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Where the road runs deeper.

Heads have rolled recently at some major corporations, notably GM, Westinghouse, and American Express. Poorly performing managements elsewhere have been called on the carpet. In some cases, the changes were wrought by once somnolent boards of directors, but at American Express, for one, the hands that held the dagger included J.P. Morgan and other mainstream investors. Suddenly, we are hearing a burst of applause, mixed with serf-congratulations, for how well the system is working.

Suddenly, too, the concept of relational investing seems to have bloomed like a hundred flowers, on the cover of Business Week and on the lips of money managers and others seeking to capitalize on the new fashion.

Not quite so fast, please. What happened at American Express, though surely useful, happened at the eleventh hour, after large, permanent losses had been sustained, and at best represented only the whistle-blowing aspect of what relational investing has to offer. The detached, passive investment style of the present-day J.P. Morgan bears little resemblance to the House of Morgan at the turn of the century or a Warren Buffett today.

The shareholder activism we are seeing, however useful, also has the same Rip van Winkle quality as the once-upon-a-time market for corporate control, meaning that shareholders may remain inert for 40 quarters, and then, in some limited, episodic burst of awakening, confront management with demands for lower executive pay, a more independent board, better operating results, or whatever. In short, there is no ongoing dialogue, no open-ended commitment. Isn't it remarkable that our present-day institutional shareholders are so allergic to nominate anyone to any board of directors, the obvious method for creating such a dialogue? No, as with takeovers, they show no interest until the target has passed down the road beyond trouble, on the way to disaster. Then, after the confrontation, shareholders can once again withdraw into their shell of indifference. Any continuing involvement, as one consultant would have us believe, is simply not profitable. Deliver the market's message and move on.

Eye Firmly Fixed

If Buffett makes a suggestion at Coca-Cola, for example, we can expect him to have his eye firmly fixed on the essential enterprise. Of Berkshire Hathaway's own year-end market value of about $13.5 billion, $3.9 billion was represented just by that one holding, Coca-Cola, which will never be sold. Buffett owns 41% of Berkshire Hathaway, and those holdings are also not for sale. Having forsaken the liquidity of the market at both levels, whatever he does at Coca-Cola is likely to be focused on the business, as free of extraneous influences as one could hope.

Paul Cabot, the highly successful overseer of Harvard's endowment in the years following World War II, wrote in Atlantic Monthly that "|a~n investment manager should know far more about the companies in which his money is invested than the average investor... |O~bviously it is far more expensive to follow closely and thoroughly a list of securities spread all over the face of the globe than a list restricted to a limited group...I think it is fair to say that the average highly diversified trust does not closely follow its list, but relies on its policy of diversification to save it...." What is striking is that Cabot wrote those words in 1929.

The immediate point is not so much whether Cabot and Buffett have been superior investors, but the extraordinary scarcity of relational/value investors. We are left with the conundrum of how to expect thoughtful, well-informed, credible oversight from investors who, exhibiting as to any particular companies such striking indifference and ignorance, lack that credibility. If, like Old Mother Hubbard, you have so many children that you don't know what to do, what sort of parent will you be?

My experience is that the Buffetts are so scarce, not because of legal or administrative barriers but because the critical ingredient is one that is so rare -- a willingness to make a selected few independent investment decisions, based on nothing more than confidence, as Ben Graham liked to say, in the correctness of one's facts and analysis. And then to stick with those companies much as one might in a marriage, without having at one's bedside the phone number of a three-cents-a-share divorce broker.

Relational investing is no guarantee of success; nothing is. But to paraphrase Samuel Johnson, depend on it; when someone knows that a major portion of his wealth "is to be hanged," in a fortnight or whenever, "it concentrates his mind wonderfully." That concentration, that singular escape from perverse incentives, is rare and very valuable.

However much we might like to do so, we have only the foggiest notion of how to make a thousand Buffetts grow. A Twentieth Century Fund task force, on which I served, issued a report last November that suggested some changes that might enrich the soil. Foremost among them was a proposal that the capital gains tax be steeply graduated, thus discouraging high turnover and encouraging holdings of more permanent sort. The purpose, of course, is not to discourage selling out as such, but rather to force money managers to do bottom-up investing, to think more carefully on the way in, more about where that business is going over some period of years than about where the market is going over some period of weeks or months.

An Equity Link

My suspicion is that the road to relational investing lies not through Wall Street, which is fee-driven and market-obsessed, but through Main Street and other industrial centers where, with the benefits of tighter business loyalties increasingly appreciated, the addition of an equity link might be seen as a useful way to reinforce the relationship. The Twentieth Century Fund report was sensitive to that possibility, suggesting changes in the tax and accounting rules that now discourage one industrial company from taking a substantial stake in another.

If a thousand relational points of light are to shine, perhaps we should not round up the usual suspects, the financial institutions, but rather look to those firms where the economic incentives run deeper. Industrial shareholders such as these are also more likely to be seen by the investee company as knowledgeable, able to offer entry into new and useful networks, and being sufficiently committed to provide not just money but, if necessary, credibility and skills -- more of everything than the 28-year-old fund manager at a money-center bank who, sitting in front of a cathode-ray tube, was recently assigned the account.

The Institutional Investor Project is planning to publish the proceedings of its "Relational Investing" conference. For information, contact Kathleen Chojnicki at the IIP at (212)854-3138.

Louis Lowenstein is the Simon H. Rifkind Professor of Finance and Law at Columbia University and Director of the Institutional Investor Project. Prior to joining the Columbia faculty in 1980, he was President of Supermarkets General Corp. and, before that, had practiced corporate law for over 20 years.
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Title Annotation:Building Brand Strength; wise investment
Author:Lowenstein, Louis
Publication:Directors & Boards
Date:Jun 22, 1993
Words:1155
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