By John A. Byrne
Many of the corporate governance reforms now being actively debated would help shift some power back to shareholders from management. And in light of the way many chief executives have run their companies into the ground of late, piling up tens of millions in pay, stock gains, and severance even as investors get pummeled, giving shareholders more clout seems like a good idea. But try to imagine, for a moment, what would happen if institutional investors had far more influence over the management of public corporations. Would CEO pay get ratcheted down to more sensible levels? Would boards of directors truly become independent fiduciaries of the shareholders? Would the investment horizons of managers become shorter or longer?
The short answer: Be careful what you wish for.
By and large, today's big and small investors are as keenly focused on making a quick and easy buck as are the highly paid CEOs who have earned their scorn. They show little loyalty to the companies they buy, and for years they have been largely apathetic toward many of the governance reforms that might have prevented the Enron Corp. implosion or others like it. As one shareholder activist puts it: "Giving them a lot of power over how companies are run would be a disaster. Heaven help our private sector."
Why? For starters, the focus on quarterly numbers would become even more intense. "If institutional investors could make money by propping up results for the short term, that's what they would do," says Darrell K. Rigby of Bain & Co. "When that runs out, they'd just sell the stock and move on to something else."
Today, many shareholders have little more patience than the average Joe at a Vegas slot machine. Shareholder churn has reached unprecedented levels. In 1960, on average, only 12% of the shares of a New York Stock Exchange-listed company turned over annually. But by 1990, shareholder turnover jumped to 46%, then 88% in 2000, and 94% in 2001. Through May, the annualized rate hit 98%.
Yet ephemeral shareholders can sometimes be the most vociferous. "The vocal portion of our stockholder body has no long-term commitment to the company," believes Henry B. Schacht, chairman of Lucent Technologies Inc. (LU) "They buy to sell. The quicker they can get a return on investment, the better."
Truth is, for all the grousing about CEO malfeasance, shareholders deserve a good deal of the blame themselves for the current corporate mess. It was institutional investors, shareholder advocates, and corporate raiders who made "maximizing shareholder value" the prevailing principle of American business. Through the 1980s' and 1990s' runup in CEO pay, you hardly heard a peep from shareholders--as long as they got theirs. Instead, investors routinely rubber-stamped the massive stock option programs that heavily diluted their own holdings and led to skyrocketing CEO pay.
And that's when shareholders bothered to vote. "Many institutional investors don't exercise their ownership rights at all," says Jamie Heard, chief executive of Institutional Shareholder Services, the proxy advisory firm. When big investors get involved, many inevitably vote management's way or focus on social issues that have little to do with corporate governance.
With less loyalty to the institution, its employees, and its products, investors are solely motivated by the stock price. "Institutional investors could just as easily turn a blind eye to accounting practices that might increase the stock price in the short term," says Beverly A. Behan, a governance consultant with Mercer Delta Consulting LLC.
Corporate America has a long way to go to restore the checks and balances that would allow capitalism to work as effectively as it could. But as the debate rages over corporate governance reform, we should be mindful of the need for reason. Like directors, institutional investors need only watch and question management, not micromanage the corporation. Byrne covers management.