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All shareholders of Churchill Downs CHDN, +2.23% get free season passes to its racetracks; Willamette Valley Vineyards WVVI, -1.83% rewards all its shareholders with discounts on its wines. Nice perks, but why not offer special rewards, in cash or votes, to a company’s most loyal shareholders, say those with lengthy and/or concentrated ownership in the stock? Companies and shareholders would gain from drawing in such patient and focused shareholders.
In today’s markets, trading is driven by a large cohort of transient investors, following news trends. Their lead is amplified by an even larger group of formulaic traders, especially diversified indexers, who buy or sell based on price changes. Left out of the process are the steadying hands of long-term concentrated holders, today a minority group that Warren Buffett long ago dubbed “high-quality shareholders.”
While trading provides liquidity benefits, average holding periods are at historic lows, moving under one year. In some cases, in annual director elections, a majority of votes are cast by those who won’t be shareholders for the directors’ full term. Other vital ballot proposals, from executive pay to board structure, are also determined by fleeting majorities.
Index funds, with their eternal holding periods, are so widely diversified that they cannot pay attention to the particular companies they nominally own. While making investing cheap and delivering market returns, they buy and sell without regard to actual value and have limited resources to weigh positions in corporate debates.
Much-publicized research on actively managed funds questions whether they can outperform passive indexes, after fees. But more refined research, led by finance professors Martjin Cremers and Ankur Pareek, shows that quality shareholders — both long-term and concentrated — outperform rivals. They load up on a stock and stick around, strengthening markets.
A select group of companies cultivate this discerning breed of investor. Coupled with excellent business economics, their pitches might include effective capital allocation, shareholder communications focused on long-term business strategy, not splitting the stock even at high prices, and substantial director ownership.
A dozen companies have gone so far as to reward stockholders with increased voting power the longer they hold their shares. Called time-weighted voting, this increases votes per share when held for a given number of years. A common design grants four votes instead of one to all shares held longer than four years. (In France, this in fact is the default rule for its largest public companies.)
This 12 company sample is too small to draw solid conclusions, including whether the plans lengthen overall time horizons of a company’s shareholder base. But Lynne Dallas and Jordan Barry, researchers who crunched the data, document that the plans reward inside ownership and also benefit smaller outside owners.
The researchers encourage experimenting with their methodology. One tweak would adjust definitions of long term. When adopted, many plans defined long term as four years, in light of contemporary average holding periods. With holding periods now fractions of that, credit for duration should kick in earlier. Corporations could also reward their quality shareholders with cash: paying a higher dividend on longer-held shares.
Another change would focus not only on holding periods but concentration levels. A time-weighted plan rewards even passive-indexers — not often the best-informed decisionmakers. Plans could add dividends or votes to shares representing a substantial portion of a shareholders’ portfolio — such as double the votes or dividends at 10% or triple at 20% — readily observable from public filings for institutional investors and both optional and subject to the company’s verification for others.
Corporate laws permit such plans, with shareholder approval, though stock exchange listing standards may need waivers to accommodate them. Alternatively, if the views of the quality shareholders warranted special weight for a particular transaction, such as a merger, the company’s board of directors alone could condition going forward on approval by a majority of the quality shares, as I explain in a new research article.
Administration of time-weighted voting or dividend plans may not be simple, as adjustments must be made at inception and ownership durations continuously verified. Administering commitment-weighted benefits would pose additional cost in recordkeeping and verification. But the work is manageable, evident in data analytics concerning both duration and concentration seen in both academic research such as by Jim Cox and colleagues and proprietary platforms such EQX Investor Capital.
Just as investors can benefit from committed long-term ownership, companies with more patient and focused shareholders also gain. For example, such shareholders offset short-term pressures that transient traders exert, offer a brain trust to consult that indexers cannot supply, and provide a deterrent to overzealous activists. While product freebies and pricing discounts for all are great, companies should consider rewards of cash or votes for the shareholders they desire most.
Lawrence A. Cunningham is a professor at George Washington University, long-time shareholder of Berkshire Hathaway, and publisher, since 1997, of The Essays of Warren Buffett: Lessons for Corporate America. To get updates, including an invitation to his exclusive webinar during Berkshire Hathaway’s 2021 Annual Meeting, sign up here.
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