Managing Leadership^®

We know that shareholders of publicly-held companies can vote on certain matters, such as the election of directors. But because these nominations are generally presented as a take-it-or leave it slate, they are at the bottom of much of the criticism of the way corporate governance currently operates.

For a number of reasons ranging from concern over wealth creation, management activity, and even ideological, social, and environmental issues, this has become a focal point in the fight by owners for a greater voice in the direction of their companies. Many protest specific directors’ nominations, demand the ousting of others, or, increasingly, seek to have their own representatives voted onto the board.

But this effort, though far from new, is still struggling against great odds with an unpromising mix of results. So, the arrival of one or another of the variously touted versions of shareholder democracy seems to be still far away, if it is realistically in the offing at all.

That leaves us with the traditional explanation of how owners communicate with management: share price. The idea is that shareholders vote with their dollars, and that the resulting effect on price communicates everything managers need to know about owner intent and interest.

That would appear to be entirely appropriate, and certainly consistent with the free-market theory of capitalism of which publicly-held companies are so prominent a part. After all, a vast amount of complex integration is accomplished in robust economies via the simple device of market price.

But it is not sufficient to the purpose we put it to, in establishing an actionable flow of information between owners and directors. This is a large topic, and we will only be able to address it briefly, here:

Generally, managers (and for the sticklers, manager-laden boards) are motivated to pay attention to share price because of the effect it has on the ease of their companies’ access to capital and their freedom of maneuver in the markets of interest to them. They assume that a rising price reflects owner confidence in their policies, and that flat or falling prices indicate less satisfaction or outright disapproval. They then attempt to reduce that information to specific policy guidance, and use those inferences to inform their deliberations about future action.

But an important problem here is that the fluctuations in share price that are perceived as this sort of communication are actually generated by a small percentage of people who may have the least real interest in the company as a business entity. These transactions may be being made by day traders using technical analysis, fund managers making minor adjustments to their portfolios, or – further complicating the picture – investors of various sorts responding to price fluctuations caused by each other. Due to its relative nature, attempts to enrich the content of this information with volume data, while perhaps of value to some traders, is generally insufficient for analysis by directors.

As it happens, the majority – or, at least, a large minority – of the equity of many publicly-traded companies may be still be retained by the original owners or other essentially private investors. Much of the rest will likely be held by institutional investors – and many of those make their investment decisions, such as they are, based on market indexing criteria rather than business analysis.

As a result, the price fluctuations we see are reflective of the trading of a relatively small – sometimes miniscule – percentage of the overall equity of the company. This means that they may be sending misleading signals about the value of the firm to everyone from individual traders to potential corporate buyers. They typically, as it turns out, are not likely to be of much value to company directors seeking information about owner intent and interest.

So if communication by owners is so cryptic as to defy interpretation, how are directors to interpret and further them? Why should they even attempt to do so? We will try to close out this part of the discussion with a brief look at those questions tomorrow.

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This post is a part of a series. You can learn about and link to the other articles here: Anonymous owners

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Today’s tip: Jeremy Dean of the UK-based site PsyBlog has been running a series on the seven deadly sins of memory. It is an engagingly presented and fascinating look at things we’ve all wondered about, and is filled with insight of use to many of us in various aspects of our lives – including our work lives. It is well-worth your time.

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