The ownership of company shares brings with it a number of important rights – and, as the founding father of value investing showed, shareholders should never be shy of exercising them
“You must give us credit for knowing better than you what is best for the company and its stockholders. If you don’t approve of our policies, may we suggest you do what sound investors do under such circumstances, and sell your shares?” No, this is not what the Tesco board said to us earlier this year when we expressed our concerns over the group’s intention to buy food wholesaler Booker – though perhaps they thought it.
In reality, this was the initial reaction of the board of Northern Pipeline – a US oil firm that, in the late 1920s, became the focus of one of the very first instances of shareholder activism. And the person they were suggesting should sell his shares was none other than Ben Graham, the founding father of value investing, whose own initial reaction after analysing the company’s balance sheet was: “I had treasure in my hands.”
The bare bones of the story, which we came across in Jeff Gramm’s excellent Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism, are that Graham worked out a company trading at $65 a share and generating $6 a share in annual earnings was sitting on millions of dollars of investment securities worth $90 a share. Graham felt that cash should be distributed to its shareholders. The company disagreed.
When shareholders disagree with management
What can a company shareholder do in such a situation? What key rights do they have? Most obviously, they own a piece of a business and, all being well, that piece will be worth something. On top of that, they have a right to any profits the business may pay out as dividends, which – as we have discussed in articles such as An old truth – have over the years accounted for a considerable proportion of the total return on equities.
Other key rights shareholders enjoy include being able to inspect the business’s books – admittedly more relevant these days to private shareholders now that PLCs must make their finances public – and to sue if it turns out the company has done something wrong. And of course, as the Northern Pipeline board made very clear to Graham, shareholders have the right to sell their shares to somebody else.
Graham’s preferred route, however, was to make use of the last of the key rights shareholders enjoy – that of having the power to vote on important issues affecting the company, such as the election of board directors and whether mergers and acquisitions proceed. So, after being thwarted in his initial attempt merely to raise the issue of distributing Northern Pipeline’s cash at a shareholder meeting, Graham stepped up his efforts.
He wrote a letter to all of Northern Pipeline’s shareholders in which he argued it was not a business’s management but its shareholders who should decide how surplus cash was used. Having failed to gain the backing of the Rockerfeller Foundation, which owned 30% of the entire company, he needed the support of the rest of the shareholders and so he set about winning them over.
Graham did this so successfully – steadily picking up the proxy votes of one small shareholder after another – that at Northern Pipeline’s 1928 annual general meeting, he and his lawyer picked up two of the five seats on the board. Within just a few weeks of that meeting, Northern Pipeline had presented a plan to distribute cash to its shareholders.
Shareholder activism was in its infancy back then – Gramm highlights an academic study that found only seven instances of it between 1900 and 1949, with the majority of those comparatively tame in their demands. Times change, however, and where Graham led, we on The Value Perspective are happy to follow, whenever we deem it is appropriate to do so.
If we believe a company in which we own a stake is taking the wrong course of action, we will not hesitate to engage patiently and constructively with its management – always with a view, ultimately, to helping them close the gap between their business’s intrinsic value and what the market deems it to be worth.