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July 23, 2012
What Good Are Shareowners?
    by Robert Kropp

An analysis published in the current Harvard Business Review argues that the rise of short-termism in the markets, and poor communications between management and shareowners, require engagement by diverse long-term stakeholders. First of a two-part series.

Sustainable investors and other shareowner advocates report that after several years of increasing votes in favor of resolutions addressing environmental, social, and corporate governance (ESG) issues, this year's proxy season has featured a new commitment to engagement by corporations.

Of the 110 shareowner resolutions tracked by Ceres this year, 44 have been withdrawn following successful engagement. And for the first time in its 40-year history of activism, the Interfaith Center on Corporate Responsibility (ICCR) reports that the corporate dialogues engaged in by its members outnumber the shareowner resolutions filed.

Despite the acceptance by many mainstream institutional investors of the financial relevance of ESG issues, short-termism continues to rule the markets, encouraging many corporate executives to engage in overly risky behaviors in the pursuit of quarterly returns. According to a recent Harvard Business Review analysis, "high-frequency traders whose holding periods can sometimes be measured in milliseconds now account for as much as 70% of daily volume on the NYSE."

The paper, entitled What Good Are Shareholders?, provides a historical account of shareowner relations dating back to the 1970s, when academic research began to support the shift of power to shareowners. However, authors Justin Fox and Jay W. Lorsch argue, "Our current muddle…comes after many years during which shareholders gained power yet were repeatedly frustrated with the results."

"It's at least possible," the authors continue, "That the problem lies with shareholders themselves."

The paper documents the profound shift in corporate ownership that has occurred during the last half-century. In the 1950s, 90% of the shares of US corporations were owned by individual investors; today, institutional investors hold as much as 70% of those shares.

In addition to enjoying significantly lower brokerage commission costs, institutional investors also have access to the cutting-edge computer technologies that allow for the trading of shares in milliseconds. "In the 1950s the average holding period for an equity traded on the New York Stock Exchange was about seven years," the authors note. "Now it's six months."

While some liquidity is necessary for markets to operate efficiently, the authors argue, "Modern securities regulation has been developed within a paradigm in which there is no such thing as too much liquidity, too much trading, or too much volatility." One solution, they suggest, could be a financial transaction tax on trades. "The possibility that it would decrease liquidity should not be seen as a slam-dunk argument against it," the authors state.

The paper also points to worsening communications between investors and managers. Putting aside the many successful engagements recorded this year by Ceres and ICCR, most communications now occur during conference calls following the release of quarterly financial information. These calls, the authors argue, "tend toward the superficial and the short term."

"When shareholders are widely dispersed," the authors ask, "How can they keep managers in check?" One solution offered by the authors is to restrict proxy voting to investors that have held their shares in a company for at least one year; an example of such a solution is the say-on-pay vote mandated by the Securities and Exchange Commission (SEC), on which only investors that have held shares for two years are entitled to cast ballots.

The authors conclude by espousing stakeholder capitalism, in which a larger circle of actors—including customers, employees, lenders, regulators, and nonprofit groups—encourage greater corporate responsibility. "Not as some sort of do-good imperative," the authors state, "But as recognition that today's shareholders aren't quite up to making shareholder capitalism work."

In a recent column, Washington Post writer Harold Myerson wrote, "Under shareholder capitalism, American big business has disinvested in the United States and moved work to where labor is cheap and the government subsidies are bigger. Among stakeholder capitalism’s many merits, it might just help bring American business home."


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