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Can Loyalty Share Programs Help Build Long-term Value for Investors?

Although they still have a low profile in the U.S. and Europe, loyalty shares are part of an international movement to promote long-term stock ownership. By rewarding investors who hold shares for a certain length of time, companies can buy themselves stability.

This May, French cosmetics giant L’Oréal began paying an extraordinary 10 percent bonus dividend to long-term shareholders. The loyalty bonus rewards those who have held the stock for at least two years; theyll get 20 euro cents a share on top of the normal 2 ($2.60) dividend this year. L’Oréal says several thousand shareholders have registered their shares to take advantage of the new program.

Still limited to a few companies, mainly those held by families, loyalty shares are spreading as the long-term-ownership trend picks up steam.

The average holding period for shares has fallen from seven years in the 1970s to seven months today, with high frequency trading accounting for 70 percent of  U.S. turnover, according to Generation Investment Management, a London-based asset manager founded by former U.S. vice president Al Gore and onetime Goldman Sachs Asset Management CEO David Blood. Generation funded a recent white paper on sustainable capitalism that called for the adoption of loyalty rewards to make sure stockholders and company management share a long-term approach.

Patrick Bolton, a professor at Columbia Business School who has written extensively on loyalty shares, says companies lose value by focusing on short-term earnings. Longer-term shareholding makes better capital budgeting and investment decisions possible, Bolton explains. He cites a 2005 study in the Journal of Accounting and Economics showing that companies under short-term market pressure often forgo valuable investment opportunities for accounting and window-dressing reasons.

So far, most of the companies using L shares have been closely held, like L’Oréal and tire maker Michelin. L’Oréal is controlled by the Bettencourt family and Swiss food conglomerate Nestl, which each own about 30 percent. Four hundred members of the Michelin family together own about 25 percent of Michelin stock. But new advocates of the L-share philosophy include governments seeking to privatize state assets, which dont want investors to flip shares after an initial public offering. In 2009, Australias Queensland Rail gave anyone who bought 15 shares of its freight business one-share bonuses if they held the stock for at least a year.

The idea still faces hurdles, especially in the U.S. In 2007, Dutch chemicals company Royal DSM announced plans to introduce L shares, but U.S. asset manager Franklin Templeton Investments sued, claiming discrimination against shareholders. The Supreme Court of the Netherlands upheld a companys right to offer loyalty shares, but DSM later withdrew its proposal because it didnt want to stand in court against its shareholders, says spokesman Herman Betten.

Theres no agreement on what form loyalty shares should take. Generation recommends a minimum three-year holding period, while others favor one or two years. Then theres the debate over how to reward shareholders. Frdric Samama, head of the New Yorkbased Sovereign Wealth Fund Research Initiative, which is supported by French asset manager Amundi, suggests issuing call warrants on stock. These would create less volatility than paying dividends, Samama maintains.

To make L shares a realistic possibility, companies would need to adapt their share registers to indicate how long shareholders have held stock. That could require legal adjustments for tracking ownership in countries like the U.S., where share certificates often change hands overnight. A workable solution might prompt more U.S. companies to offer loyalty bonuses. When you are a CEO, you need to have patient investors, Samama says, to invest in research and development, to integrate environmental, social and governance issues, and to invest in a profitable long-term project. The good news is that over the long run it reduces your cost of capital.

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