"Dear Fellow Shareholders,..."

This tract will be released in several parts, so as not to be intimidatingly lengthy. The first part covers the election by shareholders of their respective Boards of Directors, especially those in large corporations. But feel free to start commenting about it already. I only ask that we please keep it on topic, and for the love of God, [cough-ricky-cough] please let's not turn this into a thread about corporate donations to the Democratic and/or Republican Party, all right?

In the first place, I have always found this typical salutation ["Dear Fellow Shareholders,..."] in the CEO's (and or Chairman's) annual letter to his supposed peers of any given publicly-traded corporation in the United States, even companies abroad, to be terribly amusing, if not terribly deceptive and disengenuous. But it begs the question: do managements of large corporations really think the average stockholders of their companies are indeed financial brethren? Or simply a lot of annoying and irrelevant voices (or noises) to be silenced and placated?

Probably the latter, and with that judgment in mind, I will commence with PART ONE of this tract on the managerial stewardship of corporations, and how well (or badly) they treat their shareholders.
(Not to mention the lack of intelligence and diligence of individual investors.)

Part of the problem with the modern corporation and, by extension, the corruptness of Wall Street, is the way in which the shareholders elect the Boards of Directors of the companies they OWN. (People often forget that when they own shares of stock, they are part owners of a business.) Every shareholder is mailed a proxy card on which he or she can cast their vote(s) (one share equals one vote) not only on various shareholder proposals (usually voted down as per the Board's recommendation!) but for the members of these corporations' Board of Directors.

In theory, the Board of Directors is a body elected by the shareholders (the legal owners) of a publicly traded corporation to look after their interests. They form a distinct entity from Management and can therefore check and balance its authority over the corporation, specifically in the area of overseeing and guaranteeing good stewardship of the shareholders' invested capital. Should Management not be up to the task of safeguarding and enhancing shareholder capital, or act as courteously to that capital as would your average South American military junta, the Board can dump them, in favor of a new Management which is actually up to the task (or who are not corporate kleptocrats).

In practice, on the other hand, they're a body of inept (but partially clever) placaters, more or less hand-picked by management to have their backs scratched by them, in return for scratching Management's backs---they practically scratch the skin off of them, to put it mildly. Every year, before the annual meeting of shareholders, a "nomination committee" puts forth a slate of what passes for candidates (e.g., always the usual suspects) to fill the number of seats up for grabs on the Board, at that time. It is not, of course, a coincidence that the number of candidates proposed by the Nominating Committee for election (more likely "re-election") to the Board is entirely commensurate with the number of available seats on the Board. And, even worse, the CEO of the company is often the Chairman of the Board of Directors. (So much for keeping the Board disinterested.)

In other words, the way shareholders of publicly-traded corporations elect their boards of directors is not unlike the way the people of the U.S.S.R. voted in their own local elections. Yes, the Soviet Peoples voted! If, for example, there were nine seats open on the local city council, the local branch of the CPSU (Communist Party) would nominate nine [Communist] candidates. The "voters" (via universal suffrage at 18, both sexes) would simply vote "Da" or "Nyet" for each candidate; so it was not what we would call a "free and fair" or truly "contested" election. Sound familiar yet?

While I firmly believe that ALL shareholders should start exchanging their marijuana joints for ballpoint pens, and actually take the whole 45 seconds required to fill out their proxies and drop them--postage paid--into their mailboxes, I must still express my horror at the rather eerie coincidence between voting in shareholder elections on the one hand, and the afforementioned elections in pre-Glasnost Russia on the other. And yet, there is at least a chance that the situation will improve greatly if all shareholders, especially the "outside" shareholders (e.g., not Management, board members or "major" shareowners) actually took the time to find out exactly what was going on in their businesses; who was running their businesses, how well they were being run, and if the people elected to look out for their interests were doing their job watching them.

Why have shareholders allowed their watchdogs to sit idle as Managements either gorge themselves on the Kibble, or run the business into the ground, or both? While I just encouraged more shareholders to vote their proxies like good little businessmen/businesswomen (which is precisely what they are!), the election of the Board itself, usually the first question on the proxy ballot, is often a sham. That in itself is the other half of the problem.

To conclude, in the first edition (1949) of one of the most influential and insightful works of investment literature, The Intelligent Investor, by Benjamin Graham (1894-1976), the author devotes two chapters (37 pages in all) to the proper relationships between stockholders and management. He felt that becoming an "intelligent investor" does not end with buying and selling the shares themselves; even after one has become a security owner, there is still the question of him acting "in an alert and businesslike fashion" (Graham 17). Graham revised his original work three times before his death. However, by the fourth (1973) edition, he had totally given up on advising investors to act intelligently and diligently toward the managements of the businesses they own, and left the reader with a very small chapter on a management's proper policy toward shareholders in relation to dividends paid; screw it, he must have thought, nobody is listening. If Graham could have lived to see the likes of Enron, WorldCom and the rapacity and stupidity of our banking and other financial institutions (culminating in the debacle of the 2008, to present economic disaster), in combination with the stupidity and passivity of investors today (both individual and institutional alike), he might not have bothered to write the first edition, let alone four of them.

Shareholder activism and cognizence will help the problem---partially. Managments need to be held to accountability by all shareholders, large and small, if something is to be done to prevent any further such disasters. Of course, you can lead a horse to water, but you cannot make him drink, so that's not entirely likely (which the next "part" will discuss why, and how that's gotten worse). If only the shareholders of B of A, Shittigroup (excuse me, Citigroup) or Lehman Brothers, just to name a few, had been more diligent and had held their managements and Boards to account (and were allowed to be armed with the weapons needed to do so), perhaps the Great Recession would have been avoided.

Or not. But then again, the author is an incurable optimist.

----The Rt. Hon. James Hacker, M.P.

I have on these boards expressed similar feelings. Having spent my entire post-university career in the private sector, and mainly working for medium-large companies - and within others as out customers - I have indeed seen that in the UK (as in the US), there is a significant difference between democracy at large and within corporations.

We have recently seen a few 'shareholder revolts' where companies that are seen to reward senior management quite highly in bonuses compared to actual company performance see significant votes against the remunerations (where such things are recorded). But incredibly even if the vote is a majority against, the company only has to take it as 'advisory'.

Often, institutional shareholders do not vote against the Board (because they are not really interested in the detail of how a company is run, as long as they get decent ROI, and probably don't want to let any arguments come out in case it hits share prices), but some are - because if large slices of profits are going into management bonuses, and dividends are not going up, it's their returns that are being eroded.

There is, particularly when a company is profitable (or at least meeting expectations), a general lack of willingness to rock the boat. If the company struggles, then perhaps the Board may come under scrutiny, but the reality is that shareholders have 'bought into' not just the company, but the current leadership as well.

Not that more effective regulation would hurt. Majority shareholder decisions should be binding.

I cannot say whether majority shareholder decisions are required by law in any way to be implemented/executed by the shareholders' boards of directors, in this country. I fear that it may be as in your case. Then again, it could depend on the corporate charter as to whether this is so.

You are correct to mention the institutional shareholders. Now, I am willing to bet, because of our country's greater leanings toward free-market economics, a greater percentage of Americans participate in the securities markets than do Britons (or French, or Danish, or....etc.) So there are probably a helluva lot more institutional investors and really, really loaded investors in the UK and the rest of the European Union (just making a wild guess, here) involved in the stock market, owning individual stocks, than in the United States.

In the U.S. however, the rise of the mutual fund industry, and the advantages of owning mutual funds versus individual stocks, has left less and less "average" shareholders here, believe it or not. Even financial advisers (glorified "stock brokers") tend to sell their clients a portfolio of mutual funds rather than individual stocks these days; and have raised commissions on stock trades at full-service firms to exorbitant levels. (Morgan Stanley charges 10% of principal! can you believe that $hit?) So, instead of Mom and Pop owning stocks for their retirement, they'll own a portfolio, or maybe just a few, funds in what we call 401(k)'s, 403(b)'s, or Roth/traditional IRA's, and other such tax deferred (or tax sheltered) plans.

You know what they mean by mutual funds right? I mentioned "mutual funds" to a couple people from E.U. countries on Redscape, and they had no clue what the hell I was talking about.

As far as effective regulation, the massive, sweeping "reforms" passed by the Democratic Congress, and signed by Obama during the first couple years of his presidency, haven't really don't $hit. I don't want to get off topic but they haven't fixed anything like that at all. 20,000 page paperweight is what I'm told.

Mutual funds = Institutional investors. Same meaning but different terminology.

You probablt have more individual share ownership than we do. Most people in the UK who "own" shares will do so through investment into a fund, whether it is for a pension or a savings vehicle. The managees of these mutual funds invest them in stocks and bonds etc, as institutional investors.

Exactly: ditto for the United States. I think I quoted that 90 million Americans (as of 2005) owned securities, but most of them own mutual funds, not stocks or bonds outright. So then you understand perfectly what I mean by mutual funds. In the U.S. they are governed by the Investment Company Act of 1940 (as amended). They are officially classified by the Act as "open end management companies."

Despite the increase in securities ownership by Americans, owning mutual funds instead of stocks leaves us one step removed from actual ownership of these businesses. That is the down side. Of course, then again, few "average" Americans, even if they all owned shares of stock directly, instead of shares of one or more mutual funds, are likely to start the kind of shareholder revolts necessary to clean up managements of various publicly-traded enterprises. So, most of the shares of any publicly-traded firm in the United States are likely to be owned by these mutual funds and other institutions, rather than by people directly. Some do, of course, but I can't speak for how many exactly.

So this begs the question, what is really needed to clean up Wall Street, if the average investor won't, or can't?

hacker
So this begs the question, what is really needed to clean up Wall Street, if the average investor won't,

or can't?

Effective government regulation. Effectively enforced.

JimHackerMP wrote:So this begs the question, what is really needed to clean up Wall Street, if the average investor won't, or can't?

Well, one idea would be to make votes legally binding, rather than 'advisory'. That would take law.

Another would be to lobby those mutual fund administrators on the basis that if they are not holding management to account, it can adversely affect the returns they get, and so undercut their attractiveness to investors (and also their profitability).

I understand that the "better" mutual fund firms (Vanguard is a massive shareholder of stocks on the S&P 500 for example), like the ones that weren't embroiled in the massive mutual fund scandal in, I think, 2005 (?) have precisely that attitude. Bad managements, it is realized by at least some institutional investors, make bad stock prices eventually. Certainly a firm like Baltimore-based T. Rowe Price would not want an Enron-type debacle, and have the T. Rowe Price [Whatever] Fund decline about 6% because the CFO of Acme Industries, Inc. (making that up) mysterious quits and the CEO is coincidentally arrested for embezzling...yeah, that sort of thing is no more healthy to a financial institution (like Price, Vanguard, Fidelity, etc.) than it is to an individual retiree with 20 shares of Acme in his IRA.

Benjamin Graham is probably not the only one to recognize that part of "intelligent" investment is keeping track of the management of the business you own after buying it; and that security analysts ought not to limit themselves to the attractiveness of a particular issue to buy or sell, for that reason, but to keep checking up on how the business is doing while a shareholder still owns the shares.

With Ricky, I agree with the second part of his statement: "effectively enforced" (don't all die of shock at once, please...) Laws are nice-looking, multiple pieces of bound paper with a nifty-looking seal on them, and no more, unless someone actually bothers to enforce them. Obama's Great Sweeping Financial Reform is the same way. There were actually already laws in place, many have been in place since 1934, with many amendments since, which have been there since the New Deal and FDR's financial reforms of Wall Street at the time. Unfortunately, it is difficult to explain to the average person that the best way to clean up the massive financial crisis that just happened---especially if the average person just lost his home and his job---is to not create more or better laws, but simply to put pressure on the organizations which enforce and monitor them. However politically-expedient Obama's Great Sweeping Financial Reforms may have been, most of the reforms have taken place on paper.

SEC regulators got lax. The SEC by the way is terribly underfunded anyway. The new laws didn't change that unfortunately for the political reason I just mentioned. They got Martha Stewart, but they missed the execs of Shittibank, Lehman Bros., Goldman Sachs, and a dozen other massive pillars of the financial community who could have actually done something. Greed is Good, says Mr Gecko. But only to a point, perhaps.....anything beyond it is criminal, and I mean in the "against humanity" sense more than simply being against SEC regulations. Funny that NONE of the government bailouts attached caveats like "you will get $5 billion from the government to keep First Acme Financial Advisory afloat, but your execs all have to resign--no parachutes!!!!---and the new execs will have a cap on stock options....."

I think it was the last Congress under W that passed TARP, and the first under Obama that did the Great Sweeping Financial Reform acts. Not attempting to get into a Democrat/Republican thing, or a pro/anti Obama thing, here, I do not care WHO is responsible, I just want some @#$! to come along and clean it up. If you want to gloat over Congress' ineptitude, Ricky, this would be the perfect time to do it.

In any case, if the executive branch is supposed to enforce laws, then I would think the President and his predecessor are equally to blame if we're going to blame presidents. Mark my words, history will only repeat itself, until a president comes along, or a head of the SEC or Fed chairman, who has the balls to say screw political expediency, let's actually address the problem. Somebody who will go through the Street with a flamethrower. It would be nice to see some of the people who really caused (or allowed to happen) the great financial crisis of 2008 to present, go to prison, but that's unlikely. Even if they were convicted of anything, it would be like the old mafia bosses at the end of the movie Casino, who couldn't go to prison, says their lawyers, because they're too ill...or something (remember that scene? yeah...)

hacker

In any case, if the executive branch is supposed to enforce laws, then I would think the President and his predecessor are equally to blame if we're going to blame presidents. Mark my words, history will only repeat itself, until a president comes along, or a head of the SEC or Fed chairman, who has the balls to say screw political expediency, let's actually address the problem. Somebody who will go through the Street with a flamethrower. It would be nice to see some of the people who really caused (or allowed to happen) the great financial crisis of 2008 to present, go to prison, but that's unlikely.

Obama has failed nd you exactly right.
Currently, AIG is suing the US government because they didn't get a better bail out package...
If that's not an obscenty nothing is...

It is, I checked:

obscenity
[ob-SEHN-ih-tee] (n.) 1. a vulgar expression. 2. when someone drops the F-Bomb. 3. AIG suing the government because it didn't get a better bailout package.

JimHackerMP wrote:It is, I checked:

obscenity
[ob-SEHN-ih-tee] (n.) 1. a vulgar expression. 2. when someone drops the F-Bomb. 3. AIG suing the government because it didn't get a better bailout package.

Beautiful! I want THAT dictionary.

Actually, I think I ought to start a thread entirely on the mutual fund industry. But that won't come right away. Or maybe it might.

For now, I was going to add a part two to my schpiel on inside shareholders (mostly management) screwing over the average shareholder, not unlike a post-Communist "oligarch". But I think we've already started along the right direction in this discussion. I wish Sassenach would pop in and say something, Danivon and Rickyp already have.

But this is what is keeping corporate America corrupt (or at least one of the things). We discussed in another thread the corruption in Congress via big business. Perhaps if Wall Street were cleaned up a trifle, it would at least be a start to cleaning up Washington? Or, then again, managers of publicly-traded corporations may continue to stop at nothing to make sure their "votes" are much, much "larger" than mine.

Some more...

...while Graham asserts in Security Analysis that the actual compensation of the management isn't really a determining factor usually, many would disagree. For instance, the compensation for the past five years of Mr. Rex Tillerson, CEO of Exxon Mobil (XOM).

2009---$27,168,317
2010---$28,952,558
2011---$34,920,506
2012---$40,266,501
2013---$28,138,329

Rex Tillerson has been around longer than 5 years (January 1, 2006 he officially became CEO according to the Exxon Mobil website). But between 2009 and 2013 he's collected emoluments worth a total of $159,446,211. That's four Oprahs in just five years (she is worth apx. $40 mil). That's definitely more than a few mint juleps and highballs.

Now, you can see that Tillerson's compensation fell by 30.12% from 2012 to 2013. This is possibly due to the fact that, although the stock price of XOM increased 19.77%; revenues fell by 8.83%, ROE (return on equity) by 31.61% and net income by 27.41%. From 2012 to 2013, the total compensation of the "big five" executives dropped 42.65%.

Information courtesy of Morningstar: http://insiders.morningstar.com/trading/executive-compensation.action?t=XNYS:XOM&region=usa&culture=en-US

and XOM website: http://www.exxonmobil.com

Obviously, despite a continued appreciation of the stock price through 2013, the Board (of which Tillerson is the Chairman) felt a "punishment" of their executives was in order. So would I, but....wow. When you have already added $40 million to your bank and brokerage accounts one year, a drop of $12 million in your annual emoluments ain't exactly "hurting" you. But I will leave that to the shareholders of Exxon Mobil to decide. If (as I have hitherto pointed out) they actually give a damn, what with XOM at $94.11 (as of today's closing). [Morningstar again: http://quotes.morningstar.com/stock/xom/s?t=xom]

Graham insists that managements should be generously rewarded for success, as well as well-punished for failures. But what constitutes adequate "punishment" for the decrease of Net Income by 27.41% the previous year? The entire executive compensation (again the "big five" only) for 2013 was a decrease of 42.65%, including -30.12% for the CEO himself (Gee, I wonder, would any of the four senior executive VP's consider that "unfair" that their collective compensation dropped by 42.65%, while Tillerson's decrease was 30.12%?)

Yet, Morningstar--which I consider to be a valuable tool for investing in stocks/mutual funds--gives the management of Exxon Mobil an "exemplary" corporate stewardship rating; which they only give to a very small percentage of the firms they cover; 80%+ get a "standard" grade and a similarly small portion get a stewardship grade of "poor".

So the $28,138,329 question is: what is a "fair" compensation for a management, especially the CEO, of one of the top S&P 500 firms in the United States? How should they be rewarded? How should they be punished? What METRICS do we use to determine how good/poor their performance was?

Certainly food for thought.

And while you're eating, consider: according to the financial statements within their most recent 10-K (the annual report they're required to file every year with the SEC and disseminate to their shareholders), the SGA (Selling, General and Administrative expenses, which include managements' salaries) was $13,877 millions, making the five executives' compensation a hair under 1% ($133m divided by $13,877m). About one percent of ALL the SG&A expenses went to those five executives' salaries (the CEO & the top four veeps). In 2013, the total percentage was about 0.6%. That's a huge chunk of the SG&A going to just the big five. I shudder to think what the compensation of all senior executives (however they would be defined) is in percent of SG&A.

Hopefully some of you know what the hell I'm talking about.