Funny how one man’s shareholder activism is another man’s shareholder democracy.
As we’ve discussed, and as is probably evident to any reader of the Wall Street Journal, the corporate establishment has long been demonizing shareholder activists (ah, those long haired rebels!) of all sorts. Before, the Business Roundtable and the Chamber of Commerce lambasted environmental and corporate social responsibility advocates; now they savage shareholder activists, the hedge fund variety most of all. And these defenders of the corporate status quo invoke the same logic, sometimes even the same turns of phrase, that they did in their earlier campaigns.
Ironically, some of the elements of modern corporate practice, including ones that produced exorbitant CEO pay, came out of the efforts of an earlier generation of activists, namely the raiders of the 1980s. They were a much more threatening bunch that the current crop of sabre-rattlers. They took over fat companies, cut expenses, sometimes broke them up, and used the cash flow created to pay down the debt they used to acquire them. Oh, and they generally fired the incumbent management, which is why they were feared and loathed.
But their initiatives led many corporations to dispose of non-core assets, like oddball divisions, corporate art collections, and in-house jets. They thinned bloated head office staff and took a hard look at other expenses. And the managers that were brought in were given thin salaries and the opportunity to make fortunes if they improved performance. Most did.
The problem is that the lesson of this earlier generation of value-creation experts have been somewhat misapplied. Companies run unsustainably lean, in effect divesting. CEOs get high salaries and rich incentive pay, too often from growth in the general market price of stocks. Even though there are no takeover artists breathing down their necks, CEOs seem too ready to buy and sell divisions, eager to get a bump in the stock price, no matter how short lived.
So another round of getting wayward companies to be more responsive to shareholder interests in under way, generally in the form of hedge funds taking a substantial minority stake and lobbying for changes, sometimes seeking board seats if the company is recalcitrant. For example, Ramius Capital, a hedge fund with $7.9 billion in assets, has accumulated a 9% stake in Lamson & Sessions, an underperforming pipe and electrical equipment manufacturer. Ramius has put up its own slate of directors because the company has refused to take the steps it recommends, namely, selling its PVC division and using the proceeds to repurchase shares.
It turns out this sort of campaign doesn’t just benefit the hedge fund, but is also a plus for shareholders overall. The Financial Times, in Monday’s Lex column, cites an academic study that analyzed which types of hedge fund efforts were most beneficial. Ones that pursue changes in business strategy, as opposed to mere financial engineering, have the highest payoff to shareholders as a whole.
From the FT story:
Nicolas Sarkozy, French presidential candidate, lambasted hedge funds last week, saying he was “extremely troubled by speculative movements”. His bedtime reading probably does not include the latest in US academic research. A working paper on hedge fund activism concludes that, when they agitate for change, hedge funds can be beneficial for investors’ health.
The paper, by Alon Brav, Wei Jiang, Frank Partnoy and Randall Thomas, makes several intriguing observations. First, hedge fund agitators do not live up to their caricature as short-term speculators, with a median holding period of about a year. More important, their crusading seems to be linked to excess relative returns – ranging on average between 5 and 9 per cent – that do not dissipate in the months following regulatory filings. That should certainly count as wealth creation, though how much individual investors get after fees would make for good reading as well.
Second, some strategies are better than others. Market responses to changes in business strategy are more positive than to specific calls for changes in governance or capital structure. To be fair, many hedge funds request more than one outcome, so isolating the returns attributable to only one strategy is tricky. Still, it makes intuitive sense. Reasonable people can disagree on the benefits of aggressive leverage, but exiting an underperforming subsidiary can transform a company’s operational prospects.
Managers of companies do not often roll out the welcome mat when they are targeted. When hedge funds go on the offensive, target companies choose to fight them nearly half the time. That looks like it could be a waste of time, since the paper concludes that, in its sample, the hedge funds often get all or a major part of what they want. That should not be a surprise. If hedge funds go to the trouble and cost of waging war, they are not doing it to win popularity contests.
