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Column

Gary Sutton
Director
Author, Corporate Canaries

There Are No Shareholders Anymore
How to run a business when your ownership turns over every year (or less).

By Gary Sutton

The director’s job is clear. Serve the shareholders. But recent trends make that neat job description tough to follow.

Say you’re on the board of Exxon, Wal-Mart, or GE. At GE you’ve got about 10 billion shares outstanding, and on an average day 24 million shares are bought and sold. So the average investor is holding your shares for just over 400 days -- a little more than a year.

“That’s the effect of day traders and hedge funds pulling down the averages,” you say. “The institutions -- Fidelity, T Rowe Price, Morgan Stanley, etc., etc. -- hold on longer and are true investors.”

Not so. The average institutional holding period is one year. Institutions have become just a volatile as the individuals. And when you study the major shareholders of any public stock, seeing all of those institutions holding onto the stock, things look stable and long term.

This, however, is a mirage.

Your Trading Range
What most of these institutional investors do is what they call “trading around the core.” In other words, when your stock hits a certain high number, they’ll dump a percentage of their shares. When your stock dips to another predetermined number, they buy some more. This, in effect, determines your trading range. Barring some major announcement, this is how they make money -- and it also means they turn over your shares once a year, on average, despite being a shareholder for longer periods.

So directors today don’t work for shareholders, since they no longer exist. What we do have are sharetraders.

Don’t look for this to change. With the money hedge funds are tossing around and the continued deployment of automated trading programs, any long-term vision among your public shareholders vanished years ago, probably about the same time ticker tape prices started scrolling across television screens. Have you noticed how ticker numbers are noticeably shy of fundamentals?

Wal-Mart is a shade different. The family holds 41 percent of those shares. Still, with 13 million shares of Wal-Mart being bought and sold daily, and 4 billion shares outstanding, this company is bought and sold every 350 days. That’s less than a year. And since the family isn’t dumping shares, the real holding period for Wal-Mart is best measured in months. Exxon is in the same league, with an average turnover of ownership being just short of one year.

None of this is tragic; it’s just different, and way different from common perceptions. Given today’s average p/e ratios, public markets are still “cheap money” -- a superior financing resource, so even with all the expense and new Sarbanes-Oxymoron costs, going public pays off.

Don’t Be Dips-and-Spikes Focused
The problem -- and humongous risk for the system -- is that we cannot build meaningful businesses by paying much attention to these trader-created dips and spikes. Such movements relate to nothing of import. So how do we manage?

We manage best by ignoring the current wailing about stock options. We underpay our executives so their major source of net worth can be those grants. Just do it right.

Grant their options at market price on the same day each year, shortly after the annual results are announced and before enough has happened in the next quarter to reveal much. When executives exercise, allow them to sell only enough shares to cover the tax bill. Never reprice options. Make those options vest over five-year periods. Let the execs sell their remaining shares, after taxes are paid, at a rate of 20 percent per year.

The executives are clearly incentivized for the years ahead, not the quarter coming up, and can rationally look at acquisitions, possibly ramping up an expensive research project or perhaps pricing more aggressively to seize a market. That’s how we want them thinking.

How to start this? Simple. As a director, get your fellow board members to cut their fees in half, and begin by getting most of your potential compensation in the form of stock options.

Spread the Options Wide
Let all employees have small options, just enough to maintain a slight interest, but not enough to distract them. They’re more passengers than drivers, and you don’t want them focused on these wobbles in the stock price. Yeah, when another analyst starts coverage and the price bumps up, the employees will assume you’re geniuses, and that can be fun for a moment, but when the next analyst leaves his or her institution, and the replacement doesn’t “get” your story and downgrades you, it’s less fun having the troops suspect you’re stupid.

Now you’ve got a business.

Gary Sutton has been a CEO and director of a number of private and public companies in his career as a specialist in startups and turnarounds. He writes the “Sutton’s Laws” column for Directors & Boards. His latest book is Corporate Canaries: Avoid Business Disasters with a Coalminer’s Secrets (Nelson Business, October 2005). He can be contacted at garysutton@san.rr.com, or visit his blog at http://blog.coughingcanaries.com.