The Evolution of Public Ownership

Public companies, Warren Buffett has famously noted, get the shareholders they deserve. He’s right: companies that consistently fall for short-term temptations will eventually have a shareholder base of short-term-oriented investors, while companies that take a longer view will eventually attract owners that are similarly patient and far-sighted. Unfortunately, it’s harder than ever for a company to attract the “right” shareholders. Reason: the variety of institutional equity investors has expanded enormously in recent decades. Hedge funds, quant funds, and index funds, to name three, basically didn’t exist a decade ago-and yet are now major players in the equity markets. Some of these new investors have long-term interests that are in sync with your company’s. But others surely don’t. A major task of boards in the 21st century, I believe, will be to aid managements in attracting the investor base that will enable companies to carry out their long-term strategies.

Before I go on, some numbers. The share of stock ownership by individuals has been in long-term decline for decades. Individuals accounted for 90% of public share ownership in 1950, according to the Federal Reserve Board. That number fell to 48% by 1990 and is just 32% today. Pension plans essentially owned no equities back in 1950. But by 1990, pensions accounted for 27% of share ownership. Now their share is down to 21%, and falling.

Who’s been boosting their share of ownership of stocks? Mutual funds, for one. They’ve gone from an 8% share of share ownership in 1990 to 28% today. Hedge funds, as well as general and specialized index funds known as Exchange Traded Funds (ETFs), have also increased their share.

This changing equity investor base has important ramifications for public companies. First, many of these new owners are utterly disinterested in the fundamental outlooks of the businesses they own. Index funds, for instance, simply own the names in the index they are designed to track, in the appropriate weightings. They couldn’t care less about the actual performance of the companies they own. Quantitative funds, too, are less interested in the company’s business than they are in some mathematical relationship between its stock price and some other security. To say the least, these investors will not be committed owners of your company’s stock.

In addition to the disinterested investors above, there’s another class of investors that I call the “renters.” These are the shareholders-many mutual funds fall into this class, as do a lot of hedge funds-whose investment-time horizon is much shorter than the time it will take for your company to carry out its long-term strategic plan.

Further, too many money managers want to outperform the market each and every quarter, lest their own investors walk out the door. They’ll thus sell your stock at the whiff of bad news, and aren’t shy about pressuring management to take actions.

What, then, can companies do to attract the committed, long-term holders they want? I have some suggestions.

First, stop conducting quarterly earnings conference calls. Such calls only encourage “short-termism”; worse, the Q&A sessions too often give renters (and even short sellers!) an opportunity to raise near-term issues that are beside the point. Second, stop participating in investor conferences sponsored by the big brokerage firms. The events are a huge waste of management time, and inevitably attract the wrong kind of shareholder. The investor you want doesn’t likely look for long-term opportunities by trolling for stocks at an investor conference. Finally, stop giving earnings guidance. It only gives the renters and shorts something to complain about.

What should your company do to attract the right shareholders? I believe the following “investor relations best practices” would be a good first step:

• Provide prerecorded calls each quarter that provide discussion and analysis the prior period’s results, in the appropriate context. Include a discussion of key metrics you feel are most important.
• Host an investor meeting annually, for both current and prospective investors, where management can discuss the business in some detail and present its long-term strategy.
• Write an annual letter to shareholders that is robust and informative, that’s been prepared with heavy involvement by the CEO. (The best shareholder letters I’ve read were actually written by the CEO.)
• Prepare quarterly filings that that are rich in detail, and that include the metrics that are most important to management-whether those metrics are used conventionally or not. Such metrics should be consistent over time.
• Meet only with shareholders and analysts that share management’s interest in running the business with a long-term orientation.
• Finally, install a strong manager of investor relations.

  Ownership in public companies has changed enormously, and will continue to change. Amidst it all, managements will need to focus on attracting and retaining shareholders that are truly interested in the long-term success of the company.