CFA Institute

Shareholder Activism and Divergent InvestingAuthor(s): Henry T. ChamberlainSource: Financial Analysts Journal, Vol. 37, No. 1 (Jan. - Feb., 1981), p. 10Published by: CFA InstituteStable URL: http://www.jstor.org/stable/4478410 .

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Shareholder Activism and Divergent Investing "Divergent Investing for Pension Funds" by Roy A. Schotland (Septem- ber/October 1980) may not be entirely applicable to my situation as a financial officer responsible for a small endow- ment fund. Nor am I sure that his term, "divergent investing," is sufficiently descriptive and truly neutral. Yet there are some points of common interest be- tween pension and endowment funds.

Meeting the objective of the fund is of the utmost concern, but this does not mean we are unconcerned about the source of investment income. We do not invest in anything we believe to be substantially incompatible with the ob- jectives of our fund, no matter how ad- vantageous a particular investment may be financially. Other than this one stipulation (which, at least in my expe- rience, has not been a burden), I find myself in agreement with Mr. Schot- land's view that fulfilling the financial purpose of a fund, particularly in an inflationary climate, is generally the course of action most responsible so- cially.

Associated with our endowment fund is a committee on social responsi- bility. From its inception, this commit- tee has had an advisory role. The com- mittee may advise on the selection of investments, but it does not have any authority to order a transaction or to set mandatory guidelines for the fund. At the same time, I find committee sug- gestions valuable -even if I sometimes conclude that one or another should be rejected on financial grounds.

In addition, and perhaps principally, our committee is active as a share- holder. While the committee would like to increase its proxy activity, it has re- cently encountered a problem. With the advent of multiple levels of security custodians, the receipt of proxy mate- rial may be so late that a vote is impos- sible. An additional level of custodians may serve well as a mechanism to ac- celerate security transfers, but there

may also be the unintended side effect of excluding the exercise of proxy vot- ing.

Some observers believe that a well- reasoned letter from a shareholder has more effect than a proxy voting rela- tively few shares. Our committee pre- fers to vote and to write a letter explain- ing its vote, whether the vote is for or against the company recommendation. We have also received numerous seri- ous and informative responses from companies.

Our committee's preference for vot- ing as well as writing recognizes that the vote has more than symbolic im- portance. The federal three-six-ten per cent rule sets a reasonable and often attainable minimum vote to justify the resubmission of a shareholder resolu- tion. The rule gives minority share- holders a better opportunity to make their position known, but the intent of the rule can be thwarted unintention- ally by the delays inherent in multiple layers of custodians.

An obvious solution may be no solu- tion at all; i.e., it may create equal or worse problems in other areas. For example, corporations would surely re- coil at the idea of extending the minimum period between the issuance of proxy material and the meeting date. Nor is there any advantage to a fund in changing custodians if any other cus- todian it may select also uses a custo- dian's custodian. A third solution, car- rying securities in the name of the fund itself, can sometimes impede a transfer long enough to preclude a market op- portunity even when there is no thought of rapid trading. While the transfer delay can be eliminated by set- ting up the fund's own nominee, some prospective custodians hesitate to ac- cept such accounts. If a small fund needs custodian services, it may have to forego its own nominee.

It is my opinion that the custodians themselves are probably in the best po- sition to discover ways of making sure proxy material gets to the beneficial

owners of securities at least one week prior to the meeting of shareholders. If they succeed, they will make Mr. Schotland's suggestion of shareholder activism as an alternative to divergent investing much more practical.

Henry T. Chamberlain, S.I. Treasurer, Detroit Province

of the Society of Jesus

Adjusting Debt-Equity Ratios In the September/October 1978 issue of FAJ, David Lasman and I discussed var- ious accounting adjustments to re- ported financial statements that make the debt-equity ratio more realistic ("Adjusting the Debt-Equity Ratio"). In the November/December 1980 issue, James Dawson, Peter Neupert and Clyde Stickney report the results of a similar, but more extensive, study ("Restating Financial Statements for Alternative GAAPs: Is It Worth the Ef- fort?"). They conclude that adjust- ments make no difference in the follow- ing sense: The correlations between the usual financial statement ratios before and after adjustment are so high that before and after numbers are clearly not significantly different.

I have replicated the work Lasman and I did using 1979 financial statement data for the Dow Jones industrial com- panies. The accompanying exhibit re- ports these results. Their message re- mains unchanged from two years ago: (1) The conventional debt-equity ratio has a low correlation (0.29) with the adjusted debt-equity ratio. (2) The ad- justed debt-equity ratio correlates bet- ter with an independent measure of firm risk - the beta coefficient - than does the conventional debt-equity ratio. (The margin of superiority is smaller in the 1979 data than it was in the 1977 data.) (3) Much of the differ- ence between the conventional and ad- justed results stems from the effect of General Motors.

The difference between my results and those of Dawson, Neupert and

continued on page 79

FINANCIAL ANALYSTS JOURNAL / JANUARY-FEBRUARY 1981 O 10

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