Management

Gillian Tan is a Bloomberg Gadfly columnist covering deals and private equity. She previously was a reporter for the Wall Street Journal. She is a qualified chartered accountant.

(Updated )

Last week, in analyzing corporate governance at Ubiquiti Networks Inc. (the target of short-seller Citron Research), I pondered what the optimal number of board members at a public entity should be -- and determined that the company could do a lot better. Reader feedback has since prompted me to seek out what's considered best practice in another arena: The ideal level of insider control.

The median level of voting power held by insiders within the Russell 3000 Index is 4.3 percent, according to ISS Analytics, the data arm of Institutional Shareholder Services. But that doesn't tell the whole story. Here's what average returns look like for the companies with the highest and lowest levels of voting power within the Russell 3000 Index -- from SecureWorks Corp. in the top tier at 98.7 percent down to the 14 companies rounding out the bottom tier at 0 percent, including Synchrony Financial:

Advantage, Insiders?
Companies with more voting power attributable to insiders have performed slightly better over time
Source: ISS Analytics, the data arm of Institutional Shareholder Services
*All returns are as of August 30, 2017 ^Largest and smallest samples includes the top and bottom 10% of the Russell 3000 index as measured by insider voting power **Voting power of directors and officers calculated at most recent meeting ^^Some return periods could not be calculated for all companies within the Russell 3000 due to the timing of their initial public offerings and other factors

The takeaway is that corporations led by insiders with a higher level of voting power -- who are arguably more aligned with a company's fortunes -- fare better than those where insiders have little control. That makes it a variable to consider when weighing investments. 

In the case of Ubiquiti, founder and CEO Robert Pera retains control through his majority stake in the company, and the stock is up more than fourfold in the past five years. (We leave for others the debate over whether Citron's bearish arguments have merit.) Another example in this category is Facebook Inc., which on Friday dropped plans to create another class of shares that would have allowed co-founder Mark Zuckerberg to retain his hold over the company even as he sold stock after shareholders filed suit. 

Insider control isn't a foolproof predictor of performance, and there are caveats. First, the metric isn't always relevant, including among the biggest companies, whose very size is an impediment to insiders obtaining any meaningful ownership stakes. Take E*Trade Financial Corp. and Morgan Stanley, for instance, with market values of $11.5 billion and $88 billion, respectively. Even though the combined voting power of directors and officers of each is just 0.2 percent, their total shareholder returns over one, three and five years through August 30 far outpace the benchmark S&P 500 Index. On the flip-side, companies like Under Armour Inc. and Wal-Mart Stores Inc., where insiders have majority control, delivered comparatively underwhelming returns over the same time periods.

Then Again ...
Insider control isn't as much of a determinant of performance among the biggest companies.
Source: ISS Analytics, Bloomberg
*Data through August 30, 2017

Also, it's important to remember that not all insider ownership is the same. In the case of companies backed by private equity or venture capital firms, high insider control may not be as much of an indicator because those investors will inevitably reduce their stakes. 

Not a Magnet
Longevity may not be a feature of high levels of insider control. Private equity-backed companies, for example, will eventually see their control stakes dwindle.
Source: ISS Analytics
*As at most recent meeting

Still, the bottom line is this: While there's no hard-and-fast rule about the optimal level of insider voting power, there should be no complaints if management and directors have skin in the game. Some control is better than none. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The sliding scale of insider ownership also often plays a role in activist shareholders campaigns. Companies with minimal insider control are easier targets, and if insiders are selling, those moves will be especially scrutinized. Other times, activists' discontent can center on companies that have been closely managed by insiders -- but in these situations, control positions can thwart activist campaigns. 

To contact the author of this story:
Gillian Tan in New York at gtan129@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net