With the Enron trial jury selection set to begin, we have begun hearing calls again for corporate reform by increasing the power of the shareholder over that of the board of directors. I reject the logic of such calls because shareholders are not a monolithic group that mainly has one shared interest. The resulting variety of divergent shareholder interests necessarily results in conflict.
As a direct shareholder in several companies and as an indirect shareholder in the market in general (through mutual funds), I may be categorized as a long-term investor. I, along with those similar to me, have at our interest the long-term growth and return of the shares that we own. I disregard short-term swings in profit as a decision point in determining whether the sell or purchase shares. Thus, my interests directly conflict with those who would drive the company to eschew long term growth in favor of short term gains (or losses for short-sellers) as much as those who would use the power of their investment to force the firm to make non-economic decisions.
As institutional shareholders own the majority of shares in the market, they have the power to balance each other and prevent or mitigate the impacts of other powerful shareholders seeking economic interests in conflict with their own. For example, a large S&P mutual fund, with a primary goal of long-term growth for its investors, likely has the power to prevent a large hedge fund, with a primary goal of short-term profits through active trading, from influencing and forcing the firm to focus on short-term profitability. Similarly, firms that focus upon short-term profits may damage their long-term return by foregoing investment and dispersing capital to shareholders in the form of dividends instead of into growing the firm. The market would punish these firms, so that they would no longer be viable investments for those seeking long-term returns. Of course, investors would be hurt in the short term, but those who invest “in the market,” would not notice since they would see return in other areas of their portfolio. Thus, I do not see increased shareholder control for shareholders with varied economic interests as being the major focus for improved corporate governance.
Most “social” investors are placed in the context of Public and Private Union pension funds. Anectdotally, the public union pension funds are able to use their large holdings to pressure firms to accede to the demands of private unions. The use of pressure was not attributed to linked economic interests, but rather for “moral support” and retribution. When Safeway’s CEO attempted to take a hard-line stance against the United Food and Commercial Workers (UFCW), the California Public Employees’ Retirement System (CalPERS) intervened and withheld support for the board reelection of the CEO. CalPERS retaliated against a CEO who likely was acting in the best interest of his company and its shareholders in not caving into union demands. CalPERS had no interest in the matter other than also representing union workers (albeit unaffiliated with UFCW). In my opinion, examples such as these highlight the dangers of placing increased corporate management responsibilities onto the shareholder instead of the board.
Another area of activist investor is the “social activist.” Many proposals for increased shareholder power derive from the desires of these activists to use their status as shareholders to use the firm’s name, power, and treasury to advance their causes. Terms such as “Democratic Governance” and “social responsibility” come to mind when describing such shareholders. While lacking the power of the larger institutional investors (including the previously described pension funds), the social activist wields tremendous power in his ability to use apparently socially worthwhile causes to shame the corporation to become involved. Shareholder resolutions such as divestment, climate change, or unionization are often goals of socially active investors. As the public’s attention is focused on these issues (often by the social activists themselves), it becomes hard for the firm to reject these resolutions. Thus, increasing shareholder power over the board threatens to strip away the firm’s focus from economic interests.
I would argue that such shareholder activism not only carries risks to the firm, but also is distracting to the passive investor (of which the vast majority of investors are). It is also irrelevant because if the market wishes to reward those firms for being socially responsible, then the firm will act in that regard. Passive investors want to watch their investments grow under the care of the Board of Directors; they do not want to have to engage in political or social debates with other investors. Of course, I could be falling into the same trap previously mentioned - characterizing investors into just two camps – those who seek to use the firm for social activism and those who do not.
Overall, increasing shareholder power likely will not increase the firm’s performance. There are just too many conflicting interests and groups. The desires for those calling to increase shareholder power simply make too many assumptions about how shareholders will act in a collective fashion.
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