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The Limits of Private Equity Shareholder Activism

From Deal Journal:

The best advice for investors in companies that are targeted by activist shareholders like Carl Icahn and Nelson Peltz may be this: wait for the stock to pop and then head for the hills.

Harvard has a new study out that examines the performance of shares in companies targeted by activists. (Read about it in this Wall Street Journal article today.) The upshot: the modern day corporate raiders are only going to make other shareholders money if their goal is to get the target company sold — and they succeed.

Why? It seems that the skill of activists like Icahn, Peltz and William Ackman is in judging the value of companies in a sale, and not in figuring out how to improve companies’ operations and profits. Says Robin Greenwood, the Harvard assistant professor who conducted the study: “They’re investors. They’re not operating guys.” Icahn’s failed bid to shake up Motorola, and his only-somewhat-successful campaign at Time Warner are cases in point. (To be fair, Icahn reaped profits for his investors off the Time Warner campaign, and Greenwood says Icahn is among a group of activists that are a cut above the rest.)

The study’s findings go against the commonly held belief that companies benefit from activist attention. That is why shares initially tend to rise when these investors come to town. If the study’s conclusions are correct, in most cases those stocks won’t stay up for long. Especially now that there are few M&A suitors to bail any investors out.

Interestingly, the HBS abstract of the study also calls into question the utility of shareholder activism by standard institutional investors:

Are hedge funds better than large institutional investors at identifying undervalued companies, locating potential acquirers for them, and removing opposition to a takeover? Are they best equipped to monitor management? While blockholding by large institutional investors—pension funds and mutual fund investment companies—is widespread, there is virtually no evidence that these institutional shareholders are effective monitors of management or that their presence in the capital structure increases firm value. When institutional blockholders make formal demands on management, there is no evidence of their success. This working paper outlines the advantages and limits of hedge funds to manage these tasks. Greenwood and Schor's characterization differs markedly from previous work on investor activism, which tends to attribute high announcement returns to improvements in operational performance.

The study is available here in full text. A summary HBS Working Knowledge article is here.

Dutch Dominicans' Heterodoxy

Over at MoJ, Michael Perry cites (seemingly approvingly) the following report:

THE DOMINICAN Order in the Netherlands has issued a radical recommendation that lay ministers chosen by their congregations should be allowed to celebrate the Eucharist if no ordained priests are available.

In a booklet posted to all 1,300 parishes in the country, it says that the Church should drop its priest-centred model of the Mass in favour of one built around a community sharing bread and wine in prayer.

"Whether they are women or men, homo- or heterosexual, married or single, makes no difference. What is important is an infectious attitude of faith," said the brochure, which has been approved by the Dutch order's leaders. However, the Dutch bishops' conference promptly said that the booklet appeared to be "in conflict with the faith of the Roman Catholic Church". It said it had no prior knowledge of the project and needed to study the text further before issuing a full reaction.

The proposal doesn't just appear to be inconsistent with Catholic teaching; it is inconsistent with Catholic teaching. Paragraphs 1141 and 1142 of the Catechism teach that:

The celebrating assembly is the community of the baptized who, "by regeneration and the anointing of the Holy Spirit, are consecrated to be a spiritual house and a holy priesthood, that through all the works of Christian men they may offer spiritual sacrifices."⁹ This "common priesthood" is that of Christ the sole priest, in which all his members participate:

Mother Church earnestly desires that all the faithful should be led to that full, conscious, and active participation in liturgical celebrations which is demanded by the very nature of the liturgy, and to which the Christian people, "a chosen race, a royal priesthood, a holy nation, a redeemed people," have a right and an obligation by reason of their Baptism.

But "the members do not all have the same function." Certain members are called by God, in and through the Church, to a special service of the community. These servants are chosen and consecrated by the sacrament of Holy Orders, by which the Holy Spirit enables them to act in the person of Christ the head, for the service of all the members of the Church. The ordained minister is, as it were, an "icon" of Christ the priest. Since it is in the Eucharist that the sacrament of the Church is made fully visible, it is in his presiding at the Eucharist that the bishop's ministry is most evident, as well as, in communion with him, the ministry of priests and deacons.

Paragraph 893 likewise affirms that:

The bishop is "the steward of the grace of the supreme priesthood," especially in the Eucharist which he offers personally or whose offering he assures through the priests, his co-workers. The Eucharist is the center of the life of the particular Church. The bishop and priests sanctify the Church by their prayer and work, by their ministry of the word and of the sacraments. They sanctify her by their example, "not as domineering over those in your charge but being examples to the flock." Thus, "together with the flock entrusted to them, they may attain to eternal life."

Hence, Pope John Paul II in Ecclesia de Eucharistia affirmed that:

The ministry of priests who have received the sacrament of Holy Orders, in the economy of salvation chosen by Christ, makes clear that the Eucharist which they celebrate is a gift which radically transcends the power of the assembly and is in any event essential for validly linking the Eucharistic consecration to the sacrifice of the Cross and to the Last Supper. The assembly gathered together for the celebration of the Eucharist, if it is to be a truly Eucharistic assembly, absolutely requires the presence of an ordained priest as its president. On the other hand, the community is by itself incapable of providing an ordained minister. This minister is a gift which the assembly receives through episcopal succession going back to the Apostles. It is the Bishop who, through the Sacrament of Holy Orders, makes a new presbyter by conferring upon him the power to consecrate the Eucharist. Consequently, “the Eucharistic mystery cannot be celebrated in any community except by an ordained priest, as the Fourth Lateran Council expressly taught”.

JP II went on to explain that:

All of this shows how distressing and irregular is the situation of a Christian community which, despite having sufficient numbers and variety of faithful to form a parish, does not have a priest to lead it. Parishes are communities of the baptized who express and affirm their identity above all through the celebration of the Eucharistic Sacrifice. But this requires the presence of a presbyter, who alone is qualified to offer the Eucharist in persona Christi. When a community lacks a priest, attempts are rightly made somehow to remedy the situation so that it can continue its Sunday celebrations, and those religious and laity who lead their brothers and sisters in prayer exercise in a praiseworthy way the common priesthood of all the faithful based on the grace of Baptism. But such solutions must be considered merely temporary, while the community awaits a priest.

The sacramental incompleteness of these celebrations should above all inspire the whole community to pray with greater fervour that the Lord will send labourers into his harvest (cf. Mt 9:38). It should also be an incentive to mobilize all the resources needed for an adequate pastoral promotion of vocations, without yielding to the temptation to seek solutions which lower the moral and formative standards demanded of candidates for the priesthood.

As an adult convert from Protestantism, perhaps I am unduly sensitive on this point. Yet, the Dutch Dominician proposal for lay conduct of the Eucharist strikes me as precisely the sort of Protestant heterodoxy regarding the priesthood of all believers that prompted JP II to warn that "The Catholic faithful, therefore, while respecting the religious convictions of these separated brethren, must refrain from receiving the communion distributed in their celebrations, so as not to condone an ambiguity about the nature of the Eucharist and, consequently, to fail in their duty to bear clear witness to the truth."

MOJ Joint Statement on the Situation at Ave Maria School of Law

From MOJ:

We, the members of Mirror of Justice, are a group of Catholic and Christian law professors and former law professors. We wish to express our profound concern with the course of events at Ave María School of Law (“AMSL”). While we differ among ourselves in our religious and political convictions, we share a commitment to Catholic legal education and respect Ave Maria's serious desire to express its religious identity. We write as legal academics and as persons who believe and expect a Catholic law school to be “a living institutional witness to Christ and his message.” (Ex Corde Ecclesiae, ¶ 49).

The statement goes on to explain the standards by which we evaluated the situation, our understanding of the core facts of gravest concern, and the conclusions we have drawn. In closing, we wrote:

By the failure to live their Christian commitment, the AMSL Dean and Board cause scandal in the legal, academic, and religious communities. This scandal is exacerbated by the fact that their actions are taken on behalf of a law school named for the Blessed Mother of Christ. We echo this sentiment expressed earlier by an MOJ contributor: “The hour is not too late for [AMSL’s Dean and Board] to model for the legal and academic communities the essence of a Catholic Christian law school. In fact, [we] would suggest [that they] have a better, clearer opportunity to mirror Christ now than when [they] first began because the only path left open is through the cross. It may not be what [they] had planned, but God works in mysterious ways.”

We pray that all involved with AMSL will have the courage to exercise the convictions of Christian discipleship to reconcile all parties involved in the matters we have discussed.

I am proud to be part of the blogging community at MOJ and to have co-signed this important statement.

Arend on Goldsmith

Jack Goldsmith's book, The Terror Presidency, is getting an enormous amount of coverage, including a lengthy article by Jeffrey Rosen for the NYT Magazine. My friend, international law expert Tony Arend comments:

One of the great problems of the past has been that both the Executive and the Legislative branches have had a tendency to engage in what might be called "line-drawing exercises" when it comes to certain questions of constitutional power. The Bush Administration has been the master of this, making assertion after assertion about the exclusive powers of the commander-in-chief and admiting of no role for Congress in those areas. But Congress has also engaged in such line-drawing activities in the past-- the War Powers Resolution would be one of the prime examples. In that Resolution, Congress boldly asserted that

The constitutional powers of the President as Commander-in-Chief to introduce United States Armed Forces into hostilities, or into situations where imminent involvement in hostilities is clearly indicated by the circumstances, are exercised only pursuant to (1) a declaration of war, (2) specific statutory authorization, or (3) a national emergency created by attack upon the United States, its territories or possessions, or its armed forces. (emphasis added)

It is, of course, interesting to note that this provision of the War Powers Resolution does not seem to have been taken very seriously by either Branch--perhaps because of its extremism.

While there will be times when courts must decide the precise allocation of powers between the Branches, in many cases relating to foreign affairs and national security, it makes more sense to avoid line-drawing exercises that set up confrontations. More often than not, political accommodation makes more sense. Congress and the President can still have their understandings of the ultimate allocations of power, but they can bracket those claims and negotiate an approach to addressing certain concrete problems. I believe that the original Foreign Intelligence Surveillance Act represented this type of political accommodation. The President did not give up his claims to be able to conduct surveillance without a warrant in cases of a foreign power or agent, but rather the President and Congress agreed to bracket that claim and establish a functioning framework so that the ultimate question of presidential power would not need to be addressed.

We can only hope that in the next administration, the President and Congress will have the wisdom to engage in a political accommodation approach more often than in the past.

Union Pension Funds

My Examiner column:

Even though Labor Day is over, it’s still worth thinking about the role of unions in our economy. In some respects, private sector unions are almost powerless. The percentage of private sector workers who are unionized has been declining steadily since the mid-1950s.

Even though our population and the number of private sector jobs both continue to grow, the number of union members in absolute terms peaked in 1970 and today is less than half of its maximum figure. If it weren’t for public sector unions, organized labor would be a spent force.

On the other hand, what they lack in raw numbers, the unions increasingly make up in economic clout via their pension funds. The Teamsters pension fund, to cite but a single example, has more than $100 billion invested.

The National Center for Policy Analysis estimates that union pension holdings now exceed $1.4 trillion, representing almost 15 percent of all outstanding shares of stock. All told, union pension funds represent one of the largest blocks of investors in the U.S. stock market, which gives them enormous potential clout.

Union leaders recognize that their pension funds represent an important source of power.They have become activist investors, using Securities and Exchange Commission rules to put proposals up for a shareholder vote, bargaining with management, influencing the outcome of proxy contests and takeover bids, and even seeking representation on boards of directors.

Defenders of union pension fund activism argue that the unions are simply making use of rights shared by all investors. In fact, however, there’s good reason to think that union pension funds are one of the classes of institutional investors most likely to use their position to self-deal — i.e., to take a non-pro rata share of the firm’s assets and earnings — or to otherwise reap private benefits not shared with other investors.

With respect to union pension fund sponsorship of shareholder proposals under existing law, for example, Yale law professor and corporate governance expert Roberta Romano observes that "examples of potential benefits which would be disproportionately of interest to proposal sponsors are progress on labor rights desired by union fund managers. ..." In contrast, she points out, private sector fund managers are far less likely to get private benefits from activism and, accordingly, "we do not find them engaging in investor activism."

In addition to tangible private benefits, activist union investment managers also get psychic and political benefits. In a blog post at Conglomerate.org, law professor Brett McDonnell opined that when union pension funds "go after powerful, overpaid CEOs, part of their explicit point is a populist attack on privilege. That’s cool with me, and I suspect it’s cool with a lot of their constituents as well."

As a 2005 Wall Street Journal editorial explained, however, this sort of activism is distinctly uncool. It represents what the left calls "the new politics of capital," in which liberal activists attempt to turn entire corporations into lobbyists for their social and political goals, their campaigns all neatly disguised as "shareholder activism."

Not surprisingly, this sort of union activism routinely puts organized labor at odds with the interests of other investors. The pension fund of the union representing Safeway workers used its position as a Safeway shareholder in an attempt to oust directors who had stood up to the union in collective bargaining negotiations.

Indeed, union pension funds tried to remove directors or top managers, or otherwise affect corporate policy, at more than 200 corporations in 2004 alone. Brokerage houses that openly supported privatization of Social Security assets were put on notice that unions would pull their money if such support continued. Union pension funds reportedly have also tried shareholder proposals to obtain employee benefits they couldn’t get through bargaining.

Equally unsurprisingly, however, because most of the private benefits from pension fund activism redounds to the benefit of the fund managers or union leadership, union activism also routinely puts their interests at odds with those of the union members whose pensions they manage. Many union members would have gotten better returns from a low-fee indexed fund in a 401(k) than they get from their union pension fund.

The SEC is considering proposals to further empower shareholder activists. As the commission does so, it would be well advised to consider carefully just which investors would be empowered and toward what ends.

A SOX Lesson in an Odd Place

Glenn Reynolds is posting on Jack Goldsmith's book The Terror Presidency, from which he quotes the following:

[Bush officials running the GWOT] worried nonetheless because they would be judged in an atmosphere different from when they acted, because the criminal investigative process is mysterious and scary, because lawyers' fees can cause devastating financial losses, and because an investigation can produce reputation-ruining dishonor and possibly end one's career, even if you emerge "innocent."

Which prompted a Reynolds reader to write:

Welcome to the post-SarBox, Elliott Spitzer world. We in business face this on a regular basis. I can’t decide whether I’m glad public servants experience the same headaches we do or concerned because an intelligence/military failure costs lives, while a business failure costs only money (though when Spitzer was around, it also sometimes cost freedom).

In business, not only has bad judgment become a crime, so has a good decision made on the basis of incomplete information, which later turns out to have been the wrong call. This is not good for America, where innovation and risk are what we do better than Europe, China, or India.

Precisely.

Survey of Law Faculties by Scholarly Impact

Brian Leiter has released the results of his latest "ranking of the top 35 law faculties based on a standard 'objective' measure of scholarly impact:  per capita citations to faculty scholarship." There's a good discussion of the methodology and a candid analysis of the limitations of citation counts.

So how'd we do? UCLA ranked 10th by mean per capita impact, with the 10 most frequently cited scholars being: "R. Abel, S. Bainbridge, K. Crenshaw, J. Kang, R. Korobkin, L. LoPucki, N. Netanel, K. Stone, L. Stout, E. Volokh." What's interesting about that list (to me) is that for a school long known as a center of public law, 6 of the most productive scholars on are faculty are exclusively or, at least, primarily focused on private law (me, Korobkin, LoPucki, Netanel, Stone, and Stout).

Bruner on Director Primacy and Other Pure Theories of Corporate Governance

I first encountered the work of Texas Tech law professor Christopher Bruner when researching my recent article on good faith in corporate law. He had written a couple of very fine articles on that subject, from which I learned a lot. In a more recent article, The Enduring Ambivalence of Corporate Law, he ambitiously challenges just about everybody in corporate law. Bruner argues that "we have three prevailing theories, each of which has 'dealt deadly blows to the other,' as Hart might put it." These are nexus of contracts (into which he lumps my director primacy theory), Blair & Stout's team production, and shareholder-centric theorists.

Prevailing theories of corporate law tend to rely heavily on strong claims regarding the corporate governance primacy and legitimacy of either the board or the shareholders, as the case may be. In this paper I challenge the descriptive power of these theories as applied to widely held public corporations and advance an alternative, arguing that corporate law is, and will remain, deeply ambivalent - both doctrinally and morally - with respect to three fundamental and related issues: the locus of ultimate corporate governance authority, the intended beneficiaries of corporate production, and the relationship between corporate law and the achievement of the social good.

Let's look at a couple of Bruner's critiques that relate to director primacy in detail.

Bruner writes that  "it nevertheless has a difficult time accounting for the law of corporate takeovers, and the absence of any clear mandate to maximize the wealth of shareholders under any but the most limited circumstances." With all due deference, I thought I did a pretty good job of addressing those points in Unocal at 20: Director Primacy in Corporate Takeovers, 31 Delaware Journal of Corporate Law 769 (2006), which argued that:

Unocal is almost universally condemned in the academic corporate law literature. Building on his director primacy model of corporate governance and law, however, Bainbridge offers a defense of Unocal in this article. Bainbridge argues that Unocal strikes an appropriate balance between two competing but equally legitimate goals of corporate law: On the one hand, because the power to review differs only in degree and not in kind from the power to decide, the discretionary authority of the board of directors must be insulated from shareholder and judicial oversight in order to promote efficient corporate decision making. On the other hand, because directors are obligated to maximize shareholder wealth, there must mechanisms to ensure director accountability. The Unocal framework provides courts with a mechanism for filtering out those cases in which directors have abused their authority from those in which directors have not.

Since Bruner didn't address the arguments made therein, I won't further belabor them here.

Bruner at 14 argues that:

The very existence of any shareholder voting power inevitably proves problematic for those who identify the board as the very essence of the corporate enterprise itself. Bainbridge, for example, who depicts the board as a “sui generis body” and “a sort of Platonic guardian,” justifies giving voting power to shareholders by reference to the disciplinary effects of the market for corporate control (made possible by the transferability of their interests), but then proves amenable to “sharply constrain[ing]” the market for control through takeover defenses in favor of the efficiency of board governance – an account that undercuts its own explanation for the existence of even minimal shareholder voting rights.

Here he touches a nerve. In a world of pure director primacy, in which directors could be counted on to be faithful to the shareholder wealth maximization norm, shareholder voting rights likely would not exist.

I struggled with this issue most recently in The Case for Limited Shareholder Voting Rights, 53 UCLA Law Review 601 (2006), in which I argued that "shareholder voting is properly understood not as an integral aspect of the corporate decision-making structure, but rather as an accountability device of last resort to be used sparingly, at best." Why sparingly? Because corporate governance is made at the margins of an unending competition between two competing values; namely, authority and accountability. Both are essential to effective corporate governance, but they are ultimately irreconcilable. Efforts to hold someone to account inevitably limit their discretion. The inconsistency Bruner claims to see in my work arises inherently out of the tension between authority and accountability. Shareholder voting is an accountability mechanism, exercised mainly through the takeover market, but preservation of the board's authority requires that both the franchise and the market for corporate control have limits. (This, by the way, is another theme of Unocal at 20.)

Bruner makes a good case that "pure" theories of corporate governance all have problems. I've believed for a long time that there is no unified field theory that explains all of corporate governance. In Executive Compensation: Who Decides?, 83 Texas Law Review 1615, 1628 (2005), for example, I wrote that:

Physicists have long sought a unified field theory, which would provide a single set of simple laws that explain the four interactions or forces that affect matter--i.e., the strong, electromagnetic, weak, and gravitational forces. To date, they have failed, which provides a strong cautionary tale for anyone seeking a unified field theory of social interactions among fallible humans, whose behavior is far harder to predict than is that of, say, an electron.

But so what? Elegant and parsimonious models are more important for economists than for lawyers. Instead, situation-specific mini-theories often are more useful for making legal decisions than a single unified theory. I thus don't claim that director primacy explains everything about corporate governance. I simply believe that has a larger domain of explanatory and justificatory power than any other theory on the market. Bruner's article didn't change that, which I suspect won't surprise him (or anybody else).

In any case, kudos to Bruner for a very fine article that provoked a blog post that's going to get dropped straight into my forthcoming book on director primacy.

New Opinion on Appraisal as Supplemental BA Teaching Materials

Delaware law blogger Francis Pileggi flags Highfields Capital, Ltd. v. AXA Financial, Inc., 2007 WL 2410295 (Del. Ch., Aug. 17, 2007), an opinion by VC Stephen Lamb that addresses in considerable detail yet with excellent clarity the appraisal remedy. Lamb provides a concise review of the relevant legal principles governing a Delaware appraisal proceeding, reviews the testimony of experts, rejects the expert tetimony from both sides, and then crunches the numbers himself. The analysis is at too high a level of detail for inclusion in KRB's Business Associations casebook. Faculty who use our casebook in advanced courses (e.g., I'll be using it to teach Corporate Finance next Spring), however, ought to consider this case as supplemental teaching material. As Pileggi observed:

This case can serve as a helpful tutorial on Delaware appraisal actions and the DCF as well as other valuation methods considered by the Delaware courts. Footnotes 20 through 30 contain an excellent collection of  seminal Delaware cases on appraisal proceedings and the corresponding standards that the courts apply in these cases.

The UC Irvine Law School

Thomas Lifson observes:

The nascent law school designed to produce left wing lawyers (aka "public interest lawyers") is reported to be considering the perfect dean: UC Irvine is talking with Erwin Chemerinsky, according to the Los Angeles Times. Despite being declared unnecessary by the official body charged with evaluating higher education proposals, the University of California Irvine is pressing ahead, and with a $20 million donation in hand from Orange County billionaire Donald Bren, the newly-named Donald Bren School of Law is able to hire away.

Nobody denies that Chemerinsky is a smart and agile legal thinker (and talker). But he is also about as left wing as they come [intellectual division], the favorite superstar of the (needless to say, left) establishment in law, journalism, activism, and "public interest" circles.

Both Lifson and I have previously observed that the people behind new UC Irvine law school aren't being very subtle about their plans that the school have a distinct tilt to the left. Just once I'd like to see a new law school founded on the principles of free enterprise, limited government, judicial modesty, and the like. But I'm not going to hold my breath.

Some Labor Day Reading

Employee Involvement in Workplace Governance Post-Collective Bargaining: Prepared for a festschrift in honor of Philip Selznick, this essay looks back at his 1969 book Law, Society, and Industrial Justice. The focus is on employee participation in corporate decisionmaking. Taking an interdisciplinary approach (law and sociology), Selznick treats employee involvement as a means to an end; namely, industrial justice. In this model, employee participation is channeled through the collective bargaining system, especially the grievance arbitration process. Participation through such means is desirable, Selznick posits, because it promotes employee self-actualization, confers legitimacy on the enterprise, and protects employees from opportunism. Although acknowledging that LSIJ was an important scholarly work, this essay argues that the decline of private sector collective bargaining and the move towards alternative forms of participatory management calls into question the continuing vitality of Selznick's argument. The essay concludes that a transaction costs economics-based approach to employee involvement is far more revealing than Selznick's sociology-based model, in that it offers generalized predictions about the function of employee involvement that have proven explanatory over time.