$JPM is Just a Symptom of Wider Corporate Governance Issue – Why Do Shareholders Matter Less and Less?

by on May 13, 2012

in Dividend Value Stocks, Large Cap Value Stocks, Public

Credit crisis, mortgage meltdown, irresponsible risk taking and leverage, record bonuses and bailouts. Fast forward to today, and we have JPM with their “we were stupid” moment.

We all know what the problem is. Or do we? The large bonuses give the traders every incentive to load up on leverage and risk. Most of the time, these traders do not even know all the risks they are taking with their “synthetic” positions. But they do it anyhow.

Why? Is it because they are looking after the interests of their shareholders? Of course not.

What about the ever rising executive compensation? We often hear about the shareholder outrage, but time and time again, these proposals are simply rubber stamped at the shareholder meetings. What gives?

Theoretically, the shareholders own the company and have the power to influence corporate practices through their votes. In reality, majority of the shareholders are index funds and other large mutual funds, and they could care less about corporate responsibility.

Mutual funds have a fiduciary responsibility to vote with their shareholders

But mostly they don’t.

Reuters ran a good piece on mutual fund proxy votes last year and they found that for the votes cast between Jul 2009 and Jun 2010, the 26 largest mutual funds in the country supported an average of 80% of the executive pay proposals initiated by the management. Most of these proposals, you guessed it, were aimed at increasing the executive pay. On the other hand, these funds supported less than half of the proposals initiated by the shareholders that were aimed at gaining more investor input on the pay for top management.

They concluded one of the reasons this happens is that these fund companies have mutual funds to sell through corporate 401K programs and they do not want to ruffle feathers.

A cynical point of view? May be not.

I would also argue that for a fund that tracks an index, and aims to keep its expenses as low as possible, they probably do not consider proxy voting as one of their key fiduciary responsibility. After all, their shareholders invest in these funds to track an index, and are less worried about which companies make up the index and how they are governed. This is perhaps even more true for ETFs.

According to the 2012 Investment Companies Handbook, US investment companies (including Mutual Funds, ETFs, CEFs and UITs) own 29% of all the corporate equity with the rest owned by Hedge Funds and retail investors. This is a lot of shareholder influence that if not properly directed goes to waste.

What can be done about it?

A few things I will point out and there are many more that you can think of and add. My main goal with this article is to raise awareness and create conversations around this topic. Ultimately, this has to come from the shareholders like you and me – not the government or the credit agencies or any other third party that we are so fond of laying the blame on.

  1. If you invest in mutual funds, choose funds that take activist approach to shareholder issues. One good site to find this is proxydemocracy.org. This is a non-profit organization that tracks how the funds vote on various shareholder proposals. For example, according to its data, you can find that the Vanguard Total Market Index Fund (VTSMX) has voted with the management on shareholder initiated proposals on executive pay 921 times while they have voted against the management on these issues only 62 times. On the other hand, Calvert Social Index Fund (CSXAX) has voted against the management 358 times and with the management 97 times on the same issues. If you are choosing between two similar funds, it is a good idea to check their voting history on behalf of the shareholders and compare them before you make your decision.
  2. Even if a fund takes an activist approach to the shareholder votes, it may not necessarily be in line with the position that majority of its shareholders might take. If this is important to you, you should consider owning equities directly rather than through a fund.
  3. Vote your proxies. Regardless of the size of your stake, your proxy vote is important. If majority votes their proxies, corporate governance will improve and swing the pendulum back in the shareholder’s favor
  4. Finally, talk about this, create conversations, and cause debate. The dilution of shareholder influence on corporate governance is a serious issue and affects your wealth and legacy

Are you outraged? Does it bother you that banks lose billions and get bailed out by you and me while the executives take home millions in bonuses (Pay for non performance!)? Do you think there are other issues that have skewed the incentives for the managers? Do you have more ideas how this can be fixed? Please take a moment to note your thoughts in the comments below and let’s start a discussion.

For further discussion on Corporate Governance issues and initiatives please refer to CorpGov.net site.

Leave a Comment

John Hunter May 14, 2012 at 2:45 am

I have been outraged for quite some time by actions of corporate leaders taking from the corporation what they don’t deserve.  Sadly their are very few investment options to avoid insiders dipping buckets into the treasury and using it for their personal desires.  Most of the time this is done within the bounds of the law (sometimes it isn’t).  But when you want to invest in stocks sadly it is a matter of only excluding the most abusive executives from consideration (which includes any large financial institution I looked at so I never invested in them in the last 15 years.
 
They act like cleptocrate dictators – taking from what is owed to others because they can get away with it – not because it is somehow deserved.  I have written about this over the years
 
  2005: http://management.curiouscatblog.net/2005/12/04/excessive-executive-pay/
  2006: http://management.curiouscatblog.net/2006/06/22/more-on-obscene-ceo-pay/
  2008: http://management.curiouscatblog.net/2008/10/22/ceos-plundering-corporate-coffers/
  2009: http://management.curiouscatblog.net/2009/04/06/another-year-of-ceos-taking-hugely-excessive-pay/
 
The issue of shareholders finally getting tired of being ripped off by the executives of their companies reminds me of the statement by Martin Niemoeller “<a href=”http://curiouscatlinks.blogspot.com/2008/04/freedom-increasingly-at-risk.html”>First they came for the communists, and I did not speak out – because I was not a communist…</a>   Then they came for me — and there was no one left to speak out for me.”  
 
The executives taking what they don’t deserve isn’t quite as severe as societies not speaking up as liberty is taken away by police states but the process is similar.  Most of the people running our companies have no business doing so.  They don’t have the moral fiber to do so properly.  They have systemically denied reasonable pay to employees, denied reasonable customer service to customers, denied to pay taxes owed (fleecing foolish tax authorities)…  It is not wonder when their main focus seems to be how to fleece those they should be providing value to, that they turn on the owners and fleece them as they run out of others to fleece.  

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ShaileshKumar May 14, 2012 at 7:04 pm

 @John Hunter John, well put. I think it is a travesty that the shareholders are left with too little influence and the institutional investors often do not consider shareholder representation as part of their fiduciary duty. Management needs to get the idea that they report to the shareholders and other stakeholders drilled into them.

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