Thursday, May 19, 2011
The Appearance of Reality: Long-Term Shareholders
This is the seventh post in my effort to clarify corporate governance terms and concepts that now seem misleading to me. We all know what these words mean in a literal sense but in the context of governance, of business and of our post-crash world do they still mean the same thing?
I look forward to your comments.
Long Term Shareholders
There are two elements of societal interest in long-term investing: first is the perspective of the profit-making, publicly traded corporation, and second is the perspective of the investors in such companies. A corporation needs long term shareholding in order to permit allocation of resources so as to maximize long term value. Society loses when a corporation forgoes risky, long term commitments because they will reduce current “income” and, therefore, tend to depress valuation in the market place.
And then there is the risk that managers will lose their jobs. Is the focus on long-termism a euphemism for management protection? Long-term shareholders must be sure that corporate management is incentivized to carry out long term goals. Particular attention must be paid to: 1) options that are not indexed, 2) immediate rather than time-staggered vesting of incentive arrangements and, 3) termination incentives.
A corporation doesn’t care whether any particular shareholder is long term or short term, as long as a functional block of ownership – sufficient to control the venture ( the “controlling block”) – is long term and effectively active. 90% of the shareholders of public companies are institutions and not flesh and blood human beings and roughly half of ownership is created by mechanical formulae, either a form of index or the result of algorithms. This means that something north of a third of the ownership of public companies is long term. Indeed, ownership hard wired to be permanent.While there is an active trading market in ownership of index funds, the holdings of the funds in shares of large companies rarely changes very much. So long as there exists a long term “controlling block” in a particular corporation, there need no further concern as to whether the rest of the shareholders are long or short term.
The critical challenge is to develop incentives and structure so that the indexed 33% permanent shareholders can and want to act as stewards of the companies in which they have holdings.
Here are my questions:
#1 – Is the effective involvement of owners in the governance of corporations essential for profitability and sustainability?
#2 – Is there any reason why mechanically selected shareholders can make up a long term base requiring accountability for corporate performance?
#3 – Is it appropriate or not for the “active” ownership segment of corporate shareholders to be compensated for their expense in working toward the common good?
May 19, 2011 in responsible ownership
, shareholder activism
, institutional investors
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