Even As a Small Stockholder, Why Don’t I Have Any Power?

BY Paul Solman  September 30, 2010 at 12:21 PM EDT

Name: Frances Pearson

Question: I am a small stockholder. My portfolio is all blue chip. Stockholders in every company are trying to control executive compensation- to no avail. (I vote for all stockholder proposals and do not give my proxy to try to help.) What is going on? Suspicious by nature, I am wondering if representatives of big institutional investors who vote millions of proxies are given Board membership and compensation to keep the status quo. Why on this issue and others is it so impossible for stockholders to have any power?

Paul Solman: No, naked corruption does not explain the problem of what has long been called “entrenched management.” Complacency does.

The theory of corporate governance is clear enough. Stockholders buy ownership “shares” of the firm. There being too many of them to exercise control, they elect representatives to a Board of Directors to oversee top management, which supposedly runs the firm to maximize the profits of the shareholders.

But as far back as the 1930s, a fundamental flaw was recognized: ownership, if widely enough dispersed, has no real incentive to vote for directors.

There is, in economics, the famous “paradox of voting.” In a sufficiently large electorate, why would anyone bother to vote after weighing the considerable costs (learning about the candidates, getting to the polls, waiting on line, etc.) against the vanishingly small likelihood that the vote will make a difference — either to the outcome or the voter’s welfare?

If you have ever owned stock, you’ve surely experienced this problem. A “proxy statement” comes in the mail. Names are on it. But short of a CSI-style investigation, it is well nigh impossible to evaluate them. So you throw the statement out, maybe even tearing or shredding it first because it has all sorts of numbers that might appeal to an identity thief (though you know you’re almost surely being paranoid).

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Problem is, management knows you have no incentive to monitor the Board. So the CEO typically hand picks its members on the basis of friendship, business relationships, celebrity, public relations.

You wonder if institutional investors are on the take. But in fact, the only serious challenges to management-favored board members in recent years have come from the institutions, who have both the votes and the incentive — or at least more of one — to challenge floundering firms.

Photo by Flickt user lintmachine.