In the preceding post, I noted how even prominent social justice warrior CEO like Marc Benioff is embracing shareholder capitalism during the present economic turmoil. Why is he doing so? At least in part, according to the WSJ, because he's facing pressure from activist hedge funds:
At least five activist investors have taken positions in the company, including Elliott Management Corp. and Starboard Value LP. They are pressuring Mr. Benioff to change the way he runs things. In a presentation last year, Starboard said Salesforce wasn’t doing enough to increase profits.
This would not surprise readers of my book The Profit Motive, in which I discuss the role hedge funds like Elliott and Starboard have played in checking ESG impulses by CEOs. I used Etsy as a case study of the phenomenon:
The Etsy story in fact stands as a paradigmatic example of the increasing pressure public companies face from activist hedge funds to improve share price performance. ...
In one sense, activist hedge funds are akin to traditional value investors. They seek to identify target companies that they believe to be undervalued by the market. Unlike traditional value investors, activist funds are willing to be much more involved “hands on” investors. Although some activists seek value-enhancing changes through negotiation, the subcategory with which we are mainly concerned tend to be highly confrontational. In either case, however, the standard hedge fund compensation 2-and-20 rule—i.e., an annual management fee of two percent of assets under management and a performance fee of 20% of returns above a specified benchmark—encourages managers of these funds to have a laser-like focus on the stock price of the companies in which they invest. ...
Although activist investors formerly concentrated on low hanging fruit, which typically consisted of poorly managed small firms, they are increasingly willing to take on even the largest companies. Not surprisingly, the CFOs of about half of the companies surveyed by Deloitte reported their firm “made at least one major business decision specifically in response to shareholder activism,” with share repurchases being the most common. In many cases, such decisions have had distinctly negative effects on stakeholders.
As Marc Benioff is now finding out.
As longtime readers know, I am deeply skeptical of shareholder activism. In a book chapter, Preserving Director Primacy by Managing Shareholder Interventions, in Research Handbook on Shareholder Power 231 (Edward Elgar Publishing; Jennifer G. Hill & Randall S. Thomas eds. 2015), I argued that:
... 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.
I explained that:
As potential activists, hedge funds have several advantages. First, hedge funds are not subject to the sort of conflicts of interest that discourage activism by mutual funds and other financial institutions with relationships with corporate management. Second, hedge funds are not subject to the regulatory limitations applicable to mutual funds on the size of the stake they hold in portfolio companies. Hedge funds thus can take larger positions in portfolio companies than traditional mutual and pension funds, allowing them to capture a larger share of any gains. Third, because hedge fund compensation structures award them a percentage of any games earned by the fund, hedge fund managers have a higher incentive than those of mutual or pension funds to pursue activities that raise the value of their stake even if other investors are able to free ride on their efforts. (Effross 2013, 268) Finally, the free rider problem is further mitigated when multiple hedge funds band together in so-called wolf packs to target a specific company, sharing the costs and gains of activism.
...
Turning to the merits of the growing incidence of hedge fund activism, [Robin] Greenwood argues that “hedge funds may be up to the task of monitoring management—a number of recent academic papers have found that hedge funds generate returns of over 5 percent on announcement of their involvement, suggesting that investors believe these funds will increase the value of the firms they target.” (Greenwood 2007)
A recent study by Lucian Bebchuk, Alon Brav, and Wei Jiang of 2000 activist hedge fund interventions between 1994 and 2007 found “no evidence that interventions are followed by declines in operating performance in the long term; to the contrary, activist interventions are followed by improved operating performance during the five-year period following these interventions.” (Bebchuk et al. 2013) A contemporaneous literature review by Bebchuk concludes that shareholder interventions on the aggregate are “beneficial for companies and their shareholders both in the short term and the long term.”
I go on to express doubts about cases in which hedge fund managers advocate specific business decisions, while expressing less skepticism about cases--like the interventions at Salesforce and Etsy--that operate at a high level of generality and seek to hold directors accountable for focusing on interests other than those of shareholders.
