There's a great post at The New Yorker (of all places) on hedge fund manager William Ackman's failed activist campaign at JC Penney:
With the hedge-fund manager Bill Ackman having resigned from J. C. Penney’s board of directors on Tuesday, we can now declare the end of his extraordinarily unsuccessful attempt to reinvent Penney. ...
Instead of simply focussing on financial engineering, he set out to remake the entire business, giving it a new strategic direction, revamping its stores, and changing its customer base. Ackman’s vision for the company, as laid out in a presentation he gave at Ira Sohn’s Value Investing conference in May, 2012, required what he termed “an extreme makeover.” Some specifics of the turnaround effort may have been devised by Johnson once he took over as C.E.O., but the push for a wholesale transformation was Ackman’s from the start. (That 2012 presentation was tellingly titled “Think Big.”)
That turnaround effort was ill-conceived in myriad ways (which I wrote about in The New Yorker earlier this year). But what was most ill-conceived about it was Ackman’s fundamental premise—namely, that he knew what it took to run, let alone turn around, a major retailer.
This is critical. It is precisely the point I made about hedge fund activism in my new article, Managing Shareholder Interventions, in which I wrote that:
Even assuming hedge fund interventions are value increasing in general, it may not be the case that all hedge fund interventions are created equal. Modifying the schema used by Alon Brav, Wei Jiang, Frank Partnoy, and Randall Thomas (2008), we can divide the universe of hedge fund interventions into five broad categories:
- Addressing general target undervaluation to maximize shareholder value.
- Promoting corporate governance changes (e.g., rescinding takeover defenses, ousting one or more top managers), board composition, and executive compensation.
- Changing the target corporation’s capital structure (e.g., demanding an equity issuance, restructuring of debt, or a recapitalization).
- Addressing change of control transactions, such as:
- encouraging the target to sell itself;
- opposing a sale of the target (e.g., where price is perceived as too low);
- opposing an acquisition by the activist’s targeted corporation.
- Encouraging changes in the target’s business strategy.
Greenwood’s analysis suggests that gains from hedge fund interventions are especially likely with respect to the fourth category—i.e., control transactions. Greenwood argues that hedge fund managers generally are poorly suited to making operational business decisions and, with their short-term focus, are unlikely “to devote time and energy to a task delivering long-term value. After all, there are no guarantees that the effort will pay off, or that other shareholders would recognize the increase in value by paying a higher price per share.” (Greenwood 2007)
If that is correct, one ought to be especially dubious of hedge fund interventions falling into the fifth category above; i.e., those aimed at changing corporate business strategy. As Professor Lawrence Mitchell (2009) asks:
Do we really want speculators telling corporate boards how to manage their businesses? Those who say “yes” want to increase short-term management pressure and thus share prices, regardless of the corporate mutilation this induces. They do not seem to care that their profits come at the expense of future generations’ economic well-being. But if our goal is to give expert managers the time necessary to create long-term, sustainable, and innovative businesses, the answer is a clear “no.”Mitchell’s argument is supported by empirical studies finding that it is difficult to establish a causal relationship between improved firm performance, if any, and business strategy changes effected at companies targeted by shareholder activists. (Gillian & Starks 2007, 69)
And so it proved in the case of JC Penney:
Ackman, after all, had no hands-on experience in retail management, and his two previous attempts at investing in and trying to change retailers (at Target and Borders) had both ended disastrously. Yet he still took it upon himself to save Penney. The surprising thing is not that he failed. It’s that he was so sure he could succeed. The same can be said of Eddie Lampert, the fabled hedge-fund manager who bought Sears and Kmart and who, far from unlocking value at these companies, has instead run them into the ground. Lampert is now the C.E.O. of Sears Holdings (which owns both Sears and Kmart), and, as a recentBloomberg Businessweek story detailed, he’s created a culture of “warring tribes,” in which business units are forced to compete against one another for resources, often at the expense of the over-all brands. Plunging sales at Sears suggest that while Lampert may have interesting theories about management practices, he doesn’t have much of a clue about how to get customers into stores. Ackman and Lampert’s attempts to transform these venerable American retailers were farther-reaching than most shareholder activism. It’s not a coincidence that they were also more catastrophic. It’s natural that as shareholder activists have become more powerful, they’ve also become more ambitious in their plans—witness Loeb’s recent attempt to get Sony to sell off its entire entertainment division. But those are ambitions that money managers would be smart to resist.
And they are also ambitions the law should be giving corporate managers tools to resist.