Looking after something is an unpleasant business. Therefore it makes sense that we look after things when it is beneficial for us, but we avoid looking after things when it is not. Sometimes there are situations where looking after things and benefit do not meet, which easily leads to so-called moral hazard. A carton of milk on the kitchen table at the office and scratches on a rental car are everyday examples of a moral hazard. At home, the milk carton would have found its way back into the fridge fresh, and your own car into the parking space with no damages.
In a firm, the situation is similar. Each shareholder must look after the firm’s operations – or perhaps “somebody” takes care of it? Traditionally, financial research has documented that the shareholder base’s concentration has a positive effect on the firm’s success. The underlying explanation is that significant shareholders enhance governance through their (voting) rights. An underlying assumption here is also that significant shareholders are committed to looking after the firm. Somewhat surprisingly, there is weak scientific evidence to back up this assumption. So, is someone looking after things?
Together with my colleague Benjamin Maury, we examined the success of Finnish listed firms in years 1996-2005 from a shareholder commitment perspective. Commitment was measured by calculating how much the average shareholder had invested in a firm. For example, if firm A represented 10% of the average shareholder’s portfolio, and firm B only 1%, we assumed that the shareholders of firm A were more committed than the shareholders of firm B. The shareholders of firm A simply benefit more from looking after the firm’s affairs.
We concluded that owners’ commitment has an effect the on firms’ success on many levels. More committed shareholders went hand in hand with better profitability, higher valuation and greater stock returns. In fact, shareholders’ commitment was a more important success factor than their concentration. Not only was the commitment of significant shareholder important, but also minor shareholders’ commitment was of significance. An active congregation does not necessarily need a priest.
It is of vital importance to the economy that resources are managed with maximum efficiency. In light of our study, this requires committed owners, who are motivated to monitor and have the ability to influence. For listed companies, a central and effective form of influencing is voting with your feet, i.e. buying and selling shares, which has been made easier and cheaper by the internet. In addition, social media has brought direct lobbying within reach for everyone. The technical premises for active people’s capitalism are therefore better than ever.
Our current tax and pension legislation encourages diversified and indirect ownership – where someone else is looking after things. In other words, our current legislation leaves a lot to be desired. For these reasons, direct share investments should be promoted in future tax and pension solutions. Let’s put the milk carton back in the fridge.