When the limited liability company first got going as a popular structure not everyone was convinced it could work. Here’s Adam Smith on the matter in The Wealth of Nations (published in 1776): “The directors of such companies . . . being the managers rather of other people’s money than of their own, it cannot well be expected that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own.”
The question back then was who would make them — and how. Almost 250 years on, this has still not been properly answered.
The obvious bit is the who — it should be the actual owners of the company, the shareholders. The less obvious bit is the how: if every large listed company has millions of separate beneficial owners, how can they all co-ordinate to hold a board’s feet to the fire?
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Average AGM attendance rate is falling
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Long term they mostly haven’t been able to — and managers have been left to do their own thing. More recently the rise of giant asset management companies such as BlackRock and others has meant an effective contracting out of nagging the directors to a new group of powerful middlemen.
That has sort of worked — in that there is lots of nagging. But there needs to be more. Link, the investor services business, notes that the average AGM attendance rate in the UK has fallen even in the last year (from 75.9 per cent in 2020 to 73.9 per cent in 2021). It also tends to be the wrong kind of nagging — often generalised asks (adopt a net zero climate target, appoint a diverse board etc), driven by box-ticking from big proxy advisers such as ISS and devoid of much actual strategic challenge.
During the 2020-21 proxy season, BlackRock voted for one or more directors on an activist slate in only 15 per cent of US proxy contests (attempts by activists to get new directors on the board). Mostly they support management as it is. That’s a shame — as it does little to neutralise the tendency to “negligence and profusion” that Smith worried about.
Active shareholders have generated robust returns
For evidence, look to the generally higher returns from private equity, where owners are obviously active. The returns to investors here may be in the round no higher than those from the stock market.
But add in the managers’ take (usually several percentage points) and one could argue that the total return is higher. You might say that this is partly to do with their use of leverage but it also suggests that owner engagement matters. Studies from McKinsey over the past 20 years have generally found that the more active the owners of a company — and hence the board — the more effective a board.
There are, of course, many excellent activist shareholders around and, increasingly, there are also unexpected causes in the mix. There have been high-profile moves this year from activist investor Carl Icahn — he bought a stake in McDonald's and nominated two new directors to its board in an effort to change the thoroughly unpleasant way the firm treats pigs.
He is doing something similar at Kroger in a bid to change their treatment of workers and animals. There’s also been an interesting rise in more conservative activism (pushing for more scrutiny of racial equity programmes, for example).
Overall, activist campaigns in 2021 (the ones that ended up public at least) were more or less back to pre-pandemic levels. At the same time there is a trend towards a less confrontational form of activism: Pershing Square Capital Management, long one of the most vocal of these firms, plans to take a more “positive constructive” approach than in the past.
The problem is that, for most companies, having anything close to what you might call active owners is still more the exception than the norm. Passive investors are far too passive and, despite the impressive efforts of many grassroots groups, retail investors still have little way of effectively demanding any change.
How can we change this?
The first part of the answer is not the way the SEC are currently attempting it. Their plan to force activists building stakes in companies to disclose them very early on in the process will be remarkably unhelpful. If they have to disclose before building the kind of stake that gives them a voice, the profit motive rather disappears.
The SEC would be much better to focus on creating more direct pathways between shareholder and company.
There’s a lot going on in this space. In the UK this week, for example, Link introduced a new app that should ease the voting process for shareholders. But if we really want to make things simple — and to get public companies acting more like private ones — we might just work on the board.
In theory all boards represent all shareholders. In practise they tend to be bogged down in regulation compliance and succession issues, operating more as stewards than challengers.
A regulatory shift should require one well-supported non executive director to be fully responsible for shareholder communication and engagement — retail and institutional; for asking about and understanding what activist investors are thinking about; and for directly promoting their views on the board. Adding a little activist magic along the way might help change boards for the better.
• This article was first published in the Financial Times
