"Target-Proofing" Corporate Performance- How Probable Is It?

Friday's Wall Street Journal carried an editorial entitled, "Target-Proof Your Company," by Robert Pozen. Pozen is chairman of MFS Investment Management, and evidently adapted this piece from one he wrote for the Harvard Business Review.

Ironically, explaining that last part goes a long way toward explaining the rather ho-hum nature of his recommendations for how public companies may avoid becoming targets of private equity firms.

As I recall from many years reading HBR, it frequently would feature 'so-what' sorts of corporate pablum that espoused laudable, if largely unattainable goals.

For instance, Pozen's five questions for target-proofing a company are:

Is there too much cash on the balance sheet?

Is the capital structure optimal?

Does the operating plan significantly increase shareholder value?

Is executive compensation tied closely enough to shareholder value?

Do directors devote enough time and have enough incentive to increase shareholder value?

The first two questions are truly inane, at this point in modern corporate development. Any firm significant enough to merit private equity attention can afford a decent CFO who can make sure these tactical matters are appropriately managed.

The third question is, frankly, probably the toughest, hardest to achieve of any single question for modern corporate CEOs.

My proprietary research shows that, at best, only 10-20% of the S&P500 CEOs can figure out what to do in terms of fundamental, operating peformance, that leads to consistently superior shareholder returns.

Jeff Immelt's never done it. Chuck Prince never did, either. Nor most of the CEOs of large-cap companies. The best way to increase the odds of such shareholder return performance is, according to my findings, deceptively simple, and requiring of exceptional management talent and discipline.

Thus, Pozen's question, while useful, is, for all practical purposes, unanswerable by most CEOs and their boards. They simply have no clue.

If they did? They'd be doing it!

Questions four and five have elicited a myriad of posts from me over the past two years. Read my posts under labels such as 'corporate governance,' 'private equity,' 'executive compensation,' or 'Immelt.' Suffice to say, I've written about these topics prior to Pozen.

Don't pay CEOs for failure. Give them about $250-300K per year in cash, and the rest subject to a 3-5 year return performance that beats the S&P500. Lag that incentive compensation to force the CEO to focus on sustained outperformance of the S&P.

As for boards, I wrote this piece which pre-dated and anticipated Pozen's recommendations. I wrote,

"Here's another insight. If, as I wrote last summer as a solution to America's corporate governance problems, board members were required to "run" for the post, and invest significant assets of their own in the company, thus clearly aligning their financial interests with those of shareholders, it might improve corporate board oversight and involvement in the operation of companies.

Suppose private equity firm partners offered their services to a publicly-held company. Would they not, in effect, take board positions, in exchange for options to own much of the firm, or be paid a percentage of the value they created over, say, a function of the firm's prior total returns, relative to the S&P500? In effect, like my idea, they'd commit their financial fortunes to, and align them with those of the firm's. But what mechanism exists for shareholders to do this? None."

Pozen's ideas,

"Directors of private equity companies hold substantial equity in them, and share in the performance fees of the private equity funds -- typically, 20%-30% of the returns realized by these funds.

Such small boards may be particularly effective in smaller public companies, which have trouble recruiting outside directors,"

are precisely for what I have been arguing in this blog for years. They are not new.

Nor are they likely to happen. It's one thing to observe better practices. It's another to expect a set of wealthy, and growing wealthier, mediocre CEOs who sit on each other's boards to really care about their shareholders.

That's why, per this post, I forsook consulting with my research findings many, many years ago. Rather than try to change the culture of large-cap American businesses, it's easier just to invest in the ones that do what Pozen suggests, and leave the rest to muddle along on their own.