One of the foundations of capitalism is that the for-profit company is owned by shareholders. However, in the most fundamental sense, little has been written about the nature of shareholders. In a new article in HBR Justin Fox and Professor Jay W. Lorsch (HBS) argue that shareholders are more like "renters" than owners. Shareholders have limited rights rather than the full rights of ownership. The authors argument can be summarized as follows:
- The average holding period for a stock has declined from 7 years in 1950 to 6 months today.
- In 1950 90 percent of shares were held by households but today as much as 65-70 percent are owned by institutions; portfolio management approaches in many institutions reduce the focus on individual company performance.
- The nature of shareholder voting rights favor management and the board of directors rather than shareholders, which dilutes the benefits of ownership for shareholders.
What brought about most of these changes were the intended or unintended consequences of a government lead initiative to lower brokerage commissions on common stock transactions. Lower transaction costs facilitated more trading and made it cheaper to trade in and out of a stock position, thereby creating shorter holding periods (and more price volatility) and the accumulation of stock positions by institutions.
So what is an individual investor to do? Fox and Lorsch's conclusion was very theoretical and not particularly helpful. My conclusions are:
- Invest in hedge funds who specialize in short term trading strategies
- Invest in companies where there is a large shareholder (in percentage ownership terms) because these companies tend to generate better returns for all shareholders due to greater control of management self-interest
The entire article "What Good Are Shareholders", which is well worth reading, is here.