Tryanny of Corporate Management

John Bogle, the founder of Vanguard Mutual Funds, emphasizes the point that, over the long term, the return on stocks has equaled corporate dividends plus corporate earnings growth. Later in this essay I quote from his most recent book on the subject. But the point of today's essay to my family is this:

1. Bogle's conclusion regarding the critical role of dividends in the above equation. The earnings growth portion of the equation was, to a large extent, the result of increased prices resulting merely from inflation. It has therefore been dividends that have provided investors with their real (after inflation) return from stocks over the past 100 years.

2. The 4.5% average dividend yield provided by stocks over the past 100 years may be a thing of the past and is not something investors can necessarily count on moving forward.

The reason? Corporations are no longer owned by individuals who actively exercise control over corporate management. Today the vast majority of publicly owned stock is held by mutual funds or large pension funds which do not exercise their voting rights and fail to exercise any control over corporate management. In reality most Boards of Directors today are pawns of corporate management and exercise zero control because there are no longer stock owners who control the Boards themselves. Indeed, it is a small club and Board memberships are filled with CEOs from other corporations.

Contrast that to 1980 when mutual funds and pension funds held less than 10% of publicly issued stock. Back then companies (Boards of Directors and corporate management) answered to real, living, breathing stock owners. But as the number of family owned (or controlled by a small number of individuals) publicly held corporations has dwindled, the result should have been easy to predict. An almost total absence of control over corporate management. The result? A complete plundering of corporate wealth. With no checks or balances, the salaries, bonuses, and retirement packages paid to corporate executives has spiraled out of control. No individual or family controlled public corporation would tolerate even 1/100th (maybe not even 1/1000th) of the hundreds of millions of dollars in individual compensation corporate executives have paid to themselves. Indeed, during the past ten years, 2.7 trillion dollars has been siphoned from corporate dividends of US public companies simply to pay for the stock options given to American corporate managements. This situation is hinted at in a January 7, 2011 article in the Wall Street Journal - The War on Dividend Yields.

It is no coincidence that the dividend yield has fallen so low (below 1.5%). Corporations in America no longer have "owners" and it is no wonder they are being plundered by corporate management. There has been an incredible transfer of wealth away from corporate owners (i.e. today that means holders of stocks via mutual funds and pension funds) to corporate management. So long as such legal theft is allowed to continue, investors can expect to receive far lower returns from their investments since the majority of the dividends that provided the real after inflation return is instead being siphoned off by corporate management.

John Bogle is an outspoken critic of the failures of modern capitalism to address this situation (i.e. the absence of corporate owners in today's society). To get a more complete grasp of the entire situation I encourage you to read Mr. Bogle's 2005 book on the subject, "The Battle for the Soul of Capitalism".

The importance of dividends to the investor, outlined below, is taken directly from pages 322-323 of John Bogle's most recent book, "Don't Count on It":

"… the dividend yield on stocks has accounted for almost one-half of their total long-term return. Of the 9.6 percent nominal total return earned by stocks over the past century, fully 9.5 percent has been contributed by investment return - 4.5 percent by dividend yield and 5 percent from earnings growth. (The remaining 0.1% resulted from an 80% increase in the price-earnings ratio, from 10 at the start of the century to 18 at the end, amortized over the long period. I describe changes in the p/e ratio as speculative return).

When we take inflation into account, the importance of dividend income is magnified even further. During the past century, the average rate of inflation was 3.3 percent per year reducing the nominal 5 percent earnings growth rate to a real growth rate of just 1.7 percent. Thus, the inflation-adjusted return on stocks was not 9.6 percent, but 6.3 percent. In real terms, then, dividend income has accounted for almost 75 percent of the annual investment return on stocks.

... Consider this: An investment of $10,000 in the S&P 500 index at its 1926 inception with all dividends reinvested, would by the end of September 2007 have grown to $33,100,000 (10.4% compounded). If dividends had not been reinvested, the value of that investment would have been $1,200,000 (6.1% compounded) - an amazing gap of $32 million. Over the past 81 years, then, reinvested dividend income accounted for approximately 95 percent of the compounded long-term return earned by the companies in the S&P500."