Distortions in value creation.

• Author: Bogle, John C.

The whole stock option process - wealth without risk - needs serious reconsideration.

The creation of "shareholder value" as the explicit focus of corporate strategy is largely a phenomenon of the 1990s. It has been driven, in part, by the leadership of large institutional investors, notably the states of Wisconsin and Florida, CalPERS, and the New York City funds, supported by the vigorous advocacy of the Council of Institutional Investors. The important research provided by the Investor Responsibility Research Center and others has also been invaluable. This handful of heroes fully deserves the accolades of America's shareholders who are - lest we forget - the owners of our publicly held corporations.

As the responsibility to enhance economic value has become the prime article of faith in Corporate America, it has often been codified in mission statements of boards of directors. For example, the mission statement of Mead Corp., the Fortune 500 papermaker on whose board I've served as an independent director for 20 years, states:

"The mission of the Board is to achieve long-term economic value for the shareholders. The Board believes that the Corporation should rank in the top third of peer companies in the creation of economic value...which is created by earning returns over full cycles which are higher than the cost of capital, usually reflected in total return to shareholders."

In Mead's case, total return is measured by return on total capital, with our ROTC then compared with the average ROTC of both our peers and Corporate America in the aggregate. In addition to serving as the benchmark for the evaluation of corporate success by the board, this joint measurement serves as the basis for Mead's incentive compensation system.

The focus of the board - and Mead's board is hardly unusual in this respect - is on the creation of additional economic value, measured by achieving an ROTC that exceeds the cost of capital. If we cannot earn the cost of capital for our shareholders, so the essential logic goes, why should they entrust us with it?

The idea that companies must recover their cost of capital is not new. According to The Financial Times, the eminent British economist Alfred Marshall stated it clearly a century ago. "But," the article added, "it was not systematically applied to management until the 1980s." One current fashion is to cast the issue in the form of "economic value added," or EVA.

But if we all can agree that the creation...