The 800-Pound Gorilla: Shareholders arise!
Bogie, John C.
"THE 800-POUND GORILLA Shareholders Arise!" BY JOHN C. BOGIE If the message from the Enron saga is that we can't rely on the boards of directors to govern our great companies, who can we...
...If character counts—and I have absolutely no doubt that character does count—the failings of today's business and financial model, the willingness of those of us in the field of money management to accept practices that we know are wrong, the conformity that keeps us silent, the selfishness that lets greed overwhelm reason, all erode the character we'll require in the years ahead, especially in the post-September 11 era...
...But who, really, is served when a stock soars far above and then plummets far below the corporation's intrinsic value...
...We have become not an own-a-stock industry, but a rent-a-stock industry...
...If we expand the list to include non-fund managers in the Institutional Investor 200, the total rises to $7.5 trillion or 52 percent...
...Two years ago, in a speech entitled "The Silence of the Funds," I called on the ICI to sponsor an industry-wide effort to foster the interest of fund shareholders by harnessing the voting power of mutual funds...
...Or a break-out session at the ICI's general membership meeting on "Earnings Guidance—Blessing or Bane...
...Valuation that becomes unhinged from the underlying realities of the business can rob investors of savings, managers hold some $1.4 trillion of U.S...
...B Y J O H N C . B O O L E If the message from the Enron saga is that we can't rely on the boards of directors to govern our great companies, who can we rely on...
...when managements are weak, unethical or operating in their own interests rather than the interests of their shareholders, their only recourse is to replace them...
...For in the long run, stock prices are determined by corporate value—by the cash flows the firm generates.The swings above and below that value path simply reshuffle the allocation of investment returns from one investor to another...
...Together, this small number of large institutional investors constitutes the great 800-pound gorilla who can sit wherever he wants to sit at the board table...
...This article is adapted front a speech he gave in February to the Neu' York Society of Security Analysts...
...During the past year, for example, one of every 10 equity funds turned its portfolio over at an annual rate of more than 200 percent...
...And as investing has become institutionalized, these owners now have the real—as compared with the theoretical power to exercise their will...
...A majority of the stock...
...Buffett seeks not only long-term returns, but long-term shareholders...
...The fund industry can hardly be ignorant of what is going on in corporate America...
...One ray of hope recently appeared from Legg Mason's Bill Miller—he of value investing fame and conqueror of the S&P 500 Index for an unprecedented 11 consecutive years—clearly a man to whom we should listen...
...corporate stocks, nearly 10 percent of all stock outstanding...
...But it will be almost impossible to accomplish if the owners of our corporations fail to recognize that corporate citizenship entails not only rights but responsibilities...
...I propose that these firms—passive managers, if you will—come together and discuss ways to make their views felt—on full disclosure, on managed earnings, on executive compensation, on auditor independence, on pension plan return assumptions, on retirement plan investing—and forcefully present those views to the corporations whose shares they own...
...Adding only the Capital Group—surely that firm would meet anyone's definition of a long-term investor—would add another two percent-age points to the aggregate stock ownership, bringing it to almost 12 percent.And it may well be that public retirement funds, many of which are already providing responsible corporate governance, would also join the effort...
...The typical fund manager has lots of interest in a company's price momentum—changes in earnings estimates, and whether reported earnings are meeting the guidance given to Wall Street—but far less interest in what a company is worth—its fundamental earning power and its balance sheet...
...Whatever the case, the record shows only sparse attention to corporate governance issues by the corporate governors themselves—in overwhelming measure, the mutual fund industry...
...They are, as you might have guessed, our industry's index fund managers...
...By focusing on short-term stock prices rather than long-term corporate values, the fund industry has helped to create the over-heated financial environment of the recent era...
...Even before Enron came to dominate the pages of our newspapers, day after day we would read of another accounting issue, another corporate compensation excess, another company stock that devastates a thrift plan, another earnings report that has "pro-formaed" heaven and earth to produce earnings that meet expectations...
...or "Do Stock Options Really Link Executive Compensation to Shareholder Value...
...Those beliefs shaped the very character of our nation...
...Their clients profit only as corporate value grows...
...Because selling is not part of their mandate, they hold them, well, for-ever...
...One searches in vain for a seminar on corporate governance from the mutual fund industry's spokesman, the Investment Company Institute...
...Mutual funds—and, in fairness, other institutional and individual investors as well—and all the other participants in the happy conspiracy have short-sightedly adopted the view that the greatest good lies in driving stock prices to the highest possible levels.A moment's reflection makes the foolishness of that proposition clear...
...Or even a speech by an industry leader entitled "Serving Fund Shareholders by Eliminating Financial Engineering...
...While stocks were once owned largely by a diffuse and inchoate group of individual investors with relatively modest holdings, the ownership of stocks is today for better or worse -concentrated among a remarkably small group of potentially powerful institutions...
...We have met the enemy, and they are us...
...But he became serene and compliant whenever he heard the strains of "Beautiful Dreamer...
...Responsible corporate citizenship and proxy voting are rarely on a fund manager's agenda, because a company's stock may not even remain in the portfolio until the next annual meeting...
...But if the firms in the mutual fund industry realize that—as representatives of the owners of nearly half of the corporate stock in our nation—they are the ultimate governors, we can make sure that corporate governance never lets us down again...
...The owners of the corporation themselves...
...Absolute control over corporate America...
...Corporate governance has let us down, and it has let us down just when we needed it most...
...There must be other Bill Millers out there who care about restoring the integrity of our financial markets, and perhaps our Federation of Loner Term Investors will gradually grow to represent ownership of 25 percent or more of the shares ofAmerica's corporations—not yet a fully-grown 800-pound gorilla, but a strapping young 400-pounder, who will grow bigger with each passing year.cost people far more innocent than senior management their jobs, and undermine the viability of suppliers and communities...
...MARCH/APRIL 2002 • THE AMERICAN SPECTATOR 41...
...Buffett's goal is to maximize shareholder return—not to maximize the price of Berk-shire shares—for his goal is to minimize the benefits going to some shareholders at the expense of others...
...It may seem heresy to denigrate the Great God of stock price maximization...
...But if we focus on long-term value, I suggest we will also deserve the better governance that will follow...
...Indeed just six of these 40 THE AMERICAN SPECTATOR • MARCH/APRIL 2002 In part because of our industry's over-weaning focus on the short-term prices, we have gotten the corporate governance we deserve...
...There are other active managers with a long-term focus who may also want to join the effort...
...This nation's founding fathers believed in high principles, in a moral society, and in the virtuous conduct of our affairs...
...and only one of every eight at a rate of less than 25 percent—itself hardly an austere target...
...Perhaps the reason for the silence is that the overwhelming majority of mutual funds are engaged, not in the process oflong-term investing on the basis of corporate values, but in short-term speculation based on stock prices...
...In a recent Will Street Journal op-ed essay entitled "Dare to Keep Your Stock Price Low," Joseph Fuller and Michael Jensen of The Monitor Group struck directly at the fallacy of pumping up a stock's price by reaching for unprecedented earnings growth driven by unrealistic internal corporate goals and manipulation of information...
...Or because no link is perceived between governance and stock price...
...Con-forming to market pressures for impossible growth leads to damaged companies," exactly opposite to the interest of investors in our system of democratic capitalism...
...The mutual funds controlled by the 75 largest fund managers alone own $2.9 trillion of U.S...
...A substantial and clearly differentiated cadre of long-term investors does exist in our industry—managers who buy stocks but don't sell them...
...Undeterred by the failure of that earlier initiative, I'll now propose another...
...Failing that, I called for a small group of fund managers to act as a nucleus in taking up corporate governance issues, with other like-minded managers then climbing aboard the bandwagon.The response, alas, echoed the title of my speech:A silence that was truly deafening...
...Such a "federation of long-term investors," as it might be named, could become the nucleus of an aggregation of shareholdings that would grow as those active managers who adhere to long-term investment strategies join the group...
...Mr...
...So there's a lot at stake in reforming our financial system and in returning to the fine roots of our national character...
...Not to push this analogy too far, but I fear that mutual fund managers seem to be listening to "Beautiful John C. Bogle is founder and former chairman of The I'anguard Group...
...equities, equal to 20 percent of the $14.4 trillion market capitalization of the stock market at the beginning of 2001...
...Hear Warren Buffett on this subject:"The longer the shareholder holds his shares [of a corporation], the more bearing that business results will have on his financial experience...
...Miller has assembled his own group of managers who are considering placing ads in The Wall Street Journal and other publications, listing good governance best practices...
...But there's even more at stake than that...
...four of every 10 funds at a rate of more than 100 percent...
...He also proposes to challenge aggressive assumptions on future pension returns...
...Their holdings are not of trivial dimension...
...If these practices are not followed, he and his group won't vote in favor of items such as option plans...
...But the power of mutual fund managers is in fact far greater than that.The pension funds and other institutional accounts run by these same 75 managers hold an additional $3.4 trillion of stocks, bringing their total holding to $6.3 trillion, and the voting power to 44 percent...
...In the original version of the motion picture Mighty Joe Young, the protagonist was a fierce gorilla who destroyed every object in his path...
...Why, the stockholders...
...Dreamer" as they consider their responsibilities of good corporate citizenship...
...That is a far cry from the philosophy of pumping up earnings through aggressive accounting and providing free stock options that enable executives to cash out at the drop of a hat...
...Their share of stock holdings has grown steadily, and will continue to grow, perhaps even faster, in the years ahead...
...The few truly activist fund managers—one thinks of Mutual Shares' Michael Price and Windsor Fund's John Neff—have passed from the scene...
...Or perhaps because corporate activism might hurt the manager's ability to attract institutional accounts and 401(k) plans...
...If options are compensation [as they clearly are]," Miller warns, "companies have to adjust earnings and compensation has to be reasonable...
...But the only sounds we've heard in response are the sounds of silence...
Vol. 35 • March 2002 • No. 2
