Outside the marginals

a commentary on the politics that followed the UK 2010 & 2015 elections

A Shareholding Democracy?

What has happened to shareholders?

I believe shareholders have become ineffectual. There are pressure groups (share action) that are working towards changing this situation. However, I believe there needs to be root and branch reform. The 19th Century model of the limited company is out moded.
Comment by rantingsphere on Julian’s Musings: The ignored hit back

Is it outmoded or has it been overtaken?

The 19th century model sought to attract individuals to risk their capital in specific “ventures”. As a consequence you had a high level of shareholder involvement.

During the 20th century we saw two moves:
1) Numerous companies acts – which sought to regulate the way limited liability companies behaved particularly in relation to shareholders.
2) Investment funds arose acting as intermediaries between the investor and the companies.

Due to (1) companies became more distinct entities – more independent of their shareholders and shareholders were relieved of some of the responsibility to “watch over” their investment – all they had to worry about was increased share value (never mind if that was a true reflection of the company’s value) and dividend flow (never mind whether it was a true reflection of the profits of the company).

Due to (2) investors ceased to be direct shareholders, but fundholders – often unaware of the actual underlying investments. The Company management was no longer relevant – the “fund manager” was the king – and paid a king’s ransom.

Funds – either investment or pension funds – often have a “fiduciary duty” to “act in the best interests of fundholders”.  You cannot easily aggregate the different interests of different fundholders into a single “fundholder interest” – so this interest has in many cases come to mean “short-term profits” usually driven by quarterly reporting and quarterly or half-yearly dividend payments. Again this dividend flow is more important than the underlying profits. The big companies (majority owned by just a few funds) dance to the tune of these predominantly amoral funds. They even hold “analysts’ briefings” to indicated how the companies are doing. (I have never understood how this is allowed under “insider dealing” rules as said analysts get information before “normal” shareholders – and would be saints if they did not act on that information. And if they were not going to act on it, why bother telling them?)

Taxation rules often mean it is better to invest through funds rather than directly. If you talk to a financial adviser, the chances are he will recommend “funds” based on fund performance and tax advantages. Rarely will he recommend direct investment. In the days of commission based fund sales this was understandable – even if regrettable; now the movement to paying your advisor directly (rather than him getting commissions from the funds he sells) should change this. But if you are an advisor (wary of being sued) do you keep yourself informed of numerous individual companies or of a more limited number of funds (which still have tax advantages)?

A benefit of fundholding rather than shareholding is the opportunity for diversification. As you spread your wealth across more investments you stand less risk of significant loss due to low performance (or even company bankruptcy). The downside of this is that you are less concerned about the health of the individual companies behind the fund. You can push for higher dividend flow, knowing that you can afford to “lose a few” on the way. The few that get lost mean little to the fundholder, but represent a lot more to the company involved, its employees, its customers and its suppliers.

Thus the 19th century model has been brushed aside. Do we bring it back? If so how do we get more direct investment and more direct shareholder involvement – and what does that mean for those comfort blankets called pension funds?

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