Part 19: A Call for Shareholder Action

Words: 619 Time: 3 Minutes

💥 Why this Matters:

• Shareholder Activism: Investors should actively engage in corporate governance, holding management accountable for performance and ensuring responsible decision-making. 

• Reforming Dividend Policies: Companies must adopt either (i) transparent and systematic dividend policies; and/or (ii) demonstrating that retained earnings are driving continued sustainable growth.

• Criticism of Stock Buybacks: Stock buybacks often prioritize executive gains over shareholder interests, especially when used to offset stock option dilution. Shareholders should demand fair practices, accountability, and transparency in buyback and compensation programs

 Introduction

The penultimate chapter advocates for a more active role for shareholders in corporate governance and calls for a modernization of dividend policies.

Graham criticizes the historical passivity of shareholders and highlights the importance of holding management accountable for poor performance.

He also challenges traditional views on dividends, arguing for a more systematic and shareholder-friendly approach.

🗳️ The Need for Shareholder Activism

Graham criticizes the historical lack of shareholder engagement in holding management accountable.

He argues that shareholders have a right to demand explanations for poor performance and support efforts to improve or replace underperforming management teams.

While acknowledging that shareholder activism has historically been ineffective, the author points to the rise of takeovers as an external force that can pressure companies to improve or face acquisition.

This external pressure, he argues, has made boards of directors more attentive to their responsibility of ensuring competent management.

💸 Rethinking Dividend Policy

Graham challenges the traditional view that retaining earnings is always in the best interest of shareholders.

He argues that companies should either (i) pay out a reasonable portion of their earnings as dividends; or (ii) clearly demonstrate that reinvesting those profits leads to a satisfactory increase in per-share earnings.

With respect to companies with weak financial positions or mediocre performance – arguing that shareholders should demand justification for their dividend policies.

⚖️  Stock Dividends vs. Stock Splits

Graham clarifies the distinction between stock dividends and stock splits.

He argues that true stock dividends should represent a tangible distribution of reinvested earnings, while stock splits are simply a restatement of the capital structure.

He criticizes the practice of some companies, particularly banks, that declare stock dividends without a clear link to recent earnings, creating confusion in the market.

🖨️  Systematic Dividend Policy

Graham advocates for a systematic dividend policy where companies either (a) pay out a significant portion of their earnings; or (b) demonstrate that reinvested profits generate satisfactory growth in per-share earnings.

He criticizes the common practice of public utilities that pay high cash dividends and then issue new shares to raise capital, arguing that this approach results in unnecessary tax burdens for shareholders.

⏲️ Modernizing Dividend Practices

Graham advocates for a modernization of dividend policies, urging companies to consider the psychological and practical benefits of stock dividends for shareholders.

He argues that stock dividends can provide a tangible representation of reinvested earnings and allow shareholders to easily cash in on those earnings if they choose.

He also highlights the tax advantages of stock dividends compared to the traditional practice of cash dividends followed by stock subscriptions.

💡 5 Key Takeaways

1. Shareholder activism: Investors must actively engage in corporate governance, demanding transparency, accountability, and responsible management practices.

2. Proxy vigilance: Carefully read and analyze proxy statements to identify potential conflicts of interest, questionable accounting practices, and excessive executive compensation

3. Dividend advocacy: Support companies with reasonable dividend payout policies and challenge those that hoard or squander cash while neglecting shareholder returns

4. Scrutinize buybacks: Critically evaluate stock buyback programs, ensuring they are not used to enrich executives at the expense of outside shareholders

5. Demand accountability: Hold management and boards of directors accountable for acting in the best interests of all shareholders, not just insiders or executives.