Short of ideas
Aug 6th 2009
From The Economist print edition
The rights of shareholders and the wrongs done to clients
Illustration by S. Kambayashi
“ONE person, one vote” is an accepted principle, in Western democracies at least. But the idea of “one shareholder, one vote” has still not been fully implemented, particularly in continental Europe. In terms of shareholder democracy, Britain is one of the more advanced countries. Now Lord (Paul) Myners, a Treasury minister, has suggested a move in the opposite direction. He argues that institutional shareholders are too inclined to sell their stakes in underperforming companies, instead of getting involved with the management to try to improve matters. The answer could be to reward long-term shareholders with extra votes (or to penalise the short-termers by restricting their voting rights).
But are two-tier shareholding structures a good idea? Historically, they have been associated with family-run companies, which wanted to raise money without surrendering control. A system that granted shareholders extra votes for accepting a long-term horizon could easily lead to a world of unaccountable boards, protected by entrenched shareholders from the danger of potential dismissal or takeover. You could easily imagine a system, like Japan in the 1980s, of corporate cross-holdings in which managers protect each other from the investing barbarians outside the gates.
Lord Myners’s proposal has been presented as an attack on “short-termism” but it muddles several different problems. One is the principal-agent divide in which managers act against the interests of their institutional owners (who in turn may be acting as agents for beneficiaries such as pension-fund members).
In theory, as the owners of the company, shareholders should be able to keep executives under control. But in America and elsewhere, shareholders may not (yet) have the right to vote on issues such as pay; even when they can express their opinions, their votes may be ignored. Executives seem to regard investors like small children, who should be seen and not heard. Individual institutions that want companies to change policy have to spend time and money in negotiations that may not be justified by the potential gains. In any case, those gains will accrue not just to the campaigners but to other, “freeriding” shareholders who have done nothing.
A second issue is whether companies’ interests are aligned with those of society. The Myners proposal appears to assume that shareholders are wise enough to prevent corporate excess, in terms of pay packages or risk-taking. But there was little sign that shareholders in investment banks were urging them to retreat from subprime assets earlier this decade.
A third question is whether the economy would perform better if the relationship between executives and investors changed. This idea has been a feature of left-wing politics for at least the past 80 years. In Britain the Labour government of 1929-31 commissioned the Macmillan committee to investigate this point. In 1997 a conviction that companies paid out too much to shareholders, instead of investing in expansion, caused Gordon Brown, then the British finance minister, to scrap the tax credit on dividends, a change that took money away from occupational-pension funds.
But can it really be right that an obsession with dividends, or with short-term returns, has held back the corporate sector? In the late 1990s there was no sign that technology or telecoms start-ups were lacking in capital, even though they were unlikely to pay dividends for years. Venture-capital funds, which back start-up companies and pay no income, were hugely popular. In this decade, private-equity fund managers have gathered billions even though investors who back such funds have to lock their capital away for up to ten years.
It is true that professional investors tend to hang on to their shares for a lot less time than they used to. Figures from Société Générale show that the average holding period of a stock on the New York Stock Exchange fell from ten years in the 1940s to nine months by last year.
But if anyone suffers from the short-termism of fund managers, it is the clients. Funds with the highest costs produce the lowest returns, as client money is absorbed in charges and bid-offer spreads. Figures from Lipper, an information provider, show that between the end of 1994 and the end of 2008 the equity funds in the lowest quartile for costs returned 7.24% a year; those in the highest quartile returned just 4.65%. If governments really want a scandal to attack, it is the way the finance sector enriches itself at the expense of retail investors.
Copyright © 2009 The Economist Newspaper and The Economist Group. All rights reserved.
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