Losing your licence

When is a shareholder activist not a shareholder activist? When he is the US president.

Barack Obama this week did what shareholders of General Motors, even the renowned Kirk Kerkorian, had failed to do. He removed Rick Wagoner from GM's helm after nearly a decade and told the board that most of its members should be on their way too.

Mr Obama was perfectly justified. "The only thing you have to do is look at a chart that shows how much value we [as an industry] have collectively destroyed in the last 20 years,” Sergio Marchionne, Fiat's chief executive, told Automotive News in December: "In any normal world ... the very first thing you would say is: ‘Give me the names of the guys who did this! I want them all out.' ”

But why did it take the president and a task-force led by Steve Rattner and Ron Bloom to see through the latest of GM's endless restructuring plans and show Mr Wagoner the door? Why were GM's executives and board allowed by its shareholders repeatedly to steer the wrong way?

It is popular in Detroit to regard the local industry as having particular problem relationships – with everyone from unions to suppliers and dealers – that make it uniquely hard to run. It is also accepted wisdom that enterprises such as GM can only be run by a Detroit "car guy”.

The industry is certainly complex, difficult and highly competitive, with chronic over-capacity that means that plants run at an average of only 75 per cent of potential. Even with GM bleeding cash at such a rate that Mr Obama waved the stick of Chapter 11 bankruptcy proceedings, he turned to Fritz Henderson, another GM lifer, to take over from Mr Wagoner.

But the industry is not as unusual as it likes to believe. Most of its problems were caused not by the nature of cars but standard-issue mismanagement, tolerated for decades. The inability, or unwillingness, of shareholders to enforce clearly needed changes is also found elsewhere.

Take Wall Street banks. Perhaps regulators were looking the other way, but why did investors allow investment banks to run excessively illiquid and leveraged balance sheets and pay their senior executives so much that they had little incentive to restrain their employees?

It is hardly news that shareholders in US companies have limited rights to influence strategy, or even be heard, by boards of directors. But since GM shareholders and Cerberus Capital Management, Chrysler's owner, have lost most of their money, it is worth reflecting on the lessons.

First, shareholder value is valuable. That notion has taken a bashing lately, with Jack Welch, the former chief executive of General Electric, dubbing any fixation on it "the dumbest idea in the world”. But the rationale for executives listening to shareholders remains sound.

GM shareholders' interests were consistently subordinated to those of other constituencies with louder voices and more bargaining power. Under Mr Wagoner, GM's share price fell from $70 to $4 or so, while the company piled up liabilities.

The biggest problem with shareholder value, as Mr Welch pointed out, was that it came to be equated with a short-term rise in the share price. Indeed, many companies increased their levels of debt in order to pay more to their investors in share buy-backs (and investors in Wall Street banks were fooled because their equity rose in value).

It would have helped a lot, however, if GM had been more focused on the pursuit of long-term shareholder value. Instead, Mr Wagoner shrugged off Mr Kerkorian's efforts in 2006 to get GM to form an alliance with Renault-Nissan and to shed its Hummer and Saab brands when they might have been worth something.

Second, shareholders must speak up. Mr Obama could dictate terms to GM because he had a clear message and the company needed government loans to stay in business. It is harder for shareholders to grab a US company's attention. Short of selling up, the only way to ensure it listens is to launch a proxy battle to replace the board.

It is also more difficult for investors to speak with one voice because there are lots of them, with varying opinions and interests. But the shift of equity ownership from individuals to institutions such as pension funds and mutual funds has given them greater power, even if they rarely choose to exercise it.

Third, shareholders should do their research – and be prepared to publish it. There is a lot of fund management research but I can only think of one example of an investment institution publishing such clear-headed and scathing research on a company as the "viability determinations” on GM and Chrysler issued by the president's taskforce on Monday.

The taskforce did not simply take the companies' numbers and plug them into spreadsheets, as too many Wall Street analysts still do. It treated the figures it had been given with rigorous scepticism and dug up its own material to justify rejecting the Detroit companies' plans. I was not aware, for example, that 34 per cent of cars made by Chrysler go to buyers with sub-prime credit scores.

The exception to the rule was the research on Time Warner done by Lazard and published by Carl Icahn in 2006 when he took a stake in the company and tried to push Dick Parsons, its then chairman and chief executive, into shifting tack. Mr Icahn did not get all that he wanted but he did prod a slow-moving company in the right direction.

Such clarity of purpose, and willingness to stand up publicly and criticise a company's management, is rare. In GM's case, it took the president to do it effectively. By that time, it was too late.

Copyright The Financial Times Limited 2009