Benjamin Graham the Shareholder Activist

"The choice of a common stock is a single act; its ownership is a continuing process. Certainly there is just as much reason to exercise care and judgement in being as becoming a shareholder." (Security Analysis; p.508)

Introduction

A lot has been written about Benjamin Graham's being the father of value investing and its criterias on selecting bargain stocks. Little has been commented about Graham being not only the father of value investing, but having revolutionized the concept of shareholder activism.

Many "Value Investors" might have incorporated Graham's advise No.1, e.g. choosing the individual stocks intelligently and wisely. But I doubt very much that the majority of them incorporate the corollary to advise No.1, namely exercising care and judgement in being a shareholder, in any satisfactorily degree.

As a deep value investor one most of the time doesn't venture into outstanding businesses with great pricing power, where good managment abilities and integrity is of minor importance. The investor often invests in "troubled" businesses, that show at best only mediocre performance. Identifying, monitoring and (if it is in ones means) tackling corporate governance issues, especially concerning the "financial efficiency" of corporate action, are key for the success of the business venture for the individual stockholder of a company.

Graham's stance regarding corporate governance, sharholder rights and activist approaches towards the managements of underperforming companies had seen quite astounding changes over the time span of his investment carreer.

Benjamin Graham's enthusiasm on shareholder activism

At the beginning he was very vocal on that subject and wrote quite extensively about it: "Ever since 1934 we have argued (...) for a more intelligent and energetic attitude by shareholders towards their management. (...) a generous attitude toward those who are demonstrably doing a good job (...) and to demand clear and satisfying explanation when the results appear to be worse than they should be (...)(Intelligent Investor; p.487)"  " (...) the stockholders as a class are king. Acting as a majority they can hire and fire managements and bend them completely to their will. (Intelligent Investor; p.497)"

Graham was always aware of the difficulty of activism. "(...) very little altruism in finance. Wars against corporate managements take time, energy, and money. (...) hardly to be expected that individuals expend all these merely to see the right thing done (...) (Security Analysis; p.513)."  He was wary of the difficulties involved in sharholder activism not only theoratically, e.g. good judgement and reasoned thinking. More important and lesser known is the fact that Benjamin Graham had first hand experience how difficult and time consuming activism in general and especially waging a proxy contest can be.

Many people regard Benjamin Graham as a rocket chair investor. Sitting in his office, digging into financial statements and executing on investment decisions secretely. No active approach on investing. But Graham wrote on his findings and Graham tought the interested public on his insights. Already this being shareholder activism at its finest, little is known about Graham really tackling the board and management of a company.

How Benjamin Graham became a really active activist shareholder

In 1911 Standard Oil had to split up into 34 independent entities, because of the sherman antitrust act, which was supposed to curtail Rockefellers monopoly. Northern pipeline co. was among one of them. But it was only in 1926 that Benjamin Graham's became interested in Norther pipeline's financial state. In that year all pipeline companies were required to file financial statements to the Interstate Commerce Commission (ICC). Although those filings being extremely superficial, Grahams impacable value instinct made him to dig a little deeper into them. He went to Washington to have a look at Northern pipeline's full length filings at ICC. What he saw was mouthwatering. Northern Pipe Line held $95 per share in railroad bonds and other liquid assets. Meanwhile, its stock was trading at only $65 per share. "(...) Here was I, a stout Cortez-Balboa, discovering a new Pacific with my eagle eye (...)"

During 1926 the partnership accumulated roughly 5% of Northern pipelines outstanding shares. Graham requested to the management the distribution of $90 of the company’s $95 per-share surplus of liquid assets to their rightful and legal owners.(Joe Carlen) If management followed suit he would have roughly 50% of his initial investment and a viable company still adequately financed.

Rather quickly it became apparent to Graham that a dialogue with the management concerning the distribution of excess capital, not needed for the future cours of the business, wouldn't be enough. It left Benjamin Graham with no other resourse than to tackle the management with a more agressive shareholder activist approach.

At Northern Pipe Line’s 1927 annual shareholder meeting, Graham took his argument directly to the shareholders, but was defeated because of a technicality. Graham didn't give up. By 1928 he had petitioned the support of so many other shareholders that he had proxies for almost 40 percent of the company’s shares. The management had no room to maneauver. Not because Graham was the second largest shareholder of the company, but rather because he was supported by the largest shareholder, namely Rockefeller itself. Graham’s was elected to the board and the company distributed $70 per-share of excess liquid assets to Northern Pipe Line shareholders.

"(...) not only did Rockefeller approve of his campaign, but its success had inspired the aging tycoon to adopt an activist stance himself. Citing the Northern Pipe Line example, Rockefeller, whom Graham met on three occasions, reached out to the other former Standard Oil affiliates with excess liquid assets on the books.(...)This ripple effect throughout several Rockefeller-associated entities is one reason why Graham’s triumph, known as “The Northern Pipeline Affair,” helped cement his reputation as both an exceptional analyst and a highly effective activist (...)" (Joe Carlen)

Years later Graham commented; “(...) After all these years, I’m still amazed that no one in the brokerage business thought of looking at the ICC data.”

(Source: Joe Carlen)

Graham's disillusionment on shareholder activism

Graham always was kind of desillusioned regarding the average american stockholders' interest in demanding its rights as the owner of the company." It is a notorious fact (...) that the typical american stockholder is the most docile and apathetic animal in captivity. (...) (he) never thinks of asserting his individual rights as owner of the business and employer of its paid officers. The result (...) effective contol of many, perhaps most, large american corporation is exercised not by those (...) own a majority of the stock but by (...) the management." (Security analysis; p508-509)

As time went by his critisism towards the ignorance of the average shareholder concerning their property rights became stronger: "(...) But in practice the shareholders are a complete washout. (...) they show neither intelligence nor alertness. They vote in sheeplike fashion (...) whatever the management recommends and no matter how poor the management's record of accomplishment may be (...) The only way to inspire the average american shareholder to take any independently intelligent action would be by exploding a firecracker under him (...)" (Intelligent Investor; p.498)"

Towards the end of his carreer Graham seemed to have totally given up on potential interest of the average investor monitoring and changing the behavior of the corporate managers: "But the idea that public shareholders could really help themeselves by supporting moves for imporving management and management policies has proved to quixotic to warrant further space in this book. (Intelligent Investor;p.488-489).

Jason Zweig points the reader of the revised edition of (2003) to the fact, that: "Perhaps no other part of The intelligent Investor was more drastically changed by Graham (...). In the first edition, this chapter (e.g. Chapter 19) (...) ran nearly 34 pages. The original section ("The Investor as Business Owner") dealt with shareholder's voting rights, ways of judging the quality of corporate management, and techniques for detecting conflicts of interest between insiders and outsiders (...) By this last revised edition (...) Graham had pared the whole discussion back to less than eight terse pages about dividends (Intelligent Investor; p.497)"

But did Graham really give up on activism? I personally very much doubt it. From my extensive reading of Graham's writings it would surprise me if he had caved in to a dear subject that easily. I think his (later) attitude and comments towards educating the investor regarding an more active stance against their managers are as misunderstood as his remarks concerning value investing in general when he said:"(..)I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities (...). (Interview Graham). When reading the whole interview one can sense that far from disencouraging individual investors following the value approach, he does do exactly the opposite!

And far from giving up on activist approaches, I would argue that he was rather upbeat on the future of shareholder activism.

"(...) As it happens our cause has not been lost; it has been rescued by an extraneous development -  known as takeovers, or take-over bids. (...) poor managements produce poor market prices. The low market prices (...) attract the attention of companies interested in diversifying their operations (...). Innumerable such acquisitions have been accomplished by agreement with the existing management, or else by accumulattion of shares in the market and by offers made over the head of those in control. (...) in many cases, the inert public shareholder has been bailed out by the actions of "outsiders" (...) (Intelligent Investor;pp.487)

"(...)let us close this section with the plea that shareholders consider with an open mind and with careful attention any proxy material sent them by fellow-shareholders who want to remedy an obviously unsatisfactory managment situation in the company." (Intelligent Investor;pp.487)





Source:

Benjamin Graham; The Intelligent Investor; Harper Business Essentials (2003); (with commentary by Jason Zweig)

Benjamin Graham; David L. Dodd; Security Analysis; Mc Graw- Hill 1934

Joe Carlen; How Benjamin Graham revolutionized shareholder activism;  http://www.bloombergview.com/articles/2013-05-17/how-benjamin-graham-revolutionized-shareholder-activism

A conversation with Benjamin Graham; Financial Analyst Journal 1976; http://www.grahamanddoddsville.net/wordpress/Files/Gurus/Benjamin%20Graham/A%20Conversation%20with%20Ben%20Graham%20-%20Financial%20Analysts%20Journal%20-%201976.pdf