Executive Pay Comes Home To Roost

Forbes.com, Spring, 2012. This article was written with Oliver Pursche, the Co-Portfolio Manager of GMG Defense Beta Fund. It was part of a series of articles developed under an agreement with forbes.com to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site, forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

The bout has been going on for quite some time, and not just on Wall Street. Major motion pictures have a producer telling a director what to do, a major donor to a charity wants to change how things are run, etc.

And so, it’s not surprising that shareholders want to tell management how to run their businesses.

The trend has been running rampant lately. Most recently it happened with the Yahoo (YHOO) CEO’s resume, where a major stakeholder pushed the investigation. At Chesapeake (CHK) shareholders took action when they found out about the CEO financing personal deals on the side. And Citigroup (C) shareholders struck down a fat pay package for chief executive Vikram Pandit.

The rise of shareholder activism raises a fair question: Is it really good for shareholders?

I’m here to offer a resounding, unequivocal yes. More importantly, you should favor stocks where corporate governance policies favor the shareholder’s voice, and avoid those where it’s the shareholder’s money, not his or her voice, that resonates most soundly with management and the board.

This is not as obvious as it first sounds. After all, many shareholders have a focus on profits and performance that can undermine management’s longer term, perhaps more successful strategies. But years of torrid growth in executive pay have, in my opinion, finally come home to roost. The so-called “agency problem,” long a musty staple of business school texts about managers enriching themselves at the expense of shareowners is alive and well in 2012.

The reason shareholder activism is bullish comes down to simple psychology. Investors are more likely to buy and hold a stock if they have more say in what goes on with the company. Long-term retention of shares, in effect, reduces the supply. Meanwhile, at least in today’s social media fueled environment, more open governance policies put a tailwind on demand. Less supply and more demand benefits everyone, not least of which, or depending on your perspective, most importantly, individual investors.

Shareholder activism may bring to light issues that put short-term pressure on the stock such as with CHK. However, longer term, it’s a net positive for equity investors.

The only source of kryptonite for shareholder activism is a truly dynamic, free thinking executive out of the mold of Henry Ford. The last of these was Steve Jobs. Until another one like him comes around, I’ll going to stay on the side of the shareholders.