Chapter 11. Investor Activism

Given the corporate scandals, the failure of various monitoring systems, and the dramatic downturn of the markets, shareholders are naturally upset. Individual shareholders have been viewed as the innocent and helpless victims of this mess, and they rightly deserve our sympathies. After all, they lost a lot of their hard-earned savings at the hands of others. Individual investors have become nervous about investing in the markets ”perhaps rightly so. However, what about the larger institutional shareholders like insurance companies that also invest in stocks? Should we feel sorry for them, too? We think so. They also lost a ton of money, but many of these institutional investors, such as pension funds and mutual funds, are actually investing money on behalf of many smaller individual investors. Don't these large shareholders have a fiduciary responsibility to the smaller investors who invest with them? The answer is yes. So where were they during all of this? Robert Monks, a well-known advocate of shareholder activism, asks the same question when he wonders where Enron's owners were. ^[1]

In the midst of our shareholder confidence crisis, there is a uniform cry from shareholders, both individuals and institutions, for more protection. It is this very need for more protection that has everyone, from the stock exchanges to the SEC to the U.S. President, scrambling around trying to find ways to protect investors. However, one question that begs asking is, "Why can't shareholders also take care of themselves ?" That is, why can't they take more responsibility for the stocks that they own? Is it right for investors to blame everyone else but themselves?

People who own homes will often take precautions to safeguard themselves against potential burglary . The various ways to protect a home are wide- ranging , from forming neighborhood watches , buying a watchdog, or installing a security system to doing something as simple as locking doors each night. Of course, homeowners also rely on the local police to protect their homes, but the police obviously can't guarantee that all homes will be perfectly protected. This is just as true with shareholders.

No one can guarantee the integrity of our business system, and no one can ensure the soundness of our investments. So then, why don't shareholders, like homeowners, do more to protect themselves ”even if it's merely the equivalent of locking the door at night? Even on the SEC website (www.sec.org), the following statement appears, " stocks, bonds and other securities can lose value. There are no guarantees . That's why investing should not be a spectator sport; indeed, the principal way for investors to protect the money they put into the securities markets is to do research and ask questions."

There are valid reasons why individual investors don't pay more attention to what they own. Those reasons were briefly discussed in Chapter 2. Most individual shareholders don't own enough stock in any one company to be able to influence its management. Nor do most shareholders think it would be worth their time and effort to do anything because the gains (e.g., stock price increases ) from their efforts would be shared by all other shareholders while they alone would suffer the costs. If they do anything at all, it is to sell shares that they are unhappy with ”commonly known as doing the "Wall Street walk."

However, institutional shareholders that usually own many different stocks to begin with, and at the same time have some restrictions about what they can own, may not have so many opportunities to sell stocks. For them, it may be worthwhile to exert some of their ownership rights. Further, given the large amounts of stocks that they own, they may be able to effectively affect the decision-making of the firm. Finally, the potential benefits accrued from their activism may be large enough that it would be worth the effort. This being the case, perhaps there is more that institutional shareholders should have done to prevent recent scandals, especially given the fact that individuals seem to trust them to invest money on their behalf. According to the Survey of Consumer Finances, there are more individuals who own stocks through a fund than own stocks directly. In 1998, for example, 50.2 million individuals owned stocks through a fund as compared to 33.8 million individuals who only owned stock directly. ^[2] Therefore, if we really are concerned with restoring the confidence of the individual investor, it may be worthwhile to consider institutional shareholder activism as playing an important role.

This chapter discusses investor activism of various forms. For example, it describes ways that individual shareholders can exert some influence over the firms that they own. However, the focus of this chapter will be on activism by institutional shareholders who, by virtue of their enormous ownership stakes, have the potential and the power to be active and effective owners. We will also summarize anecdotal and academic evidence that suggests that their activities may be beneficial. Finally, and perhaps most importantly, we will also point out some of the problems and constraints that institutional shareholders currently face, which may explain why they were largely inactive before and during the recent corporate system failures.