III: Securities Law in Twenty‐First Century America: A Conversation with SEC Commissioner Robert Jackson

SEC Commissioner Robert Jackson comments on three major issues the Commission has been investigating: (1) the concentration of ownership among American stock exchanges; (2) the extent of common ownership of, and potential for undue influence over, U.S. corporations by large institutional shareholders; and (3) the role of corporate boards in promoting and protecting stakeholder interests as well as shareholder interests. In the first of the three areas, Jackson argues that the ownership of 12 of the 13 U.S. stock exchanges by just three financial conglomerates suggests a competitiveness problem— one that, despite the significant reductions in trading costs during the last 15 years, should receive further investigation. To the concerns raised by the common and increasingly concentrated ownership of U.S. public companies by institutional shareholders, the Commissioner's main response is to note that whatever culpability corporate America is forced to assume for our large and growing environmental and social problems must be shared with the largest U.S. institutional shareholders, whose collective resources and influence confer a responsibility to help guide companies when responding to such problems. Finally, on the issue of stakeholder theory and ESG, Jackson insists that asking corporate boards to put the interests of all stakeholders on a par with their shareholders’ when making strategic business decisions would be a mistake. Besides creating a major accountability problem, the adoption of stakeholder theory in place of “the clear, single‐minded objective function of increasing long‐run shareholder value” would deprive boards of their principal guide “when making the difficult tradeoffs among stakeholders that effective oversight and management of public companies require.”     

U.S. Corporate Governance: Accomplishments and Failings A Discussion with Michael Jensen and Robert Monks

Two of America's most prominent shareholder activists discuss three major issues surrounding the U.S. corporate governance system: (1) the case for increasing shareholder “democracy” by expanding investor access to the corporate proxy; (2) lessons for public companies in the success of private equity; and (3) the current level and design of CEO pay. On the first of the three subjects, Robert Monks suggests that the U.S. should adopt the British convention of the “extraordinary general meeting,” or “EGM,” which gives a majority of shareholders who attend the meeting the right to remove any or all of a company's directors “with or without cause.” Such shareholder meetings are permitted in virtually all developed economies outside the U.S. because, as Monks goes on to say, they represent “a far more efficient and effective solution than the idea of having shareholders nominate people for the simple reason that even very involved, financially sophisticated fiduciaries are not the best people to nominate directors.” Moreover, according to both Jensen and Monks, corporate boards in the U.K. do a better job than their U.S. counterparts of monitoring top management on behalf of shareholders. In contrast to the U.S., where the majority of companies continue to be run by CEO/Chairmen, over 90% of English companies are now chaired by outside directors, contributing to “a culture of independent‐minded chairmen capable of providing a high level of oversight.” In the U.S., by contrast, most corporate directors continue to view themselves as “employees of the CEO.” And, as a result, U.S. boards generally fail to exercise effective oversight and control until outside forces—often in the form of activist investors such as hedge funds and private equity—bring about a “crisis.” In companies owned and run by private equity firms, by contrast, top management is vigorously monitored and controlled by a board made up of the firm's largest investors. And the fact that the rewards to the operating heads of successful private equity‐controlled firms are typically multiples of those received by comparably effective public company CEOs suggests that the problem with U.S. CEO pay is not its level, but its lack of correlation with performance.     

The Role of Corporate Boards: A Roundtable Discussion of Where We're Going and Where We've Been

In this roundtable that took place at the 2016 Millstein Governance Forum at Columbia Law School, four directors of public companies discuss the changing role and responsibilities of corporate boards. In response to increasingly active investors who are looking to management and boards for more information and greater accountability, the four panelists describe the growing demands on boards for both competence and commitment to the job. Despite considerable improvements since the year 2000, and especially since the 2008 financial crisis, the clear consensus is that U.S. corporate directors must become more like owners of the corporation who “truly represent the long‐term interests of all of the shareholders.” But if activist investors appear to pose the most formidable new challenge for corporate directors—one that has the potential to lead to shortsighted managerial decision‐making—there has been another, less visible development that should be welcomed by wellrun companies that are investing in their future growth as well as meeting investors’ expectations for current performance. According to Raj Gupta, who serves on the boards of HewlettPackard, Delphi Automotive, Arconic, and the Vanguard Group,

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BEHIND THE CORPORATE HEDGE: INFORMATION AND THE LIMITS OF "SHAREHOLDER WEALTH MAXIMIZATION"

The article begins by setting out three alternative conceptions of the corporate objective function. Relying on this framework, it shows that legal analyses tend to neglect conflicts between the interests of the corporate entity and the interests of shareholders over the amount of corporate risk-taking. Financial analyses tend to ignore both constraints on managerial discretion imposed by law and a fundamental ambiguity the author identifies in the “shareholder wealth maximization” assumption that underlies such analyses. This ambiguity arises in part from market “frictions”–particularly, the investor uncertainty and heightened price volatility that stem from informational “asymmetry.” Such an information gap between management and outside investors (along with market “irrationality”) can cause material disparities between the actual trading price and the intrinsic value (or what the author calls the “blissful price”) of a company's shares. As a consequence, corporate hedging that maximizes actual share values may not maximize intrinsic values (and vice versa), thus giving rise to a managerial dilemma. Previous analyses have also failed to give adequate consideration to the expectations of shareholders. If, for example, the shareholders of a natural resource company are seeking a relatively “pure play” on that resource–in part because they believe the company's management has no comparative advantage in managing price risks–corporate hedging that increases shareholder wealth may re-duceshareholder welfare. In this sense, the usual “shareholder wealth maximization” directive is not only ambiguous, but also incomplete. These problems stem not only from informational asymmetry, but from other institutional realities (such as the “political” taint associated with reported derivative losses of any kind) that raise the information costs of using derivatives. The article concludes with some suggestions for improving disclosure of corporate risk management “philosophy.” Better disclosure may not only help reduce such information costs, but could also encourage corporations to find–and stick to–their derivatives niche.     

Is Managerial Myopia a Persistent Governance Problem?

Critics of U.S. corporations have long argued that companies are overly focused on short‐term results and, as a consequence, sacrifice their own long‐run value and competitiveness. These criticisms have expanded in recent years to include those from prominent politicians, investors, consultants, and academics. If such criticisms have merit, they would imply a massive governance failure in which there has been decades of underinvestment with little adjustment on the part of managers, boards, or the market for corporate control. This article evaluates the economic underpinnings of these criticisms and analyzes their implications in the context of empirical evidence produced by several decades of research on corporate investment policies, the outcomes of corporate control events, investor horizons, and the market pricing of companies with little if any earnings. In reviewing the findings of these studies, the author finds little evidence to support the view that U.S. companies sacrifice long‐run value and competitiveness by systematically underinvesting. First, although U.S. companies have indeed cut back on tangible investments such as property, plant, and equipment, these cutbacks have been more than offset by the dramatic growth in investment in intangibles, such as spending on developing knowledge capital, brand‐building, and IT infrastructure. Second, when subjected to events that have the effect of reducing managerial control over investment policies and transferring control to outside investors—such as leveraged buyouts and recapitalizations, forced CEO dismissals, and shareholder activist campaigns—companies tend to reduce, not increase, investment spending. In fact, it is difficult to find any corporate control threats that have had the goal or effect of increasing investment. Third, and at the same time, the rising concentration of large institutional investors, including indexers such as BlackRock and Vanguard, suggests that investors have become, if anything, more long‐term oriented over time. Fourth, there is no evidence that the market shuns companies that have yet to report large (or indeed any) earnings. These findings suggest that curbing overinvestment, and not discouraging myopia and underinvestment, may well still be the larger corporate governance challenge facing investors when monitoring and attempting to influence the performance of U.S. companies.     

A CEO's Playbook for Creating Long‐Term Value: Ten Essential Resource Allocation Practices

A former CEO of a large and successful public company teams up with a former chief investment strategist and a well‐known academic to suggest ten practices for public companies intent on creating long‐run value:

1. Establish long‐term value creation as the company's governing objective.
2. Ensure that annual plans are consistent with the company's long‐term strategic plan.
3. Understand the expectations embedded in today's stock price.
4. Conduct a “premortem”—and so gain a solid understanding of what can go wrong—before making any large capital allocation decisions.
5. Incorporate the “outside view” in the strategic planning process.
6. Reallocate capital to its highest‐valued use, selling corporate assets that are worth more to or in the hands of others.
7. Prioritize strategies rather than individual projects.
8. Avoid public commitments, such as earnings guidance, that can compromise a company's capital allocation flexibility.
9. Apply best private equity practices to public companies.
10. CEOs should work closely with their boards of directors to set clear expectations for creating long‐term value.

These practices, as the authors note in closing, “are meant to provide a starting point for public companies in carrying out their mission of creating long‐run value—and in a way that earns the respect, if not the admiration and support, of all its important stakeholders.”     

The Icahn Manifesto

The title of this opening chapter in the author's new book on activist investors refers to Carl Icahn's solution to the “agency” problem faced by the shareholders of public companies in motivating corporate managers and boards to maximize firm value. During the 1960s and '70s, U.S. public companies tended to be run in ways designed to increase their size while minimizing their financial risk, with heavy emphasis on corporate diversification. Icahn successfully challenged corporate managers throughout the 1970s and 1980s by buying blocks of shares in companies he believed were undervalued and then demanding board seats and other changes in corporate governance and management. This article describes the evolution of Icahn as an investor. Starting by investing in undervalued, closed‐end mutual funds and then shorting shares of the stocks in the underlying portfolio, Icahn was able to get fund managers either to liquidate their funds (giving Icahn an arbitrage profit on his long mutual fund/short underlying stocks position) or take other steps to eliminate the “value gap.” After closing the value gaps within the limited universe of closed‐end mutual funds, Icahn turned his attention to the shares of companies trading for less than his perception of the value of their assets. As the author goes on to point out, the strategy that Icahn used with such powerful effect can be traced to the influence of the great value investor Benjamin Graham. Graham was a forceful advocate for the use of shareholder activism to bring about change in underperforming—and in that sense undervalued—companies. The first edition of Graham's investing classic, Security Analysis, published in 1934, devoted an entire chapter to the relationship between shareholders and management, which Graham described as “one of the strangest phenomena of American finance.”     

A Fireside Chat with Raj Gupta: What It Takes to Create Long‐Term Value

The chairman of two public companies (and former chair and CEO of Rohm and Haas) draws on his experience as a director of five private and 15 public companies in discussing the challenges and opportunities facing today's corporate boards. Perhaps the most formidable challenge is the pace of technological change, which is making business models ‘in all industries and countries’ obsolete and forcing companies to adapt much more quickly than in the past. Along with the risk of obsolescence is the increase in ‘reputational risk’ associated with an ‘information age’ in which companies are forced to monitor the nearly continuous flow of fact, hearsay, and outright fabrication. The author recommends that public company boards adopt a new ‘partnership’ model. Besides ensuring an ‘ethical tone at the top,’ corporate directors should aim to become partners with the senior management team by playing more active roles in strategic planning, risk management, and the design of performance evaluation and incentive pay systems. In the most striking departure from current practice, the author urges directors to seize the opportunity created by the ‘reconcentration’ of ownership of U.S. public companies by actively engaging large institutional investors in a strategic dialogue about the companies' strengths and vulnerabilities. In so doing, proactive directors can help their management teams preempt shareholder activists and create long‐run value by creating a more effective two‐way channel of communication, one with the potential to give management more confidence when undertaking large strategic investments with longer‐run payoffs.     

Bank Corporate Governance,Beyond the Global Banking Crisis

Following up on the publication of the Walker Report ( 2009 ) in the United Kingdom, international organizations such as the Basel Committee ( 2010 ), the OECD ( 2010 ), and the European Union ( 2010 ) have proposed guidelines to improve bank corporate governance and, more specifically, risk governance. These international reports vary widely on what the prime objective of bank corporate governance should be, with one group recommending a shareholder‐based approach, and the other a stakeholder‐based one. Moreover, the focus of these reports is exclusively on risk avoidance, with little guidance as to how an acceptable level of risk should be defined. Drawing on insights from economics and finance, this paper is intended to contribute to the debate on bank corporate governance. Our four main conclusions are as follows. Firstly, the debate on bank governance should concern not only the boards but also the governance of banking supervision with clearly identified accountability principles. Secondly, since biases for short‐term profit maximization are numerous in banking, boards of banks should focus on long‐term value creation. Thirdly, board members and banking supervisors should pay special attention to cognitive biases in risk identification and measurement. Fourthly, a value‐based approach to risk taking must take into account the probability of stress scenarios and the associated costs of financial distress. Mitigation of these costs should be addressed explicitly in the design of bank strategy.