The new guardians? Institutional owners can exert a powerful influence on governance. The question is, will they ever embrace that role?

• Author: Raymond, Doug
• Position: LEGAL BRIEF

IN TODAY'S corporate governance environment, accountability, independence, and transparency are the watchwords, and directors are seen as the watchdogs. The stockholders are seen as having an economic stake in the company but with little influence individually, and as lacking the ability to effectively act collectively. The stockholders are at a substantial disadvantage in election and other governance debates because of management's control of the proxy machinery, the forces of inertia, and the isolation of individual stockholders from each other.

The mandate for boards is therefore to ensure that management acts in stockholders' best interests. The importance of this mandate has in recent years been underscored by the many instances in which directors have failed to carry it out, including the unfolding scandals over option timing.

However, the relationship between public company director and stockholder is more complex than is reflected by this model, largely because of the dramatic changes in how stocks are owned. In 1950, individual households--the general public--owned more than 90 percent of all publicly traded equity securities. Today, they directly own just 32 percent. At the same time, ownership by financial institutions, including pension plans and mutual funds, has increased to 68 percent of all stocks. Consequently, the majority of the shares in many (if not most) public companies are held not in small stakes by voiceless individuals, but instead by well-informed professional investors with the sophistication and the resources to make their voices heard.

The shift from direct to indirect ownership is only part of the story. According to John Bogle, the preeminent advocate for mutual fund investors, America's 100 largest money managers alone now hold 58 percent of all stocks (www.johncbogle.com). In many instances, these money managers can cast the votes for the shares that they hold, often without guidance or direction from the individuals on whose behalf the shares are owned. This is an unprecedented concentration of power that is only now beginning to be fully appreciated.

We might expect that the concentration of so much stock ownership under the control of a few sophisticated and informed money managers would encourage an involved and activist stockholder constituency, making greater demands of managements and boards. To some extent this has occurred, as this past proxy season's initiatives on majority voting illustrate...