Sunday, April 4, 2010

Stock Ownership: Theory vs. Reality

"Own a piece of the American Dream!" That, essentially, is the philosophical argument for including stocks in your portfolio. "Earn a good return on your investment!" That is the financial argument for including stocks in your portfolio.

While there may be some merit to both points, especially #2, I think the stockholder is being shortchanged in significant ways.

First, let's examine ownership. To own something normally implies a certain amount of control. If you own your car, you're the one who gets to drive it. But if you're an ordinary stockholder in an American corporation, your power to control -- or even influence -- anything about that company's behavior is essentially zero. (OK, that doesn't apply if you own a significant percentage of the shares; but very few people fall into that category.)

Do you want the company you "own" to lobby less -- or more? Do you want your company to operate in an environmentally sound manner? Establish operations (or not) in politically sensitive countries? Adopt employee-friendly personnel policies? Establish a reasonable level of executive compensation? Write a letter. Attend the annual shareholders' meeting. Good luck! Even large and organized groups of shareholders are typically stymied in such efforts.

All right,management by committee is a bad idea -- and totally unworkable if the committee has thousands of members. So we "owners" delegate our power to management. This would be prudent if management legitimately looked out for our best interests.

This brings us to point #2. A good case can be made that top level corporate managers look out mostly (gasp!) for themselves. Most of them even do it legally (i.e. without resorting to backdating of stock options).

Case in point: according to news reports, the CEO of WellPoint -- you know, that giant insurance company (with its subsidiary Anthem Blue Cross)) that doesn't exactly have a stellar reputation -- got a 51% pay hike last year. She earned $13.1 million, up from #8.7 million the previous year. Three other top executives at the company earned, cumulatively, $16.1 million. Goodbye hamburger, hello filet mignon!

Another case in point: according to the New York Times (4.1.10), the top 25 hedge fund managers earned, collectively, $25.3 billion in a single year. How did they do it? The guy who single-handedly earned $4 billion "bet on the country's survival" by surmising that the government would bail out the big banks.

Most people earn a simple living either by helping create a product or by providing a useful service. Hedge fund managers use other people's money to place bets, and it earns them a fortune. Hooray for capitalism!

I own a very small piece of the American Dream -- almost inevitably -- through mutual fund holdings in my retirement accounts. Philosophically, this gives me no grief at all. Being an executive myself, in a medium-sized non-profit agency, I'm familiar with compensation issues, and I don't begrudge hard-working people an acceptable salary. But I can't help wondering how much more I (and millions of other Americans) could be earning from our stock portfolios if the billions of dollars paid in executive compensation (based on rationale that is marginal at best) were distributed to the shareholders. That money must come from somewhere -- and in my view, it comes right out of the pockets of the "owners."

1 comment:

  1. You have stumbled upon the principal/agent problem, one of the fundamental obstacles of economic theory, and unsolved to anyone's satisfaction.

    As to the hedge fund managers, I suggest not buying their products. Hedge funds don't provide very good returns for anyone but the managers. Usually they get their money from public pensions who are looking to shore up their finances because they've over-promised for decades, and stupid rich people.