We have seen enough corporate scandal in the past year to fill an encyclopedia.
From Tyco to WorldCom to Enron to Andersen to Smith Barney to Merrill Lynch, there are as many kinds of misdeeds as there are corporate meltdowns.
Predatory chief executives. Shifty chief financial officers. Lazy boards. Compromised accountants. Sold-out analysts.
The blame has spread around, but it hasn’t quite landed yet on one big, culpable group: Investors.
Not just any investors, either. Institutional investors. They should shoulder some responsibility. And they belatedly got some blame last week when the Conference Board’s blue-ribbon commission on corporate governance delivered its plan for restoring trust in the nation’s financial markets.
Among the less-noticed recommendations: Lawmakers, investors and fund managers must stop rewarding institutions for dumping stock holdings at the first sign of trouble.
They didn’t put it quite that curtly, but that’s what they meant.
Institutions once were the most loyal holders of a company’s stock. Their size gave them access to corporate executives, and access gave them influence. They provided stability by offering loyalty to bulwark companies that followed solid long-term strategies.
Not any longer.
These days, institutions are hot-handed money. In the 1950s, they changed only about 20 percent of their portfolio in an average year. That figure rose to 80 percent turnover in the 1990s. It has topped 100 percent for the last three years.
The fickle investment approach has taken root even as their importance has grown. Institutions today control more than 61 percent of the stock in the largest 1,000 U.S. companies, up from a 45 percent share in 1987. More remarkable yet: The 100 largest funds control fully half of those big-company shares.
“These are the owners of corporate America, this little handful of shareholders, and yet we do nothing to change the system,” says John Bogle, whose Vanguard Group is one of the big players. “We act more like traders, more like speculators, than we do like owners.”
The short-term mind-set has a corrupting influence on corporations. Institutions that treat their investments like poker chips create casino incentives that reward the kind of crooked conduct that can turn promising companies into Enrons and WorldComs.
People have clucked about the institutions’ short-term mind-set for years. In New York last week, the Conference Board commission on corporate governance put out a specific action plan.
The commission urged lawmakers to consider tax policy that favors long-term investment. It suggested companies should stop offering “earnings guidance” that entrenches a short-term mind-set. It advised mutual funds and pension funds to reward portfolio managers for holding shares, not just trading them.
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Good luck.
Institutions are addicted to short-term results. Portfolio managers are rewarded for quarterly returns, not good-governance instincts. It will take more than high-minded talk to get them to kick the habit.
An altered tax policy would be a quick cure. Warren Buffett has proposed a 100 percent tax on short-term investment profits.
Buffett may be half joking. He’s more than half right. But given President Bush’s tax-axing tendencies, he probably doesn’t stand half a chance of seeing any behavior-modifying tax passed any time soon.
The biggest shame of it all is that institutions could be such a big force for change. Just ask John Biggs, a commission member and former chief executive of pension fund TIAA-CREF.
At TIAA-CREF, Biggs pursued a patient-money policy. Rather than cutting and running at the first sign of difficulty, the fund proposed more than 50 annual-meeting resolutions at companies in its portfolio. Its success rate in negotiations with corporate management: 95 percent, Biggs says.
Institutions could have a big positive influence. Instead, their short-term mind-set causes long-term damage–and they seem unlikely to change for a good long time.