On August 11, 2016, stocks achieved all-time highs, with the Dow Jones Industrial Average, S&P500, and Nasdaq all achieving record highs on the same day, something that hadn't happened since December 31, 1999.
With these record high closes, as well as subsequent record highs, one would reasonably expect that the underlying companies would, from a fundamental business perspective, be performing (very) well. Also, given the length of the current "bull market" and the length of the current (as officially designated) economic expansion, one might reasonably believe that America's largest corporations would be in a strong financial condition and otherwise be well-positioned for the future.
However, the current-era financial and business environment in the United States is one of great complexity, as well as one with many special circumstances.
One especially notable development that has intensified over the last couple of decades is companies' focus on the stock price. This intensified focus has been caused by many factors, perhaps none more prominent than executive pay packages being heavily constituted by such items as stock options and stock-derived compensation schemes. As such, this compensation factor, as well as other factors related to the stock price and overall corporate valuations, has served to galvanize executives' (and other factions, such as corporate board members) focus on the stock price towards ways to increase it. Of course, shareholders have also played a major role in this intensified focus, as they naturally want to see the company's stock price advancing at an (at least) appropriate pace relative to the company's peers and the overall market.
However, from an overall corporate governance perspective, is it appropriate to have such a strong corporate focus on the company stock price, and should executive compensation be so strongly aligned with the stock price? There are many reasons why, from a prudent long-term corporate governance perspective, neither condition should exist at such an extreme level. I discussed these issues at greater length during 1996 in Barron's and Director's Monthly.
The greatly increased focus on the stock price has served to promote various deleterious practices, as well as foster neglect of various key practices that are prerequisites of long-term corporate success. While the impacts of this intense stock-price focus varies by company, such impacts appear to be broad-based among public companies and as such various generalizations can be made.
The harmful practices include:
- an intense focus on short-term factors
- high levels of stock repurchases at high prices
- excessive (special cash) dividends
- assumption of (excessive) indebtedness to fund share repurchases
- (highly) excessive - and not strongly linked to fundamental business performance - (executive) compensation
- broad-based indiscriminate (knee-jerk) expense reduction often resulting in various (very) harmful actions, including mass layoffs/employee turnover
- mergers that often lack strong rationale and/or destroy intrinsic value
As one might expect, the intense focus on the above-mentioned deleterious practices has caused a neglect of various beneficial practices. These beneficial practices include:
- long-term management and planning
- fundamentally improving underlying business results
- fostering attractive revenue growth through product and service offerings
- scenario planning
- various corporate practices including most effective pricing management
- long-term employee development and training
- improving the financial strength of the company
Also lacking are properly functioning and independent boards and other effective corporate governance practices. As David Dalka, Founder and Managing Director at Fearless Revival, a CEO and board advisory services firm stated, "There are abundant opportunities for boards of directors to influence CEO’s to achieve superior long-term operating results. Board effectiveness can improve in areas like board independence and focus on primary board responsibilities versus getting deeply involved in the detailed work of corporate staff (audit, compensation, etc.). Returning board focus to the ongoing concern and CEO succession planning will improve outcomes for customers, employees, and shareholders.”
While the stock price should be monitored and analyzed by executives and corporate boards - and can have an appropriate role in compensation - the undue focus on the stock price has led to various problematical issues as discussed above. Even for those companies that believe a higher stock price should be the primary objective, that is not to say that overt measures to promote such a higher price should be enacted. It can be argued that a company run with an objective of maximizing fundamentally-based business objectives - including generating long-run profitability and cash flow, maintaining and advancing market position, and strengthening the long-term financial condition of the company - will be a far more viable strategy for maximizing the stock price - especially over the long-term - as opposed to engaging in risky and short-sighted schemes in an effort to "game" the stock price.
While it is difficult to quantify the adverse impact that the undue focus on the stock price has caused, the overall impact of such appears to be rather large. Furthermore, many of the consequences of such - such as the assumption of debt - serves to increase the risk of future insolvency.
(October 2016)
