Shareowners, the providers of capital, are on their way to becoming a new public enemy.

 We can't pinpoint exactly when the backlash became serious, but it's time for shareowner advocates, and indeed corporate management—we'll explain why in a minute—to wake up to the dangers that lie ahead. First, let's look at some examples of the ‘blame shareholders' theme. Consider the following:

Cornell visiting law professor Lynn Stout's new book The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public has received an empathetic reception from some, including, surprisingly, those who normally skewer the excesses of Corporate America, such as New York Times Columnist Joe Nocera. Stout's polemic blames the shareholder-value movement for short-termism in corporate America.

The Conference Board recently began publishing a blog series titled “The Rise of Shareholder Value and its Unintended Consequences.” Author Christopher Bennett attributes the fragility and scandals of the financial sector to the pay structures created to appease the shareholder-value movement.

Nationwide Insurance has launched a new multi-million dollar advertising campaign, centered on the fact that it is a mutual insurance company. “We put our members first because we don't have shareholders,” is now the rationale for why “Nationwide is on your side.”

As corporate governance experts and long-time shareowner advocates, our first reaction is to shake our heads. Shareowners' rights caused a reduction in our standard of living? Or poor customer service by insurance companies? Or the fall of Lehman Brothers?  Clearly, these are ridiculous claims, but further reading suggests there's a bit more going on here. Stout, Bennett, and the Nationwide ad campaign decry the rise of market characteristics that are insidious and destructive: short-term thinking, an executive compensation system that rewards transitory or illusory and non-sustainable performance, and lack of corporate responsibility to the wider economy—dangerous characteristics that we have long criticized.

Just because they correctly name harmful features, however, doesn't mean they correctly identify who is responsible and what to do about it. Stout is surely right that short-term pressures are at work in the marketplace. But she misplaces the blame for them at the feet of the shareowners. Yes, it's true that the average holding period of a U.S. company has dropped precipitously from an estimated seven years in 1940 to about seven months today. But averages by definition crush a wide variety of investing styles into one number. In the past few years, we have seen a meteoric rise in high-frequency trading; firms that employ such methods (we refuse to call them “investors”) have holding periods closer to seven seconds. The result, according to research from Notre Dame Professor Martijn Cremers, is a shareholder base that is as layered as a wedding cake, with frothy high-frequency traders layered atop a mass of more traditional investors with more traditional holding periods. Cremers finds that the average holding duration (Cremers' metric of share-weighted holding period) of traditional

investors has remained remarkably steady over the years. In fact, contrary to

popular myth, it appears to have increased slightly, even as daily turnover has

skyrocketed. 

By focusing on daily stock price, companies empower the short-term traders and ignore loyal long-term owners. Wouldn't a better tactic be to communicate directly to the longer-term holders, who vote the majority of the proxies and have multi-year time horizons?

Ironically, that fact is intuitive to most CFOs, corporate secretaries, and investor relations officers. They know that the list of their top shareowners remains remarkably consistent, as a whole, quarter after quarter. It's also obvious to the CalPERS and Blackrocks of this world, which spend millions to engage with companies with which they have issues, rather than just sell the shares. Yet, somehow corporate boards and C-suites say they have no option but to kowtow to the perceived short-termism of the market, inferring from short-term stock price movements either validation or criticism of their latest corporate strategic plan or announcement. The reality is that price is driven by in-and-out traders over the short term, not by that steady list of top long-term owners—the company's most important owners—who may not trade the company's stock for months. By focusing on daily stock price, companies empower the short-term traders and ignore loyal long-term owners. Wouldn't a better tactic be to communicate directly to the longer-term holders, who vote the majority of the proxies and have multi-year time horizons?

Similarly, Bennet has a point on executive pay, but has mis-attributed the cause: Innumerable post mortems of the financial crisis have pointed to executive compensation plans that rewarded short-term growth at the expense of prudence and sustainability as a contributing factor (along with lax regulation, structural changes in the banking system, and a host of others). To his credit Bennett, a compensation consultant by profession, notes that it was a simplistic application of pay-for-performance that incentivized bankers to take unacceptable short-term risks. But he doesn't apportion any blame to his industry or its clients; rather, he says it was the rise of the shareholder-value movement that was the “tipping point” in creating the financial crisis. To us, that seems a bit like blaming the victim: What of the compensation consultants who created those structures, the compensation committees that granted them, or the executives who negotiated for them and cashed the checks. Certainly, shareowners did not put a gun to those heads and say “please pay them boatloads of money to blow up our investments.”

In fact, most of the investigations that identified executive compensation as a contributing factor to the financial crisis suggested increasing, not decreasing, shareowner power. And, interestingly, say-on-pay seems to be the one aspect of the Dodd-Frank legislative package that most think is working well, on balance. It has increased the conversation between the shareowner and corporate community, largely in a respectful and constructive manner.

None of this is to say that the shareowner community is free of blame. Institutions allow unreformed short-term corporate raiders to dress themselves in the colors of investor advocates, and even occasionally employ them and cheer them on, rather than denounce them. Too often, these raiders lack respect for the skills and experiences of the board and C-suite officials and the challenges they face. But funds have matured tremendously from the 1980s, when confrontation was de rigeur, largely because they couldn't get boardroom attention any other way.

Our fear is that we're about to see that youthful mistake repeated, but this time by the corporate world. By correctly identifying maladies, but then misidentifying the causes, Stout, Bennet, and even the Nationwide advertisements have the potential to demonize shareowners at exactly the time when engagement and constructive dialogue behind the scenes are gaining traction. And that would be a shame for all.

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