For decades now, Ira Millstein, a senior partner at Weil Gotshal & Manges LLP (pictured), has been the dean of corporate governance lawyers -- so much so that he has an academic center, the Millstein Center for Corporate Governance and Performance at Yale, with his name on it. Millstein is to corporate governance what Marty Lipton is to corporate prerogatives: the law giver, the man of authority. And so, when Millstein writes a piece, with former Bankers Trust (here's blast from the past) chairman George Vojta, that confronts the disaster in front of us, it's worth a close read. (Bankers Trust, for readers too young to remember, pioneered commercial bank involvement in derivatives in the '80s and '90s, occasionally to its regret. BT was sold to Deutsche Bank AG in 1998. Vojta, like Millstein, is someone who knows the terrain.)
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The piece, which is running in the December issue of Directorship magazine, should make waves in the corp gov world. The reason: Millstein and Vojta are shaken enough by the financial mess that they are actually revising long-held orthodoxies, not only about the heterogeneity of corporate investors (particularly for financial firms) but about the centrality, and culpability, of the shareholder-centric model. They say, what is not said often enough: "These weaknesses [in financial firms] -- inappropriate risk-taking and malfeasance -- must be acknowledged with honesty, without reservation, and requisite remedial action must be defined and rigorously and visibly implemented."
Their two points are connected. Although it's been clear for some time, most corp gov advocates argued for a kind of single shareholder interest -- thus conflating interests as disparate as hedge funds, buyout funds, index funds, pension funds and individual investors. Millstein and Vojta now agree that shareholder interests are very different, even contradictory, and they blame that heterogeneity in part on the lack of accountability and excessive risk-taking in the financial sector. "The proliferation of new owners puts the model of shareholder activism which was envisioned in the 1980s and 1990s under severe strain," they write. "With this new array of owners came a blizzard of new financial instruments, which are complex and often incomprehensible."
Their solution to this situation is a striking bit of heresy. They urge boards and senior managers to shift from a shareholder to a stakeholder focus. "The first priority is for boards to change their focus from profit for the benefit of themselves and management to a renewed commitment of managing society's savings (ours) for the benefits of their shareholders and stakeholders (us). Boards must re-establish and enforce the standard that risks must be undertaken for the benefit of constituents."
They go on to make a series of recommendations, most of which involved enhanced risk management in companies. All this is fine, but it does bring us back to the orthodox model: All the risk management in the world won't work if there's an alignment of interest between some shareholders, managers and board that a risky, short-term strategy is desirable. Saying stakeholder is one thing -- and in this case a sort of call to arms -- but executing plan is something else entirely.
This article then is a little like Ronald Reagan suggesting communism as a possible business model. In fact, both of their points were obvious years before the mortgage crisis broke -- and obvious not just in financial firms but public companies generally. Whether stakeholder theory was the solution -- and that will be a bitter pill to swallow for many -- it's been clear for years that activist investors often held other shareholders hostage, and forced companies in directions that satisfied their own, often short-term self-interest (this helps explain the attractiveness of private equity). Perhaps the most incendiary nugget in their argument is the essential fact that in a world where shareholders are empowered, shareholders must shoulder some of the responsibility for a systemic mess. Once you reach that point, you have to rethink the model completely. - Robert Teitelman
Robert Teitelman is the editor in chief of The Deal.
