âCorporate managers get the shareholders they deserve.â That old saying has rarely been more important. In todayâs corporate proxy battles, when the margin of victory can be slight, managers and shareholders alike are subject to control by thin majorities. Thatâs why savvy corporate leaders sculpt their shareholder base.
How? One way is via the bully pulpit, to deter shareholders unaligned with corporate philosophy. For example, at a Starbucks SBUX,
Besides hectoring to deter, many corporate practices are useful in attracting a certain shareholder base, one that is both patient and focused. This cohort was dubbed by Warren Buffett as âhigh quality shareholdersâ (QSs for short). While not rubber-stamps for incumbent directors or strategies, their voting records suggest a focus that makes them more knowledgeable than indexers or proxy advisers, and a patience that makes them more willing than transient shareholders to credit and support long-term thinking.
Evidence shows an association between high densities of QSs in a company and the managerial quest for superior corporate performance. Why? One possibility is that QSs are drawn to companies which boast competitive advantages that boost performance and deflect rivalsâ threats. Often referred to as âmoats,â these include economies of scale, distribution systems, patents, network effects and brand strength.
Rankings of some 500 companies by moat strength are regularly tallied by investment researcher Morningstar, and rankings of some 2,000 companies by QS density have been developed by the Quality Shareholder Initiative at George Washington University.
Comparing 200 companies common to both lists, one-third of the Morningstar moats are in the top 10% of the QSI ranking, two-thirds are in the top 25%; and the overwhelming majority â almost 90% â are in the top half. In other words, the data confirm widely known anecdotal evidence that moats attract QSs.
Leaders in both moat strength and QS density
Accenture PLC ACN,
Dominoâs Pizza DPZ,
Eli Lilly LLY,
Jack Henry & Associates JKHY,
Roper Technologies ROP,
Among moats, brand strength appears to be a particular magnet for QSs. There is a strong association between managers regarded as the best stewards of great brands and QSI rankings. For instance, among U.S. managers ranked in the global elite for brand guardianship, a total of 38 executives, all but one are in the top half of the QSI rankings. In short, managers wishing to attract more QSs should invest in brand strength and other moats.
Leaders in both brand strength and QS density
Cisco Systems CSCO,
Walt Disney DIS,
Estee Lauder EL,
Home Depot HD,
Johnson & Johnson JNJ,
Procter & Gamble PG,
UnitedHealth Group UNH,
A more intriguing reason why high densities of QSs are associated with corporate outperformance is that the QS cohort is itself a source of competitive advantage, akin to network effects. These arise when a systemâs value increases as more people use it. In most cases, network effects represent a tangible benefit to customers, as with fax machines in the old days and social media today.
Similar advantages can arise from a network of QSs. As a group, QSs are more likely than other major shareholder cohorts — such as indexers or transients — to care about the identity of fellow shareholders. This âbirds of a featherâ effect is visible among the companies held by leading QSs, such as those listed below.
Leading QSs that may draw fellow QSs
Berkshire Hathaway BRK.A,
Capital Research Global
Lone Pine Capital
Southeastern Asset Management
Companies tap into the broader QS ecosystem, where members tend to know one another or know of one another. Resulting network effects reinforce all the advantages of a high-density QS base of patient and knowledgeable shareholders.
The QS cohort may also help brand a company. After all, consumer brands become competitive advantages when they assure that consumers recognize product features. A corporate reputation for attracting QSs is a competitive advantage when a company repeatedly commits to the values patient focused shareholders appreciate, including long-term performance metrics and rational capital allocation policies.
To reach patient and focused individual QSs, many companies cultivate reputations among both consumers and shareholders. Examples include Churchill Downs CHDN,
Whatever explains the association between high densities of QSs and corporate outperformance, managers and companies alike benefit from having many QSs on the shareholder list. When ownership of corporate equity is dominated, as it is today, by unfocused indexers and impatient traders, such a cohort of QSs will often be the swing vote in corporate proxy battles. Properly courted and catered to, these loyal shareholders can determine the outcome of elections, as well as the course of corporate prosperity.
Lawrence A. Cunningham is a professor and director of the Quality Shareholders Initiative at George Washington University. He owns shares of Berkshire Hathaway. His new book is Quality Shareholders: How the Best Managers Attract and Keep Him. Register for his upcoming free book talk hosted by the Museum of American Finance and Fordham University here.