Corporations should be owned by people. They should be owned by living, breathing people. But they’re not. As I mentioned yesterday, at least 67% of all outstanding US stocks are owned by institutional investors. This is a huge problem, and it’s a big part of why the economy of today feels so disconnected from the economy of our fathers – and even the economy of our own childhood.
This problem manifests in multiple ways. The first problem is, who’s in charge? For those who are unfamiliar with it, corporations are organized along a certain pattern that’s more or less universal. The day-to-day operations of the corporation are controlled by the officers of the corporation. These are people with titles like President and Vice President, and sometimes titles like Chief Executive Officer (CEO), Chief Financial Officer (CFO), and Chief Operating Officer (COO). But you can’t rely on title alone, because sometimes those last three aren’t officers, they’re actually directors (more on them in a minute).
Officers make daily decisions. They’re often authorized to spend corporate money – within certain budgets and up to certain dollar amounts – on their own authority. They’re in charge of hiring people. At small corporations, the officers may make all of the hiring decisions. At larger corporations, they usually hire the top managers and grant them authority to higher lesser people. They set corporate policies. They set the overall goals and strategies. They control the organization of the corporation.
They also have legal responsibilities to the corporation in most states. If the books of the corporation are wrong, the officers can be held liable. If the corporation commits a crime, the officers might be held liable (maybe – this can be murky). They have legal duties, such as preparing stock reports and filing annual (sometimes quarterly) paperwork with the state.
But they can’t just do whatever they want. Officers are appointed by the board of directors. The board of directors makes the very high level decisions of a corporation. They hire officers – and fire them. They usually set the budgets that are available for officers to spend – dictating not only how much, but also the broad categories that the money should be spent on.
Finally, the directors are appointed by the shareholders. These are the people (ahem) who actually own the company. Shareholders meet at least once per year, and usually vote at each annual meeting on some number of the board of directors (some companies elect directors every year; some stagger the elections and have directors serve multi-year periods).
Although they usually exercise little day-to-day influence, shareholders have ultimate control over a corporation. If they don’t like the way a corporation is run, they have the power to change it. In theory, the board of directors acts as a stand-in for the shareholders. Ideally, the shareholders say they don’t like something, the directors tell the officers to fix it, it gets fixed. In extreme cases, the shareholders fire the directors and appoint new ones and the new directors fire the officers and appoint new ones, and then something gets done.
But what happens when the shares aren’t owned by individuals anymore? When, instead, those shares are owned by mutual funds and investment firms? Mutual funds and investment firms are very different, but at the core, both of them pool money from multiple contributors and invest the larger pot of money as one. There can be a lot of advantages to this, but that’s a post for another day.
The relevant point is this: when you put your money in a mutual fund or another kind of pooled investment, you’re almost always also signing way proxy rights to any investments bought with that money. What does that mean, exactly? Think of each share as a vote in shareholder meetings (the most important vote being the selection of the board of directors). When you put your money into a mutual fund, the director of that fund now has the right to cast your votes for you on any stocks bought by that mutual fund.
So, for example, as of this writing, Vanguard Total Stock Market Index Fund controls 3,089,008,230 of stock (1.64%) in The Walt Disney Company. The director of that group has a larger say in the selection of Disney’s board of directors than any individual person does. In fact, he has more than twice the say of the top five largest individual shareholders in Disney – combined.
Who the hell is the director of the Vanguard Total Stock Market Index Fund? I don’t know. I didn’t choose him. Even if you own that fund (which is a hugely popular fund, so you might), you didn’t choose him, either. Unlike most mutual fund directors, he doesn’t even keep or lose his job based on earning profits – this is an index fund, so the investments he makes with it are almost automatic.
But most of the others who have large votes were “chosen” because their funds make money, by thousands of individual investors who have absolutely no idea what’s being done with the money they’ve invested.
When corporations are owned by people, those people have an exposure to the company’s activities. If they don’t like the way a corporation is operating, they can direct the board to change it. But in this case, who get’s to make that choice? Not the founders of the company. Not the people. Not even a handful of rich bastards who own most of it with their own money. No, the decisions are made by a handful of rich bastards who bought most of it with your money.
These people have no skin in the game. They get their (very high, often in the millions of dollars) salaries for managing the mutual funds whether or not it makes a profit. And it’s not uncommon for them to get seven figure bonuses even when the funds lose money. The company does something illegal or unethical? These guys get to shrug and point out that their only legal requirement is to make their clients money. Then they go live the high life.
Who watches the watchmen? In a word, nobody. Our corporations aren’t owned by people anymore. But they should be.