Monday, 3 September 2012

Olson, Hirschman and shareholder activism

Something that can seem quite odd on first glance is why shareholders expend any effort on issues like executive pay. After all, as I bore on quite frequently, there are a variety of reasons why we might expect them either to not bother, or to be ineffective if they do try. One argument I realise that I personally rarely invoke for shareholder reluctance to get stuck in is the classic collective action problem.

In fact Mancur Olson directly referred to this in relation to shareholders:
Why, then, do not the stockholders exercise their power? They do not because, in a large corporation, with thousands of stockholders, any effort the typical stockholder makes to oust the management will probably be unsuccessful; and even if the stockholder should be successful, most of the returns in the form of higher dividends and stock prices will got to the rest of the stockholders, since the typical stockholder owns only a trifling percentage of the outstanding stock. The income of the corporation is a collective good to the stockholders, and the stockholder who holds only a minute percentage of the total stock, like any member of a latent group, has no incentive to work in the group interest. Specifically, he has no incentive to challenge the management of the company, however corrupt or inept it might be.
To be fair, Olson was referring to individual shareholders, rather than institutional investors. However, given that even large institutions rarely hold more than a few percent the point still holds. In straightforward cost/benefit terms shareholder activism doesn't seem to make any sense, or rather it doesn't seem to make sense to lead it, you should free ride. 

The reason I don't use this argument is because I rarely run up against it when dealing with people in the the corporate governance microcosm. The nearest you get is that some people will sometimes tell you that they don't want to take the lead in engaging with a particular company because they have a very small holding - meaning a fraction of a percentage. But even then they are typically still voting. In practice, then, quite a lot of the time asset managers with relatively small holdings (certainly small enough that they would derive a very marginal gain from any uplift in value) do bother to engage. But why?

Of course some people will suggest we can discern some other interest. Certainly in a few cases assets managers and other providers offer shareholder engagement as a service, so you could argue that they simply do it because they are paid to. But, again, I don't think that captures it. Why the upsurge (as limited as it might be) in shareholder opposition this season? It is clearly not the result solely of the activism of those paid to be activist - they don't have enough power to do it alone (and were presumably doing it already anyway) and in any case we know that some mainstream investors are involved.

One of the best responses to Mancur Olson came from my old fave Albert Hirschman in the book Shifting Involvements. Again focusing on individual motivation, Hirschman says that at certain times the model of cost/benefit analysis changes:
[A]t some stage in our cycle, the benefit of collective action for an individual is not the difference between the hoped-for result and the effort furnished by him and her, but the sum of these two magnitudes! And a further surprising consequence follows immediately: since the output and objective of collective are ordinarily a public good available to all, the only way in which an individual can raise the benefit accruing to him from the collective action is by stepping up his own input, his effort on behalf of the public policy he espouses. Far from shirking and attempting to free ride, a truly maximising individual will attempt to be as activist as he can manage, within the limits set by his other essential activities and objectives.
It's important to be clear that Hirschman's book is about how commitment to public versus private activities goes through waves as punters become disappointed with one, then turn to the other, then back again. Therefore, according to Hirschman's theory, it's only at a given point in the cycle when activism might be its own reward. Nonetheless it does put a rather different spin on how shareholders, and specifically those individuals undertaking engagement activity, might approach it. I don't think this by any means captures the range of motivations, but it does at least point us away from the assumption of a bottom line cost/benefit approach (where activism is a cost) which does not reflect what we see in practice.  

For what it's worth I think the current round of activism is taking place in no small part because some investors at least believe that it is a good thing that it does so, regardless of whether they can show a real financial benefit. Their views about the merits of shareholder engagement are more important than any notional financial returns. One of the things I like about Hirschman is that he looked at how ideas develop over time (The Passions and the Interests being the stand-out example) and the impact they had in practice.  I think that at least currently he can offer us some better insights into what shareholders are up to than Olson.

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