It’s Time for Careful Reform of Wall Street

It’s fine to criticize American business for being shortsighted, for being preoccupied with boosting today’s profits even at the expense of tomorrow’s. The question is what to do about it.

The simple answer is to remove some of the incentives for behaving that way. Many of those incentives have to do with the stock market, and while regulating the market is always difficult, some legislative action is badly needed. It need not be overly intrusive.

Part of that legislative focus should be on corporate pension funds, the way they are invested and the influence the corporations are permitted to have on them. Another part should be on trading abuses that have fueled corporate raiding and created an atmosphere that led to the insider trading scandal currently rocking Wall Street.

The reason the funds are so important is that their investment activities give them a dominant position in the stock market. Competition to manage pension monies has grown intense. Caught up in that competition, investment managers have taken to trading the portfolios of the funds with the same intensity as any market speculator. This activity, in turn, causes the fund managers to put growing pressure on major corporations to keep profits up at all cost and thus hype the price of their stock.

Corporate leaders themselves are among those pushing the funds for faster portfolio growth because it reduces what a company must contribute to maintain pension benefits. In the past couple of years, companies have been able to transfer substantial sums from their pension fund back into profits simply by assuming that portfolio appreciation will be rapid.

In sum, it is a vicious circle, and while it keeps stock prices up for a while, there’s reason for real concern that both the companies and their stocks will be weaker in the future because of it.

One way to shift the attention of the funds back toward the longer-term investment goals they used to have is to give the beneficiaries of the funds--future retirees of the corporations--more influence over them. In contrast to the short-term goals of corporate management, the interests of the employees lie naturally in ensuring the long-term strength of the pension fund and of the corporation that sponsors it. Companies could give employees this greater voice if they wanted to, but if they don’t, Congress should find a way to encourage the process.

That will get at part of the shortsightedness problem. More is needed, however, to curb another source of unreasonable pressure on corporate management, the fear of takeover. Much of that fear would disappear if corporate raiders were denied the free use of the public stock markets at so little risk. At present, raiders are permitted to manipulate stock prices and thus profit whether or not they are successful in their takeover effort.

One manner in which this happens is that the raider secretly buys a block of stock, big enough to produce significant profit if the price runs up but small enough to avoid public disclosure requirements. The raider gets in cheap, then announces his intention to buy a controlling interest at a price well over the current market price. When the market responds, the raider has a built-in profit with the stock he already owns. He’s also in a position to get the target company to buy him out at that higher price. Congress should make such market manipulation illegal. It can do this either by requiring the raider to disclose his true intentions before buying the first block of stock or by requiring him to give up the profit later.

The current insider trading scandal gives considerable impetus to reform efforts. The illegal profits made by some key figures in the market were directly related to information passed secretly about impending takeover campaigns. That doesn’t mean all professional traders are profiting from such information, but it demonstrates how risky it is to let the professionals get too much influence over stock market activity.

Legislation alone can’t make American executives farsighted. It would, however, help to take some of the speculative fever out of the market. That, in turn, would encourage corporate management to pay more attention to the business and less to the price of the stock.