ClusterStock has an article by John Carney, How Ignorant Are Shareholders?, in which he argues that the financial crisis has “dealt a serious blow” to the “idea that corporate governance reforms that empower shareholders to direct the activities of corporations would make companies more financially responsible.” We think John’s got it wrong, but before we begin our rant, let us just say that there is much to respect about John Carney. According to his bio, he’s got a law degree from the University of Pennsylvania, and he practiced corporate law at Skadden, Arps, Slate, Meagher & Flom and Latham & Watkins, both of which are preeminent firms. We also almost wholly agree with his positions on plenty of contentious issues, as summarized here in his bio:
He has argued that failed banks should not be bailed out, Lehman’s collapse was not a disaster, AIG should be declared bankrupt, that naked short selling is not a problem, that backdating isn’t so bad, insider trading should be legal, many corporate CEOs are underpaid, global solutions are worse than local solutions, Warren Buffett is overrated, Michael Milken is a great American, the collapse of the hedge fund was not a scandal, hedge funds are over-regulated, education is overrated by the educated, bonuses at successful Wall Street’s firms are deserved and possibly undersized, management buyouts are boons to the economy, Enron’s management was victimized by an over-zealous prosecution, Sarbanes-Oxley should be repealed, corporate compliance culture is a disaster, shareholder democracy is overrated, hostile takeovers ought to be revived, the market is permanently moving away from public ownership of equity in corporations, private partnerships are on the rise, public ignorance is encouraged and manipulated by governments and corporations, experts overrate expertise, regulatory agencies are controlled by the businesses they supposedly regulate and Wall Street is much more fun than people give it credit for.
He’s trained in the dark arts of the law and he’s practiced with the best. In other words, he should know better.
John’s premise is that financial companies that score highest on most measures of corporate governance performed poorly during the crisis. He argues that shareholders are ignorant, and giving them more say in the management of a company is like tossing the car keys to a blind man and jumping in the back seat:
In political science, the roles of irrationality and public ignorance are well understood. Studies going back decades prove that the public is not only ignorant, it is stubbornly ignorant. It remains ignorant even in the face of widely available and easily obtainable information. Voters are so ignorant that they cannot rationally choose between different programs offered by politicians. And the ignorance persists so that they cannot assign blame or credit to the parties responsible for the programs that are ignorantly selected.
If economists were to take this seriously and apply it to shareholder behavior, they might discover that the case for shareholder democracy is seriously undermined. Instead, many continue to doubt that shareholder ignorance is a serious problem. And those who acknowledge it could be a problem, often assume it can be overcome by providing shareholders with more information. This simply ignores what we’ve learned in political science about shareholder ignorance.
Now, we don’t disagree that many shareholders are ignorant. It’s well known that many don’t read disclosure documents, and many can’t read financial statements. We’ve also argued previously that even those who do read financial statements often ignore important parts of those financial statements, like the balance sheet. Our own About Greenbackd page argues that there are opportunities for investors focused on the balance sheet, because many investors are mesmerized by earnings and totally ignore assets. Where earnings understate the asset value, this creates an opportunity for investors like us. No, we don’t disagree that many shareholders are ignorant. In fact, we rely on that ignorance to make our living.
The point at which we diverge from John is his contention that this ignorance precludes a shareholder from voting. We don’t allow shareholders to vote because that is the best way to manage a company. Shareholders vote because it is their right to do so. A share is nothing more than a bundle of rights: A right to a dividend, a right to a share of the assets on a winding up, a right to a say in the affairs of the company on certain issues, a right to determine who directs the affairs of the company. They are property rights, and standing is accorded to the holder to enforce those rights. The board, and, indirectly, the officers of the corporation, serve at the pleasure of the shareholders. Often a board will seek to prevent a shareholder attempting to demonstrate this last point, for example, by implementing poison pills and other shareholder unfriendly devices, but that is nothing more than an implicit recognition by the board that it is true. Voting, then, is simply a shareholder exercising one of their property rights. If you advance your money, we think you should get all of the attendant property rights, whether you’re ignorant or not. In this society, for good or ill, the owner of property is the person who controls its destiny. We’d argue that this is generally a good thing, and almost all progress the world over stems from this simple principle. Any attempt to sever the relationship between private property and ownership strikes right at the heart of capitalism.
So why the seeming relationship between “good corporation governance” and poor returns? Who knows, really? Statistics can be massaged to say anything. If we had to guess, without reading the paper, we’d guess that it’s a problem of definition. The phrase “good corporate governance” is at best meaningless, and at worst a smoke screen to obfuscate what it really is: an attempt by management to operate on behalf of “stakeholders” (read “parties other than shareholders”), to adhere to the “triple bottom line,” “The Equator Principles,” and other similar ideas irrelevant to shareholders. It’s no wonder that the corporation performs poorly. The board’s worried about everyone other than the owners. We’d argue that those are not proper considerations for the board. What sensible suggestions fall within the remit of “good corporate governance” are necessary only because shareholders don’t have sufficient voice in the operation of the company. They are simply unnecessary, additional regulation to paper over holes left because shareheolders are disenfranchised.
What’s the alternative? Plato’s Republic shoehorned into the corporations law? Philosopher-king CEOs? Frankly, the thought makes us gag. No, the real alternative is shareholder enfranchisement. Force the stewards of capital – the boards and officers – to recognize the rights of shareholders – the rightful owners of that capital. Ensure that shareholders are properly able to deal with their property as they see fit, and to express their desires for that property to the board without restriction. Carl Icahn has prepared a good starting point in a series of essays, Capitalism Should Return to Its Roots, We’re Not the Boss of A.I.G. and It’s Up to the Shareholders, Not the Government, to Demand Change at a Company.
John concludes by calling on economists to “survey shareholders and objectively document ignorance.” There’s no need. They can be as dumb as a box of hammers, but they should still be allowed to cast their vote. If that right is taken away the key foundation of capitalism is lost, and we’re pulling our money out of the market and putting it into shot-gun shells and tinned food.
End rant.
We opened a position in VNDA and got a great return. We lost our nerve with BGP and missed out on a great return. We completely ignored ATSG, DTSG, SMRT, RFMD, PIR and CHUX although all appeared on our NCAV screen at some stage earlier this year. A little more evidence that diamonds can be found if you dig through enough trash.
Summary balance sheet adjustments
Greenbackd 