So Long, Stockholder

Posted by Stephen Davis (Harvard Law School), on Thursday, March 8, 2018

As US companies put finishing touches on proxy statements for spring annual meetings, activist investors are set to challenge CEOs and corporate boards to generate more value, and quickly, or face the threat of ouster. Not even the biggest companies are immune to insurgency. So now might be a good time to reveal a simple, one-word “tell” anyone can use to test which US company might have a better chance of gliding unscathed through the season, and which might be a more likely target for attack. Scan the language a firm uses to refer to its investors in those forthcoming proxy statements. If it favors the term “stockholder” over “shareholder”, watch out.

A four-letter difference might not seem like much, but it exposes profoundly different attitudes among executives and board members over a vital question: For whom should American business be run?

“Stockholder” was the term once used by virtually all US companies. That’s largely because Delaware—where about two thirds of large firms are incorporated—long made it the default expression to describe those who own pieces of a company’s equity. Delaware comes by “stockholder” honestly. The word emerged in common law from 12^th century England: medieval lenders would keep the longer part of a wooden stick—known as a “stock”—as a record of a transaction. As village trade and barter transformed over time into today’s global capital market, that timber morphed into a paper certificate and, later, a virtual, electronic notation.

“Stockholder”, though, retained its core meaning: it connoted a passive bookkeeping entry rather than active ownership. Sure, in modern times US and state law awarded certain powers to “stockholders”, mainly the right to vote in corporate director elections. But until recently that authority was hollow. Most notoriously, investors hadn’t any option to vote “no” in director elections, no matter how disastrous the corporate board. Instead, if they wished to register opposition to directors, investors’ only choice was to “withhold” their vote. That produced little. Hypothetically, if just a single share voted yes while every other share vote was withheld, the entire slate of directors would still be installed.

No wonder many institutional investors treated voting as a bothersome afterthought especially when, in 1988, President Ronald Reagan’s Department of Labor required funds—through the “Avon Letter”—to cast virtually all share ballots. Regulators ruled that retirement funds could better protect their members’ nest eggs if they expressed views about portfolio companies through the corporate ballot box. But while mandating the vote, the federal government took no parallel steps to give it impact, for instance by reforming director elections. It was like instructing someone to flip a light switch while failing to supply electricity. So big institutional funds voted because they had to. But—quite rationally—they put negligible resources into the effort. And many robotically voted “yes”. US executives could run companies well or catastrophically, and set escalating CEO pay, with minimal concern for investor oversight. In that sense, the word “stock” evoked another definition of the term in the Oxford English Dictionary: a flock of sheep.

Today, the term “stockholder” gives off a whiff of a Mad Men-era world where investors were bystanders. Nearly all institutional investors have junked “stockholder” for “shareholder” when referring to themselves. They see their roles not as passive holders of electronic notations but as parties sharing responsibilities for performance when they invest in a company. That’s why Blackrock CEO Larry Fink recently wrote to corporate boards referring to investors conspicuously as “owners”— the word “stockholder” is nowhere to be found.

Why the shift in self identity among investors?

First, nearly all S&P 500 companies have voluntarily moved to meaningful director elections. Any board member failing to achieve a majority of votes must resign. Boards still have the power to re-install what some investors dub “zombie directors”. But the vote now carries real power to sway company leadership. Second, research increasingly demonstrates that accountable companies perform better over the long run. So funds calculate that hard financial rewards might result from using their voice to advocate for effective corporate governance. Third, more millennial savers are telling fund salespeople that they want their money used to advocate for responsible corporate behavior on climate change and other issues.

In response to all this, the big three fund companies who together control some 75% of all US money in index funds—Blackrock, Vanguard, and State Street Global Advisors—have multiplied resources behind what they now call “stewardship”, that is, raising the shareholders’ voice through voting and dialogue with company boards when they see faulty behavior. The big three have even taken steps—unthinkable as late as two years ago—such as voting against management at ExxonMobil on climate change and insisting on more women on boards. They have a long way to go as they begin to assert ownership, while many other fund companies are still at the starting gate. But one thing is clear: these pace setters are no longer your grandparents’ “stockholders”. They are asserting themselves to get companies run in alignment with their long-term interests.

Despite this profound transformation in the investor world, too many corporations, perhaps unwittingly, project an image that they are living in the past. You can readily spot some of those. We find that no fewer than 60% of top US companies drawing highest votes against directors in 2017 used “stockholder” rather than “shareholder”, according to data provided by MSCI. It’s not a perfect “tell”: Proctor & Gamble management used “shareholder” though in 2017 it waged a titanic board battle with activist Trian. But last year blue chips such as Wells Fargo, Netflix, CVS Health, and Hewlett Packard Enterprise were among firms sticking to outdated language, and drawing high director “no” votes.

For now, “stockholder” remains a revealing “tell”—at least until proxy writers see this column and hit the “replace all” key. Then it will be up to investors to judge if renovated glossaries are signals of accountability, or cover-ups of corporate dysfunction.