The usual answer is that activists have a short-term focus. But while that is sometimes true, it's not the real issue. Jeffrey Gordon makes this point succinctly in a recent post:
When we examine the behavior of institutional investors who are the majoritarian stockholders of the largest public firms, we learn that the same investors who purportedly follow the activists’ siren song for the “short term” also turn over large sums to venture capital firms and private equity for investment in promising companies over a ten year commitment period. This is the very definition of long term investing.
Instead, the real issue is whether activists are able to come up with strategic plans for portfolio companies that are superior to whose of the incumbent board and managers. Gordon thinks they are:
Ownership of large public companies is now re-concentrated in institutional investors – pension funds, mutual funds, insurance companies — which have the capacity to evaluate competing strategic alternatives for portfolio companies. Now turn to an activist’s campaign, which starts with a claim that the current management is making serious operational or strategic mistakes, reflected in the company’s underperformance. Institutional investors have the voting power to determine the outcome; how should they respond? To start, institutions increasingly have come to understand the activist is sincere in its belief about problems at the “target,” since it has made a significant upfront investment and has a business model that depends upon repeated successful engagements. ...
In short, the present wave of shareholder activism shows us that the current corporate governance infrastructure is creaky, a swaying bridge that needs renewal. To cast this as a debate over “short term” vs. “long term” misunderstands a genuine problem.
This is where I (respectfully) disagree. As I argued in my essay Preserving Director Primacy by Managing Shareholder Interventions (August 27, 2013), available at SSRN: http://ssrn.com/abstract=2298415:
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.
But even so, Gordon does make one point with which I am in agreement:
Reform should move not in the direction of closing down the activists who are bringing the news about this design flaw. Rather we should develop a new role for the board: credibly evaluating and then verifying that management’s strategy is best for the company (or making changes if it is not). Boards need directors who will have that credibility, which is won through deep knowledge about the company and its industry and an appropriate time commitment. Venture capital and private equity firms attract funds for long term investing because they provide a different style of corporate governance that includes directors who are engaged and knowledgeable. Such “thickly informed” directors provide “high powered” monitoring of managerial performance. They enable investors to trust that the firm is pursuing a planning horizon that is suited to its genuine opportunities, “right termism.” Public corporations will be better run if their boards are staffed by directors with such capacities.
Which brings me to my article with Todd Henderson Boards-R-Us: Reconceptualizing Corporate Boards (July 10, 2013), available at SSRN: http://ssrn.com/abstract=2291065:
State corporate law requires director services be provided by “natural persons.” This Article puts this obligation to scrutiny, and concludes that there are significant gains that could be realized by permitting firms (be they partnerships, corporations, or other business entities) to provide board services. We call these firms “board service providers” (BSPs). We argue that hiring a BSP to provide board services instead of a loose group of sole proprietorships will increase board accountability, both from markets and judicial supervision. The potential economies of scale and scope in the board services industry (including vertical integration of consultants and other board member support functions), as well as the benefits of risk pooling and talent allocation, mean that large professional director services firms may arise, and thereby create a market for corporate governance distinct from the market for corporate control. More transparency about board performance, including better pricing of governance by the market, as well as increased reputational assets at stake in board decisions, means improved corporate governance, all else being equal.
I believe that permitting BSPs would provide precisely the sort of board reform for which Gordon correctly calls.
