A new paper by Alessio Paces puts a new and potentially very helpful spin on hedge fund activism (I say potentially only because I'm still thinking through the implications):
In my recent article, I discuss the policy response to hedge fund activism. I argue that the short-termism debate cannot shed light on the desirability of such activism. Rather, hedge fund activism should be regarded as a conflict of entrepreneurship, namely a conflict about the most efficient horizon to maximize profit. The choice of this horizon, which is uncertain, belongs to the entrepreneur. An engagement by hedge funds reveals that their views about this particular point differ from that of the incumbent management. Because the efficient horizon to maximize profit varies with the individual company and with time, companies should be able to choose whether to be exposed to hedge fund activism and to alter this choice during their existence. In particular, companies should be allowed to introduce dual-class shares after they have gone public, subject to a majority-of-minority shareholder vote. Such transactions would only be acceptable for institutional investors in the presence of investor protection guarantees, such as board representation, and sunset clauses. I argue that this solution is more efficient than general curbs on activism, including loyalty shares. ...
In my paper, I argue that institutional investors cannot always be trusted to make the right decision. Although there are no studies on which category of investors are decisive in hedge fund campaigns, conceptually the key investors are those that vote without having the option to exit strategically, namely the index funds. Empirical evidence reveals that most index fund managers vote actively and independently. However, asset managers usually base their voting on low-cost policies that tend to enhance the returns on their portfolio as a whole. As a result, the judgment by index fund managers is trustworthy as far as standard behaviors, such as expropriation or mismanagement of free cash, is concerned. The same judgment, however, cannot be relied upon when the issue is more about the strategy that a company should pursue. ...
This solution would provide the following advantages. First, the veto right by the institutional investors would screen for the companies for which curbing hedge fund activism can arguably increase value. Second, managers would have to commit to protecting investors against expropriation and mismanagement while the dual-class structure is in place. Third, institutional investors could only accept the restriction if it expires within a defined period, after which managerial performance will again be assessed by the market. In this way, dual-class shares would deliver one unfulfilled promise of loyalty shares, namely the temporary character of the departure from one-share-one-vote.
The article is available here.
I've written about dual class stock a couple of times, one of which is available at SSRN: The Short Life and Resurrection of SEC Rule 19c-4. Washington University Law Quarterly, Vol. 69, Pp. 565-634, 1991. Available at SSRN: https://ssrn.com/abstract=315375 or http://dx.doi.org/10.2139/ssrn.315375
