A Corporate Governance Thought Experiment: Part 1

Since November of last year, I have written 9 pieces on this blog concerning CEO compensation, and 8 concerning "corporate governance." There was a bit of overlap between them, so it's maybe a total of 15 pieces.

In some discussions with my partner and a few other friends recently, I've begun to form a new view of the overall notion of "corporate governance." Simply put, if the "corporation" is viewed, legally, as an ongoing "person," then perhaps what is needed is an explicit articulation of when that "person" needs to be put down. And, thus, how the company should be seen as dispersing its genetic material in order to continue to grow the value of its owners' capital investments.

When I put forth this notion to a consultant friend, she replied that 'there are already spinoffs.' However, I feel these have been historically done ad hoc, sometimes from outside pressure, less often from internal calculation. Or, even worse, under pressure from investment bankers, whose focus is always fees, and rarely, if ever, sustained superior performance of businesses to which they offer their "services." The answer isn't just "spinoffs," but, rather, how the entire notion of value preservation and transference, then growth, is perceived over time for a company's shareholders.

So, let me begin with a thought experiment, the first part of which I will post here. Suppose I had empirical evidence that demonstrated, based on many researched cases, that a specific pattern of revenue and profit growth, and consistently superior total return performance, which then flattened, was statistically unlikely to ever regain its former growth rate?

In such cases, would it not be sensible for a board to plan for the point at which the company begins to consciously cease to spend its resources on the parent's poor growth prospects, and, in a conscious, organized manner, deliberately identify, spinout and exploit various attractive businesses from the parent? Not in a reactive mode, but as part of a conscious plan to provide shareholders with the best chance of continued consistently superior returns from the seeds planted by the parent company.

There is a flip side to this challenge. That is, the large company which is now in a mature product/market, generating more cash than it can invest at similar returns in its existing businesses. My partner and I discussed the most obvious example of this situation- GM in the late 1980s, when it stumbled into buying EDS and Hughes. Both moves were, at the time, criticized as questionable, given the corporate charter of GM, and its existing business focus. Now, of course, it's laughable to think that they truly made those deals. But think of how much better off GM might be today, had it put as much energy into understanding and managing its automotive business as it did in making distracting acquisitions. Other examples which come to mind are the lockstep purchase of PBMs by major pharmaceutical companies in the last decade, only to see most of them unwound later. Who knows how much that distraction cost Merck, which now struggles just to maintain momentum in its main business?

To successfully manage such explicit transitions of value sources from a parent to a spinoff, of course, compensation plans and executive selections would need to reflect the evolution of the company's focus from self-growth, to propagating offspring ventures, while slowly winding down the parent.

Again, as a thought experiment, one can envision changing the staffing and compensation, so that revenue growth in the existing company becomes secondary to launching sustainable ventures which are not in the main area of the parent's business, as well as increasing profits. In essence, rather than have a management attempt to grow a mature business, perhaps shareholders are better served by an explicit exit strategy which rewards the 'right' behaviors, including, at some point, merging or selling the parent in what would have, by then, likely become a commodity business.

Such a strategy would not necessarily, or even likely, be possible for all consistently superior-performing companies. For instance, just now, amidst this week's various technology-related stories in the business media, I would constrast Microsoft, Intel, and Dell. Based upon their technological developments over the years, I believe Microsoft and Intel would be candidates for my concept of explicit evolution of a company to propagate worthwhile spinoffs. In fact, as I discussed with my partner last week, these companies, with their internal venture capital units in the late 1990s, probably were on the right track. They just looked in the wrong places- outside, rather than inside.

Dell, however, as an assembler and retailer, is unlikely to have much in the way of value to propagate beyond its own enterprise.

At this point, I'll end the first part of this idea, and continue it in a future post.