Category Archives: Business Strategy

The New York Times recently published an article on shareholder activists and how they can sometime abuse shareholder democracy for their own short-term gain (see ‘Shareholder Democracy’ Can Mask Abuses).

The article noted a recent conflict between activist/investor David Einhorn and Apple in which Einhorn has requested Apple distribute cash to investors. Marty Lipton criticized Einhorn’s actions and, more broadly, the practices of some activist investors. According to the New York Times:

Martin Lipton, one of the nation’s top corporate lawyers…wrote a scathing memo to his clients on his view that “shareholder democracy” has run amok…Mr. Lipton said that long-term shareholders in public companies are being undermined “by a gaggle of activist hedge funds who troll through S.E.C. filings looking for opportunities to demand a change in a company’s strategy or portfolio that will create a short-term profit without regard to the impact on the company’s long-term prospects.”

Although I don’t always agree with Marty Lipton (best known for inventing the poison pill), I think he’s onto something here.

Clearly, it can be problematic when the goals of short-term institutional investors don’t match those of the companies in which they invest, where the incentives should favor long-term outcomes.

I’ve written about these issues in the context executive compensation (see Revisiting Executive Pay: The Problem is Systemic), but given the prominence of institutional investors with short-term horizons, I think the overarching issues are worth revisiting.

In a previous article I mused:

Who are shareholders? Although seemingly a silly question, the answer has important implications…

Historically, shareholders were individual company owners (often dispersed) who held stock for long periods of time. Today, the picture is quite different. Shareholders are represented less and less by individuals and institutions holding stocks for the long-term, and more and more by individuals and institutions looking to make a quick profit – buying and selling shares with frequency. The rise of such traders who seek to profit from near-term volatility in stock prices has changed the nature of the system. These traders are inconsistent with the spirit of the view of the shareholder as a long-term owner. They are not really owners, and sometimes have little interest in the long-term survival of the firm. They often only care about micro-movements in share price in a very narrow window of time.

I think what really drives this point home is the fact that even the definition of “short-term” has gotten, for the lack of better words, shorter. In the 1960s, investors held stocks for an average of about 8 years. That number can now be counted in days (see Stock Market Investors Have Become Absurdly Impatient). Add in high frequency traders, and the average hold time can be counted in seconds (see How long does the average share holding last? Just 22 seconds).

I think we really need to ask ourselves: Given the decreasing shareholding periods, are current shareholders congruent with our vision of shareholders as long-term owners?

The short-term mentality now prevalent among a certain strata of shareholders is not only a troubling in its own right, but it can also have serious implications for companies and how they are managed on a day-to-day basis. How can the CEO and the company’s top management team focus on long term outcomes when they are forced to cope with a set of stakeholders who favor near-term performance? After all, according to theory, managers are supposed maximize profitability over an infinite time horizon.

So, how can we solve the problem of some institutions trying to game the shareholder democracy system? For me, one interesting possibility lies in differentiating between ownership classes of stock and trading classes of stock. For example, perhaps we could consider creating “ownership” classes of stock that must be held for longer periods of time and come with certain, enhanced voting privileges so as to better align the incentives of shareholder/owners with the company. We could also create “trading” classes of stock with fewer ownership and control rights that can be freely traded at will. I’ve written a bit about this idea in the blog post entitled “Different Stock Classes: Trading vs. Ownership Shares“. I’d encourage you to take a look if you have an interest in the topic.

Nevertheless, whatever the outcome, one thing is for certain –this issue hasn’t been getting nearly the attention it deserves.