Who Best Protects Shareholders? The Shareholders



Giving shareholders more rights is good for a company to do.

That is not a political judgment. It appears to be an investment truth, though discovered only recently - in a study that found that the stock prices of companies that place the most restrictions on their shareholders' rights have lagged behind those that had the fewest such limits.

The restrictions take many forms. Particularly well known is the poison-pill defense, which aims to immunize management from hostile takeovers. Others include the staggered election of company directors - which keeps shareholders from throwing out an entire board in any given year – and requirements for supermajorities in voting. These changes make it difficult for shareholders to exercise real influence or control.

But as many and varied as the restrictions can be, their net impact on long-term performance has been negative, according to a new study by three researchers - Paul Gompers, a professor of business administration at Harvard Business School; Joy Ishii, a graduate student in economics at Harvard; and Andrew Metrick, a finance professor at the Wharton School of the University of Pennsylvania. The team studied 24 ways in which a company may restrict shareholder rights and combined them into an overall index. A low reading meant that a company imposed few restrictions.

Working with a database of companies representing 90 percent of the market, the team constructed 10 portfolios, according to those companies' index values. The portfolios were reconstructed periodically. From Sept. 1, 1990, to Dec. 31, 1999, the researchers found, the portfolio with the lowest index values gained 9.3 percentage points a year more, on average, than the one with the highest values. While the other eight did not always adhere to the pattern, the performance difference between the extremes has withstood
attempts to explain it away.

To put the researchers' findings in perspective, consider that the performance difference is almost double the five-point margin of victory that growth stocks had over value stocks during the same period - a heyday for growth investing - according to the Standard & Poor's 500/Barra indexes.

But how could a difference of such magnitude have escaped notice? For one thing, researchers couldn't have detected it until recently. Widespread shareholder restrictions are relatively new; most companies did not impose them until the mid- to late 1980's.

Furthermore, to the extent that shareholder restrictions could have been studied, previous researchers tended to focus on the immediate market impact. But over the short term, that impact is ambiguous. For example, even though a poison-pill defense turns out to be a long-term negative, the market may react to it positively over the short term because it may signal that a hostile takeover attempt is imminent.

Why would companies that restrict shareholder rights be such poor performers? The authors of the new study are careful to stress that the jury is still out. Maybe the restrictions lead to a deterioration in a company's culture - away from shareholder responsiveness and toward immunity from competitive pressures - and eventually to poorer fundamentals and inferior stock performance. Or maybe the restrictions on shareholder rights are just symptoms of a deterioration caused by something else.

I find it safe to say, however, that investors should begin to pay more attention to a company's culture. Assuming that restrictions on shareholder rights are either a cause or a symptom of cultural deterioration, an investor should be less inclined to buy, and more inclined to sell, a company that chooses to impose them.

That also means that investors should consider a company more favorably if it relaxes previously imposed restrictions. Companies that imposed heavy restrictions were so beaten down by the market over the last decade that changes in their corporate cultures could unleash enormous potential.

Mark Hulbert is editor of The Hulbert Financial Digest, a newsletter based in Annandale, Va. His column on investment strategies appears every other week. E-mail: strategy@nytimes.com


Return To Board Options Home Page