Dennis Berman has a must read column in today's WSJ:
"Shareholder value," was once a guiding principle for CEOs and directors. Now it has turned into a brittle orthodoxy.
Investor activists made this so. Using persistent menace and frequent success, their agenda—buybacks and dividends, cost-cutting and tax gambits—has hardened into the default boardroom agenda, too. ...
The answer is that the activism market, like any market, has begun to adapt. And this is where things will get very interesting for the future of business. Scarcity is forcing activists to become more than value stockpickers, but exotic and operational nit-pickers on capital structure, products, personnel and R&D costs. They're turning into self-imposed management consultants.
All of this could bring some fresh innovation into the way American companies are run.
Points of agreement: (1) At the moment, it seems like activist investors are ruling the corporate roost. (2) Activists are turning from investors into self-appointed management consultants.
Points of (apparent) disagreement: (1) This may not be a permanent shift. For a brief period back in the 1980s, it looked like corporate raiders and their academic allies (Frank Easterbrook & Daniel Fischel, Ronald Gilson, etc....) had prevailed over management. But they got rolled back by a combination of litigation successes by management and developments like the poison pill. It remains possible that today's activists and their academic allies (e.g., Lucian Bebchuk) can be rolled back by a determined campaign of litigation, activist poison pills, and regulatory reform.
(2) Activist shareholders as management consultants is a terrible idea.
I address many of these points in my essay Preserving Director Primacy by Managing Shareholder Interventions:
Abstract ... Even though the primacy of the board of director primacy is deeply embedded in state corporate law, shareholder activism nevertheless has become an increasingly important feature of corporate governance in the United States. The financial crisis of 2008 and the ascendancy of the Democratic Party in Washington created an environment in which activists were able to considerably advance their agenda via the political process. At the same time, changes in managerial compensation, shareholder concentration, and board composition, outlook, and ideology, have also empowered activist shareholders.
There are strong normative arguments for disempowering shareholders and, accordingly, for rolling back the gains shareholder activists have made. Whether that will prove possible in the long run or not, however, in the near term attention must be paid to the problem of managing shareholder interventions.
This problem arises because not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors.
This [essay] proposes managing shareholder interventions through changes to the federal proxy rules designed to make it more difficult for activists to effect operational changes, while encouraging shareholder efforts to hold directors and managers accountable.
In this post, however, I want to focus on just one of those points; namely, the idea that activist investors are likely to be a positive force when it comes to operational decisions. In my essay, I wrote that:
Even if we grant Bebchuk (2013)’s claim that hedge funds have incentives to pursue what he calls “PP Action”—i.e., corporate courses of action that will have positive effects on both short- and long-term value—do we really think a hedge fund manager is systematically going to make better decisions on issues such as the size of widgets a company should make than are the company’s incumbent managers and directors? Of course, a hedge fund is more likely to intervene at a higher level of generality, such as by calling for the company to enter into or leave certain lines of business, demanding specific expense cuts, opposing specific asset acquisitions, and the like, but the argument still has traction. Because the hedge fund manager inevitably has less information than the incumbents and likely less relevant expertise (being a financier rather than an operational executive), his decisions on those sorts of issues are likely to be less sound than those of the incumbents. It was not a hedge fund manager who invented the iPhone, after all, but it was a hedge fund manager who ran TWA into the ground.
If Berman is right and operational interventions are going to become more likely because the activists have plucked all the low-hanging fruit, the need to roll back their gains becomes all the more urgent. The reforms that I and others have advocated are now essential if American business is to withstand the assault by the ilk of Ackman and Icahn, whose track record confirms they are not competent to run a business that actually makes goods and provides services.