Investor activism and its impact on company performance

Firstly, while in an electoral exercise there are parties and their backing, there is no known block of votes that has already been delivered to a particular candidate.

Published: 07th November 2021 01:14 AM  |   Last Updated: 07th November 2021 10:20 AM   |  A+A-

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Let me start by giving you an analogy. The citizens of a democratic country all have the same rights and responsibilities written into the constitution and apart from enjoying the benefits of living in the country, they have the opportunity to vote and elect their representatives to govern the country as per a given schedule. 

Similarly, shareholders of a company have the same rights and responsibilities under corporate law and while all of them enjoy the fruits of good performance of the company, as translated in dividends declared and stock price appreciation, they also get an opportunity to vote on major decisions taken by the company management and to elect independent and non-independent directors as per a schedule. 

However, I think the similarity ends just there. When voting for representatives to the government, all of us will be passionate about our views, stand in queues and feel proud of exercising our franchise. Each one of us knows that by our own self, we will not make any difference, but the sense of collective participation is so strong that we would like that contribution to be felt. 

On the other hand, in the case of companies, shareholders have the right to vote at every annual general meeting. The processes that have been set up to register and count votes are just as elaborate and formal, maybe not at the same scale; but individual shareholders in companies do not exercise their vote. It is something that is valuable and has been granted to you, but almost all individuals choose to ignore it. I find this quite confounding, but there are a few reasons for the same. 

Firstly, while in an electoral exercise there are parties and their backing, there is no known block of votes that has already been delivered to a particular candidate. In case of companies, except for a rare few which are completely professionally managed, the owners /promoters are the largest single shareholders and their exercise of vote matters that much more. It is also to be expected that owners/promoters having a substantial stake in the company, would have the best interest of the company in mind when they run it or review the performance of the management in board meetings. The company not doing well will hurt them the most and conversely the company performing well will help them increase their wealth the most. 

The last and perhaps the most important factor is that individual shareholders do not have the ability to analyze proposals that have been put up to vote, or the actual contribution that has been provided by each of the directors in the company. So when the proposals come to them, it is the easiest to just ignore as exercising the vote is a right but not a responsibility. 

While in most cases it is true that the promoters and/or management try their absolute best and the performance of the company is limited only by the external environment and the abilities of the management, there are rare cases where the intent and objectives of the promoters start to differ from that of the company or the shareholders at large. 

One of the main decisions to be taken by the promoters and management is regarding the use of cash generated by the company. When a company starts to generate significant free cash flow - after factoring in all requirements including payment of debt and maintenance expenses - the options are to return cash to shareholders through dividends, buy back shares of the company, to go for faster pace organic growth, or to do inorganic growth through acquiring another company or business. 

In the rare cases, this deployment of spare resources which belong to all shareholders, but are decided upon by the promoters and management, is not aligned in everyone’s benefit. This may be due to the promoter’s personal ambition to enter and operate into a certain unrelated sector. Debt or other liabilities taken separately by the promoter that need to be serviced etc. 

The key question then is, how does an individual shareholder understand when the company management is working in the interest of all shareholders or in the interest of a certain category of shareholders only. This is where institutional shareholders and independent shareholder advisory companies come into play. If the shareholder has the time and intent to analyze proposals sent by the management before the AGM, that is ideal. Otherwise at least s/he should read up on the advise being given by independent agencies and look at the position taken by larger institutional shareholders to decide the stand. But decide they must! 

Just as in the case of elections, each shareholder should understand that they have a moral responsibility to vote. At least in cases where they come to a conclusion that the management is not doing its best for all shareholders, they need to vote - however futile it may look to them. As they keep voting, slowly but steadily their combined vote will start to matter and bring in the much needed accountability for promoters and management, which is currently missing.

Pankaj Chopra is the Founder of Five Rivers Portfolio Managers


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