The Board of Directors is legally required to maximize profits on behalf of
shareholders. Consider the case where a CEO must choose between two
plans:
a) maximize short term gains with long term losses after the CEO
quits, or
b) much larger long term gains and short term losses.
If the
CEO chooses (b), there is no guarantee that the long term gains will
materialize. Also, the average term of a CEO is only a few years or so. It is
even shorter if the company loses money. As such, if the CEO chooses (b), any
impatient mutual fund shareholders will cause trouble, the CEO will get fired,
and at the very least, the CEO will not get any money if option (b) is
chosen.
If the CEO chooses (a), then he is richly rewarded because the short
term profits permit the company to maintain a high stock price. Once the
long-term losses set in, the CEO can also claim that these losses were
unforeseen, and pretend to execute a turn-around plan.
From a Board of
Directors perspective, Option (a) also has the advantage that they can be seen
to be doing their legal duty, maximizing returns. If the Board of Directors
launches into Option (b) and the plan fails, the Board of Directors will be
looking at shareholder lawsuits, tanking share prices, and generally pissed
shareholders.
The law doesn't say you have to maximize short term gains.
However, in the absence of a single controlling shareholder (as in a private
company), then effectively a public company must maximize short term gains.
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