Where Have All the Investors Gone?

An article in today’s Wall Street Journal, “Wrong Way? Street Signs Point to Speed,” contained some data that does much to explain the current problems with corporate governance:

According to Sanford C. Bernstein chief investment officer Vadim Zlotnikov, the average holding period for stocks on the New York Stock Exchange and American Stock Exchange last year was less than seven months. In 1999 — stereotyped as a time of rapid-fire day trading — the average holding period was more than a year.

One has to ask, why should such short-term shareholders exepct to have any say over corporate matters, like what CEOs pay themselves? If they do happen to time their ownership so as to have a vote in one year’s proxy, they won’t the next. No wonder boards and CEOs act as if they aren’t accountable to the funds and individuals who hold their shares on a transitory basis. These investors aren’t shareholders in any meaningful sense of the word. They are speculators.

The irony is that the “activist shareholders” that the corporate establishment likes to demonize are in fact far more deserving that the average 7 month duration shareholder. Activists typically hold their positions for 9-10 months. They typically accumulate reasonably large stakes, in the 5-10% range (even more if several are acting together). And they are seeking to effect changes that will benefit all shareholders, even if they are self-interested.

With whom in the investing community does the company have a long-term relationship? Its equity analysts and the financial press. That explains why companies have become so short-term oriented. It isn’t simply the lack of loyalty and continuity of their shareholders. It’s also the fact that they are heavily influenced by constituencies, the media and the analysts, that benefit from reputational pump and dump. Both gain from touting companies that appear to be on the upswing, and savaging ones that stumble. And enough investors are trading oriented that (despite their protests that they make up their own minds the signals they get from these sources play into their trading calls.

What’s the solution? There is a simple one that will never be implemented. Increase trading costs by imposing a transaction tax. If trading became more expensive, trading volumes would go down and average holding times would go up. Of course, such a change would wreak havoc on Wall Street, which has gotten used to both high trading volumes and cheap cost of entry and exit in its increasingly important principal investing. Similarly, some hedge funds would have trouble adjusting their strategies to a regime that made rapid trading costly (note that others would be relatively unaffected). Spreads would widen with lower trading volumes, which would also increase tranaction costs. And the brokerage firms would probably increase commissions where they could to compensate for lost volume.

But such a simple fix would be depicted as anti-consumer and anti-investor, when it is more like imposing sin taxes, like taxing alcohol or cigarettes. Investors should not be tempted to act like speculators. That should be left to the true pros. But low transaction costs and plenty of hype encourages individuals and fiduciaries to trade to a degree that is not likely to improve their results and is detrimental to investors as a whole.

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