Equity markets can be agents of change for an economy, providing funds for companies to pursue their dreams and a stake for investors in an expanding economy's growing wealth.
Faith of the individual investor in the system is thus of paramount importance. The daily news about shenanigans in the world of corporates (Enron, Worldcom etc) and financial institutions (Lehman, AIG, Fannie and Freddie etc) resulting in blood on the street for individual investors does nothing to retain their faith in the system.
The interest of corporate management and of minority shareholders are, at times, divergent. Management pursues growth, partly under pressure from minority shareholders for improved performance, quarter on quarter, but also because of the desire of management for the clout (and perks) that bigger companies bring. Unbridled growth then results improperly allocated capital and lowers returns for shareholders. It is also often pursued without care to the associated risks, as we are now discovering amongst financial institutions.
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The interest of minority shareholders is only to maximise returns for their own money. They demand fealty to the business from those in control (through restrictions on 'insider trading') but have, themselves, no loyalty to the business and are free to sell anytime. They do, however, need someone to assume the role of a watchdog to check management in their quest for growth without an assessment of risk, or, indeed, of downright fraud.
One such watchdog nominated by the State, is the regulator, whose raison de etre is protection of minority shareholder interest. In a football game a referee can run on the field alongwith players, and blow the whistle as soon as a foul is committed. In the corporate world, a regulator cannot. By the time the regulator enters, usually on somebody else blowing the whistle, it is too late, and minority shareholders have suffered losses. There is no fair way to compensate them for such losses.
It was thought that mutual funds would become watchdogs. The growth of mutual funds has been enormous to the extent that assets under their control in the US, e.g., is now a multiple of the banking industry. Mutual fund managers, however, generally do not play the role of a watchdog but vote with their feet, exiting the stock of a company they feel is being run badly.
Enter the activist shareholder. Calpers is the largest and most famous of this breed. They try and use their voting clout to affect change and are often able to improve things for minority shareholders much more than what regulators or larger mutual funds can do.
The Sep 2008 issue of Alpha (disclosure: the author is India representative for Institutional Investor, a sister publication) carries a fascinating article on hedge fund manager Chris Hohn.
Chris Hohn is an activist fund manager who is rethinking his activist role. This is bad news for minority investors. He established his reputation with Perry Capital European Fund, which he left in 2003to start The Children's Investment Fund Management (TCI) company. But he wanted to do something more meaningful. So he and his wife Jamie Cooper-Hohn, linked a foundation, The Children's Fund Foundation to TCI in an interesting model. TCI agreed to contribute a third of its 1.5% management fee to the Foundtation for its charitable activities. The Foundation now does some wonderful charity, including a programme, together with the Clinton Foundation, to bring down the cost of AIDS treatment to some 300,000 African children.
TCI has had battles with the likes of ABN Amro (which was forced to offer itself for sale) Deutsche Bourse, the German Stock exchange and CSX, a US railroad. He wants Deutsche Bourse, which has a single silo model, to spinning off the three parts separately, to unlock value, viz. the exchange itself, the posttrade processing firm Clearstream and the derivatives exchange, Eurex. Deutsche Bourse management is resisting this, and its stock price has fallen, impacting TCI's performance.
The battle with CSX has been more demanding in terms of time and money and yes, reputation. Ultimately TCI has succeeded in getting seats on CSX Board, but his enthusiasm for such activism has lessened.
That would be a pity because, as unfolding events are showing, there is need for more activist shareholders willing and able to pressurise management of companies and financial institutions who manage badly.