Shareholders and rights
By Daniel M. Ryan
"It is a notorious fact…that the typical American stockholder is the most docile and apathetic animal in captivity" - Ben Graham
Those words appeared right after the introductory section of chapter 44 of Security Analysis, and are still there for us to wonder about. Although not quite true as of now, thanks to the rise of shareholder activism, Mr. Graham's observation is still true enough to resonate… and to perplex someone who knows nothing about business but a lot about politics.
Starting from zero knowledge of American business, we have a setup that resembles a pre-Reform-Bill borough in jolly old England. Election of a Board of Directors is not determined by one person, one vote; it's governed by one share, one vote. There are no limits to the number of votes one person can accumulate, except for availability of traded shares. There are more than a few companies where one man, or institution, has enough votes to sway an election if seriously contested. Some companies have one man, or institution, that can decide an election without an ally. There are others with votes more widely distributed, but even these companies have shareholders with large voting blocks.
When described in a vacuum, it sounds like the shareholders – particularly, the big ones – have a lock on the electoral process. Someone knowing nothing about business would, common-sensically if mistakenly, assume that the directors are kowtowing toadies who do nothing but cater to shareholders' whims. That's close to how politics went in a pre-Reform-Bill U.K. electorate. The pocket boroughs, which resemble a public company whose shares are mostly concentrated in a few hands, were run that way.
Such a political junkie would be shocked to discover how things are really run. Despite the apparent pocket-borough set-up, it's management who usually calls the shots. The skeleton comparison above suggests that management would be filled with sweating Milquetoasts who fear the wrath of a big shareholder. The opposite is closer to the truth.
It's an interesting conundrum for students of the political process. Voting power is concentrated in the shareholders' hands in a way that would be outrageous in politics. And yet, the ones with the power are effectively powerless. In shareholder-management conflicts, it's almost a sure bet that the party that's being taken for a ride is the shareholders. The outcome is the opposite of what a naïve political analyst would conclude.
There are reasons proffered to explain this paradox. The most known one is the fact that it's easier to sell than fight. As the market becomes even more liquid, it becomes easy for even a large shareholder to get rid of the shares. Continuing the pocket-borough analogy, it's as if the public-company nation was full of pocket boroughs, a very liquid land market, and personal teleporters that make moving a quick and near-effortless procedure. Given this set-up – and ignoring similar mobility power on the part of electees (directors) and the staff (management) – it's plausible that the powerful members of the electorate would be passive. Or is it?
The opposite may very well be the case. What if a well-known ward boss threatens loudly to move to a different ward? Would the local politicians' reaction be the same as the typical one from top management when a large shareholder threatens to do so in an annual meeting? Is it normal for a politician of that sort to say, "don't let the door hit you on the way out"?
The explanation could be that there's no two-party system in corporate electioneering. Unlike in truly democratic politics, where there's always a loyal opposition, there are no shadow board of directors that can give the incumbents a good run for their money come election time. This reason could very well be the most correct one, but it begs a certain question. A ready-to-govern opposition is an august, although taken for granted, tradition in all mature democracies. Shareholders have had at least a century to perceive this "blinding glimpse of the obvious." Why haven't they?
A partial explanation is found in another reason brought up to explain shareholder passivity: Management knows how to run the business; shareholders don't. Expertise trumps voting clout, so management gets its way. When the blanks are filled in, we have arrived at the real reason: corporations are not polities. A new politician who doesn't know how to govern won't upset the system, because (s)he gets guidance from the constituency. A new Chair of a Board of Directors can't do that successfully, without currying favor with the people who are really running the show – namely, management. A corporation thrives or perishes based upon the demands of people who are irrelevant to the shareholder-voting process: customers. In politics there are no customers (so to speak) who aren't already voters, unless they're legal wards of voters. In a corporation, this match-up usually does not exist.
Perhaps this is the reason why the SEC has its mission to protect shareholders, some of whom are rich and influential people, as if they were part of the helpless. Shareholders are narcoticized into thinking that they are part of a polity, even though a corporation is profoundly different. (Even the purpose of a corporation is markedly different from that of a government.) That false analogy stops shareholders from becoming businesslike about their holdings, except for selling decisions.
The SEC continues to proffer solutions that have their root in the corporation-as-government analogy, such as this one announced last week. Although well-intended, such measures perpetuate a kind of false consciousness regarding the corporation. A more businesslike attitude - seeing a shareholding merely as a contractual relationship between one economic entity and another – might very well be the escape hatch. To adapt the words of the late, great Milton Friedman: if there's something chicanerous, you exercise your right to sue. Although groups of angry shareholders are slowly learning to act in this way, the chief launchers of civil actions against companies allegedly wronging shareholders have been the regulatory agencies. It's ironic that the regulatory agencies are the most "businesslike" in this regard, even though they're not businesses.
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