Nasdaq Speaks to Martin Lipton of Wachtell, Lipton, Rosen & Katz about the New Paradigm in Corporate Governance
This article originally appeared on the Nasdaq Listing Center Clearinghouse blog.
Martin Lipton, a founding partner of Wachtell, Lipton, Rosen & Katz, specializes in advising major corporations on mergers and acquisitions and matters affecting corporate policy and strategy. We spoke with Mr. Lipton about his most recent publication, “The New Paradigm – A Roadmap for an Implicit Corporate Governance Partnership between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth,” a blueprint for eradicating the short-termism that, he believes, is crippling long-term corporate growth and investment.
Q: Do you see any parallels between the corporate takeover atmosphere of the early 1980’s and modern activism, which has been accused of shifting corporate focus to the short-term?
A: There is a strong similarity between the corporate raiding of the ‘70s and ‘80s and activism. Modern activism is a reflection of the overwhelming control of public companies by the major institutional shareholders, which own somewhere between 65-85% of the stock of most listed companies. The real pressure on companies is meeting the expectations of the institutions that have the ability to control them, versus any other kind of defense to deal with in activist attack.
I believe the best free market approach to protect shareholders from attacks by activist hedge funds is my New Paradigm for corporate governance, which places the deciding power in the hands of a majority of shareholders who are acting with knowledge of corporate strategies and in accordance with their fiduciary duties.
Q: If you had to boil down your “New Paradigm” paper to one takeaway, what would it be?
A: The New Paradigm is a corporate governance framework that derives from the recognition by corporate CEOs and boards of directors, and by leading institutional investors and asset managers, that short-termism and attacks by short-term financial activists significantly impede long-term investment by corporations. The New Paradigm recalibrates the relationship between public corporations and their investors, conceiving of corporate governance as a collaboration among corporations, shareholders and other stakeholders to achieve long-term value and resist short-termism.
In this framework, if a corporation is diligently pursuing well-conceived strategies developed with the participation of independent, competent and engaged directors, and its operations are in the hands of competent executives, investors will refuse to support activists seeking to force short-term value enhancements without regard to long-term value implications. As part of their stewardship role, investors will work to understand corporate strategies and operations. Investors also will engage with corporations to ensure they understand investors’ opinions so corporations can adjust strategies and operations in order to receive investors’ support.
Q: In practical terms, who at the company should collaborate with investors and how do you recommend they do so?
A: The key is a double use of engagement: appropriate corporate governance involves real engagement between management and the board of directors, as well as between corporate management and investors. Institutions want to know that there is an independent, competent and experienced board of directors overseeing and engaged in what management is doing. Corporations need to know what governance their institutional investors expect of them.
As a practical matter, the relationship between a corporation and its investors should be overseen and participated in by the CEO and carried out on a day-to-day basis by the investor relations and corporate governance staff. There should be periodic participation by the lead independent director, independent chair (if any) and members of the board. Director participation is a case-by-case decision depending on circumstances, including whether the investors have interest in meeting with directors.
When engaging with institutional investors, it’s important for corporations to understand what investors want, to communicate effectively what management does not think appropriate and therefore will not do, and ensure investors have confidence in that. It’s also critical to be fully transparent with investors with respect to operations, and earnings, and other material information. Corporations should ensure that investor relations are first rate and that institutional investors are satisfied with the access they have to the board of directors if they desire to communicate directly with the directors.
Q: Your paper states that engagement is a two-way street, with investors holding up their end of the bargain. Do you think the investors are ready for it?
A: Most major investors—especially BlackRock, State Street and Vanguard—have equipped themselves for engagement, and most are committed to strengthening their engagement capability. Engagement is strongly supported by FCLT Global (not-for-profit organization dedicated to developing practical tools and approaches that encourage long-term behaviors in business and investment decision-making) and all of the major investor associations.
Q: While the paper calls for changes through market forces without new regulation, do you think there is anything that exchanges can contribute through the regulation of listed companies?
A: I’m very hopeful that a large number of major institutions, investors, and corporations will endorse the New Paradigm, and that we will see a significant decrease in the pressure for short-term performance as a result. Corporations need encouragement and support from their investors to make the long-term investments that lead to sustainable growth.
The exchanges could make a major contribution to the universal adoption of, and adherence to, the New Paradigm by endorsing it and stating that they believe it is an effective means of achieving long-term investment and growth. If both corporations and investors adhere to the New Paradigm, no new regulation would be needed.
Q: Another publication attracting attention in the corporate governance community is “Principal Costs: A New Theory for Corporate Law and Governance.” Why do you think principal-cost theory has taken so long to emerge, allowing instead for the agency-cost theory to dominate?
A: From the very outset of shareholder activism—say Milton Friedman in 1970— it was recognized that the cost of shareholders forcing changes in business strategy and operations could have an adverse impact on investment in research and development, on capital expenditures, on employment, employee training and attracting top executive talent. It just didn’t have a catchy name like “shareholder democracy” or “agency cost.”
What Professor Goshen has made clear is that it’s the function of the board of directors, and of investors dealing with the corporation, to find the optimal governance structure through exercising balanced stewardship. If you pressure for short-term performance, higher dividends or share buy backs, you are causing the corporation to reduce R&D and capital expenditures and increase leverage to the point that companies run into financial difficulties. There’s no better example than what happened in the fiscal crisis in 2008.
As Jack Welch has said, “maximizing shareholder value is the dumbest idea in the world. Shareholder value is a result, not a strategy…your main constituencies are your employees, your customers and your products.”
Q: Do you think the New Paradigm will affect the balance in the capital markets between short- and long-term investors?
A: I believe the New Paradigm will have a significant impact on promoting long-term investment. CEOs, management teams and boards of director are highly responsive to the views and requirements of their investors. If a majority of shareholders are acting with knowledge and in accordance with their fiduciary duties, it will promote a reasonable balance between short-term and long-term goals.
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Lisa Roberts is a Vice President in Nasdaq’s Legal and Regulatory Group, where she co-leads the Listing Qualifications department and advises on governance matters for our issuer community. She also manages our Governance Clearinghouse website, which includes original articles on a variety of topics relevant to public companies, such as market structure, corporate sustainability, boardroom diversity, legislative advocacy, cybersecurity, and risk management. This site is available to all public companies and their advisors free of charge.
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