In a Weird World Where Shareholders Don't Matter

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Public companies not taking their shareholders seriously aren't anything new. For seasoned market watchers, it may even seem like grand tradition.

So to that extent, seeing major public companies shrugging off the interests of their shareholders isn't particularly weird. What does make it strange is that some really startling examples of this time-honored practice are taking place in the wake of the collapse-inspired Dodd-Frank reforms, which included provisions intended to make shareholders' voices more powerful.

What about Vikram?
Newshounds might be quick to note that shareholders recently provided a stern rebuke for Citigroup's (NYSE: C  ) Vikram Pandit and his desire to take home a $15 million paycheck. A Time headline crowed "Capitalism Is Back, Baby!" and went on to suggest that shareholders were showing that they do have a voice and are willing to slap a CEO on the wrist when performance disappoints.

Unfortunately, the compensation smackdown on Pandit isn't really a great example of shareholders acting like savvy owners. In 2009, Pandit took home less than $130,000 and in 2010 he was paid $1. This was while he was treading water to keep one of the largest banks in the world from imploding after the dance-happy Chuck Prince piloted the bank right into the center of the iceberg. That most articles covering the vote pointed to the fact that Citi's stock hasn't performed well is only encouraging wrong-headed thinking from public-company shareholders.

But, hey, these days I guess we'll have to take what we can get.

Because it's far worse than that
Even if we assume that the rally against Pandit is a thrust in the direction of shareholder empowerment, it's still a drop in the bucket.

Last week, Reuters provided a solid reminder of just how ugly entrenched governance problems can be when it uncovered the billion dollars in loans that Chesapeake (NYSE: CHK  ) CEO Aubrey McClendon took out to fund his personal highly leveraged gamble on the company's wells. The company has long claimed that the program in question -- which allows McClendon to buy directly into wells that Chesapeake is drilling -- aligns McClendon with shareholder interests. But that claim rang hollow in the past, and it rings even more hollow now.

For reasons that I just can't figure out, Chesapeake shareholders have continued to support McClendon (admiration of his sheer level of chutzpah?). But the company has also taken steps to make sure that shareholders can have a limited effect on the entrenched powers -- which includes not only Lord McClendon, but also a board whose members mostly make more than $500,000 per year. And it's exactly that sort of ugliness that we're seeing a lot of these days.

Google's (Nasdaq: GOOG  ) recent move is along exactly those lines. From the get-go Google had a dual-class share structure that gave insiders a 10-to-1 advantage in terms of the number of votes they held per share. With the introduction of a third class of stock that offers shareholders no voting rights, Google insiders are making sure that public owners can exert even less influence over what happens at the Big G.

Google's shareholder unfriendliness may be more notable because of the company's slogan "don't be evil" (do as we say and not as we do?), but it's hardly alone. Online game maker Zynga's (Nasdaq: ZNGA  ) share structure is even more shareholder unfriendly. Not only do executives hold higher-vote B shares, but CEO Mark Pincus lays claim to his very own Class C shares that have 70 votes to "normal" shareholders' one. LinkedIn also features a dual-class share structure and, as a nod to the fact that this isn't just a Web 2.0 thing, The New York Times gives investors the same raw deal.

This isn't a waning trend, either. Yelp's (Nasdaq: YELP  ) March IPO left insiders with nearly 98% of voting control even after raking in more than $100 million from public investors in the offering. Facebook is slated to hit the public markets with Class B shares that carry 10 votes to Class A shares' one. Viva la Zuckerberg. Empire State Realty Trust, owner of the Empire State Building, will join the club too if/when it makes it to the public markets.

In essence, these management teams are saying, "Public market investors, please give us your money, then shut the heck up."

Investors tempted to shrug this off may want to think twice. The interests of millionaire or billionaire public-company CEOs and boards of directors are not always in line with those of small individual investors or even the public pension funds or mutual funds investing on behalf of mom-and-pop investors. Allowing them voting control vastly out of line with their economic interest in these companies sets them up to pull internal levers based on what benefits them -- whether that helps or harms you and your portfolio.

Somehow, highly successful companies such as Procter & Gamble and IBM manage to do just fine with one share class that gives all investors equal voting power. So next time you've got some cash on hand and are ready to Foolishly buy a stock -- that is, buying as if you're buying into the business and becoming an owner -- take a moment to consider whether you want to invest in a company that really wants you as an owner, or one that just wants you and your dumb money to sit quietly in the corner while the insiders' club does whatever the hell it wants.

The Motley Fool owns shares of Google, LinkedIn, Citigroup, and International Business Machines. Motley Fool newsletter services have recommended buying shares of Chesapeake Energy, Procter & Gamble, Google, and LinkedIn. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.

Read/Post Comments (11) | Recommend This Article (23)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 26, 2012, at 4:15 PM, rv1977 wrote:

    thanks Aubry and your board (puppets) maybe your OSU Board director will give shareholders a break on tuision fees.

  • Report this Comment On April 26, 2012, at 4:57 PM, rv1977 wrote:

    Why did he need to borrow? The board would have just given him another bonus.

  • Report this Comment On April 26, 2012, at 5:50 PM, billmitts wrote:

    In reality anyone with nthe money can buy an interest in the wells Chesapeake drills, the problem seems to be that it is the CEO who is backing the company's bet. If the banks are not worried about their collateral why is Reuters; besides sensationalism. The SEC must now get in the act to verify the auditors did their due diligence in determining these interest were not VIEs required to be consolidated, if they are then all minority interest holders are and all must be consolidated, then will the statements be CHK's. This issue is should the CEO or his family have personal financial interest in anything that may influence his decisions as a CEO. Well McClennon has never been accused of being conservative and this is an opportunity for the contrairian investor to make some $

  • Report this Comment On April 26, 2012, at 6:19 PM, ynotc wrote:

    I have eliminated Google from my list of possible investments. While they will surely make money what is the value of owning a "C" class share that should trade for less than "A" or "B" class shares?

  • Report this Comment On April 26, 2012, at 6:52 PM, xetn wrote:

    "So to that extent, seeing major public companies shrugging off the interests of their shareholders isn't particularly weird. What does make it strange is that some really startling examples of this time-honored practice are taking place in the wake of the collapse-inspired Dodd-Frank reforms, which included provisions intended to make shareholders' voices more powerful."

    So much for the blind belief in government regulations. The same belief that resulted in Bernie Madoff, et al.

    The only true protection for everything is you voting with your money and doing your own due diligence.

  • Report this Comment On April 26, 2012, at 8:11 PM, EquityBull wrote:

    The best way to deal with it is to not buy the stock and not invest in these co's. If nobody buys their stock or funds them then they are pretty much dead. That said there will always be mindless sheep to fund these and get taken advantage of willingly so no saving them.

    I remember fool recommended chipotle (thanks for the tip..I bought at 45 and still have all my shares). They recommended the B shares because they were at a 10% plus discount to the A shares. What was the difference? Surprisingly the B shares had 10 votes to the A shares 1 yet they traded at a discount to the A's! Why? Because most pro's and retail investors are dumb sheep. They are that stupid and do not do research.

    This A/B share at chipotle spread lasted for years. Eventually Chipotle bought all the B shares back and retired them. In their buybacks they always bought the B shares. When asked why they bought the B shares they said "because they were cheaper". When asked why they were cheaper they would say "we don't know. they have the same claim on earnings and 10 times the votes". I'll tell you why again...people are actually that stupid. Don't ever underestimate this fact when you invest.

    One last example. Microsoft grew 4% and Apple grew 94% this past quarter. MSFT trades at higher multiple then Apple! Amazon also grows at a fraction of apple's rate and has a small fraction of apple's margins as well yet trades over 100 times earnings while apple trades less then 10 times ex-cash. Why? People are that stupid. It's not just retail, the pro's and MBA's are also that dumb. Sorry to say.

    This is why Buffett did so well and said he would guarantee he could do 50% annually if he had 1 million to invest today. He knows how stupid and irrational people are and it is taking advantage of this fact that makes you a billionaire. BTW Buffett is one of the few that does not fall into the aforementioned stupid category.

  • Report this Comment On April 26, 2012, at 11:20 PM, lowmaple wrote:

    I admittedly have not studied citigroup that much but I have to rant again about just being a banker does not mean your taking everyone to the cleaners. Pandit has straightened the bank up and who knowsw how poorly the shares would have done without his work. So I think people should find out the facts before they complain about his wages. The stock's price may have been half of what it is now with some one else at the helm.

  • Report this Comment On April 27, 2012, at 12:11 PM, jrj90620 wrote:

    I agree that a lot of top management are overpaying themselves but would you want too much of great companies run by the idiot public?I mean,look at the U.S. Govt.It is an entity,ultimately run by the voters.I wouldn't want the companies I own stock in,to be run by American voters,who are unqualified to be running those companies.Maybe it's just inflation that is driving these high salaries.Look at what sports players get.I remember the Beverly Hillbillies or Gilligan's Island,TV shows,where millionaires were considered massively wealthy,Now,you have to be 1000 times that rich,or a Billionaire,to be considered really wealthy.

  • Report this Comment On April 27, 2012, at 12:13 PM, jrj90620 wrote:

    How about a modified Buffett rule.After you've made your first $40 Billion,taking advantage of lower cap gains tax rates,you're future taxes would go up to at least 30%.

  • Report this Comment On April 27, 2012, at 1:51 PM, Realexpectations wrote:

    I see it like this

    You only matter as a shareholder....unless you own 10% of the shares and when that happens they act like JcPenny and put you on the pill.

    But besides that, I don't really want a say in the company.

    Because first of all, I don't know how to run a company!

    Second they got big and made profit on what they were doing in the first place, I am not one to try and change that because I know better some how, when they are the ones actually making the cash and customers come back every day.

    I let the people who know best, do what they do best, its best not to interfere.

    If I don't like how they run it, I put my cash to work somewhere else.

    Free market baby!

  • Report this Comment On April 27, 2012, at 3:45 PM, ibuildthings wrote:

    xetn said:

    "So much for the blind belief in government regulations. The same belief that resulted in Bernie Madoff, et al.

    The only true protection for everything is you voting with your money and doing your own due diligence."

    Well said. There is no substitute for motivated, intelligent people. But regulation do offer some protection for the less watchful, at the cost of an extra burden on the honest.

    Congress and regulators should consider each new regulation as an expensive burden with impact on honest people and impact on the economy as a whole. They should see regulations as a necessary evil, and look for ways to get the most protection for the least impact.

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