Shareholder Rights - Are You A Shark, Lion or Sheep?

Shareholder governance may not be a sexy investment topic, but it can be pivotal to realizing shareholder value.
By Richard Barrington

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Investors like to hear about innovative products, market share and growth strategies. Corporate governance, on the other hand, does not generate much buzz. Increasingly though, it is drawing the attention of professional investors who see forcing changes in governance as an investment strategy.

How much this interests you depends on whether you are a shark, lion or sheep as an investor. However, even if you are a sheep, you would be wise to keep an eye on what the sharks and the lions are doing.

Sharks, lions and sheep

Here are the roles played by sharks, lions and sheep on Wall Street:

  1. Corporate raider (sharks). These sharks of the shareholder world have been prominent since the 1980s -- think Gordon Gekko in the movie "Wall Street." They can succeed in shaking up corporate management, but their bad reputation comes from their tendency to do this for short-term gain, such as selling off assets.
  2. Shareholder activist (lions). Like corporate raiders, shareholder activists seek enough control over a company to fight management via proxy votes. However, they may do this by rallying support of other shareholders, and the reason they are able to rally that support is that they have a long-term plan for the company. This is why they are increasingly viewed more as lions than as sharks.
  3. Passive investors (sheep). With the popularity of index investing, many investors take no interest in individual companies. These sheep follow blindly, putting their money into companies because those companies are in a certain stock index, and never question how those companies are managed.

Company managements definitely favor passive investors -- the sheep who will be quiet, not interfere and not hold management accountable. Sometimes, managements structure things to keep the sheep as passive as possible.

Share and share alike?

Supposedly, investors who buy shares in a company also obtain the right to have some say in that company. However, there are a few ways managements can make sure that the voice of public shareholders is muted:

  1. Limited share issuance. A company looking to raise money by going public may only issue a minority of its shares to the general public, keeping the bulk of the ownership -- and control -- inside management.
  2. Separate voting classes. Companies can also issue shares in different classes, with those issued to outside shareholders having subordinated voting rights. This way, management gets the liquidity of owning tradable shares, but they make sure their votes pack more punch than ordinary shareholder votes.
  3. Staggered boards. Boards of directors are subject to shareholder votes, but management can blunt the impact of this by having directors come up for re-election at different times. For example, only a third of the board may be up for re-election in any given year. In this way, even a successful shareholder resolution only impacts a minority of the board.

How do they do it?

Why do investors put up with such inequitable arrangements? Often, it is just a question of inertia. Besides the huge amount of passive investing described earlier, even many active stock pickers are passive when it comes to exercising shareholder rights, either because they feel too small and isolated to make an impact on a company, or because they are more focused on a short-term investment opportunity than the long-term management of the company.

For their part, companies are especially likely to stack the deck against public shareholders when they are the subject of a hot IPO. For example, when a popular Internet company is going public, investors are often clamoring to get a piece of the action, with no questions asked. It also helps when the CEO is a particularly prominent and charismatic figure, as sometimes happens when the successful founder of a company takes the firm public.

What does this mean for shareholders? Well, no matter how hot the company or visionary the leader, remember that the corporate structure may be in place long after the buzz fades or that figurehead moves on or gets distracted. Even if you do not plan on taking an active voting role yourself, keep in mind that any company that is structured to suppress shareholder rights may also end up suppressing shareholder value.

The bottom line is that if you are a short-term trader, issues of corporate governance probably don't matter much to you. However, if you take a long-term buy-and-hold approach, shareholder voting rights may come to matter greatly in realizing the value you deserve from an investment. You don't have to be a shark or a lion, but don't pay top dollar just to mix in with the sheep.

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