A challenge to the directors can shake things up.
A common complaint about quoted companies is that their owners (the shareholders) don't bother to properly supervise the directors. As a result, they are able to award themselves massive pay rises and bonuses, even when the business is losing money.
The problem is that the vast majority of quoted companies' shares are owned by financial institutions whose managers really don't want to become involved. So they let the "fat cats" get away with it.
But occasionally an activist shareholder, someone with a big personal stake in the company, will challenge the directors. If they choose to address their concerns, or are replaced by new directors who make a better job of it, this should boost the returns for all shareholders and not just the activist.
Everyone's boat rises
Some companies are run by their directors as a personal fief. Their top priority is feeding at the trough instead of representing their shareholders' fiduciary interests. Rather than trying to change the situation, most investors will eventually register their disapproval by selling their shares.
But if an activist shareholder decides to shake things up, this can greatly improve the situation and thus the share price. This is currently happening to one of my larger shareholdings, Canadian Pacific Railway (NYSE: CP.US).
Last October the hedge fund Pershing Square bought a 12% stake in Canadian Pacific, which it has since raised to 14.2%, and it is pressing for it to cut its operating costs to a similar level to those of its main competitor, Canadian National Railway.
Pershing Square has called for Canadian Pacific's chief executive officer (CEO) to be sacked and be replaced by Hunter Harrison, a former CEO of Canadian National who was responsible for turning that company around.
It's been nothing but good news for me as Canadian Pacific's shares have risen by over 50% since early October, mostly thanks to Pershing Square's activities!
Small-scale activism is possible
It's an impossible task for most private investors to cause a big company like Canadian Pacific to change its ways. Our stakes are trivial in comparison with those of the institutions, most of whom don't want to rock the boat because it might draw attention to their own pay and bonuses.
However, when it comes to smaller companies with market values in the millions or low tens of millions, then it becomes a whole new ball game. That's because private investors can hold a substantial stake in these companies and, when they act in combination with other private investors, the directors are far more likely to pay attention.
These shareholder action groups, some of which have been organised by private investors who are regulars here at The Motley Fool, have in some instances persuaded companies to change their ways.
A recent example of investor activism was seen at the annual general meeting of the property company Conygar Investment Company (LSE: CIC), where many private investors turned up to complain about the amazingly generous bonus scheme that the directors had awarded themselves.
Unfortunately, they were outvoted by the institutions. You can't win them all!
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> Tony owns shares in Canadian Pacific Railway