Christopher P. Skroupa: There has been extensive academic debate about whether activists create or destroy corporate value. What is the state of the evidence on this question?

Robert J. Jackson: While the weight of the evidence suggests that activism enhances, rather than destroys, long-term value, the question is far from resolved. One recent study found that the short-term value increases associated with activists’ 13D filings are sustained over a period of several years. Another paper, however, has indicated that those findings may simply be the product of a selection effect—that is, that hedge funds are simply good at finding firms that will soon improve their operations and hence their value. Researchers, policymakers, corporate directors and their counsel are still searching for decisive evidence on whether hedge fund activism is good or bad for long-term value creation.

Skroupa: What are the best arguments on each side about the effects of activists on long-term value?

Jackson: The strongest argument in favor of hedge-fund activism has been advanced by Lucian Bebchuk, who has forcefully contended that activists discipline corporate managers. In a world where the poison pill makes hostile takeovers nearly impossible, he argues, the threat of an activist attack, and the proxy fight that often comes with it, is the only way to ensure that corporate managers act in shareholders’ interests.

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Some of the most combative shareholders are deploying the most powerful weapon possible – sound advice.

Every business leader fears getting a certain kind of letter. It comes from an activist shareholder who has acquired at least 5 percent of the company’s stock and wants to have a meeting. You can’t just tell the investor to take a hike; that might lead to a battle to take over the company’s board and C-suite. And anyone who doesn’t want to hear what he has in mind should rethink that idea. We are living in a time when an activist just might have some good ideas for an operational overhaul- even if the advice is painful to hear.

Activism as we know it dates back to the 1980s- and 1990s- era private equity masters of the universe who relied on financial engineering, with their eye on short-term gains. The grandfather of shareholder activism, Carl Icahn, is still out there railing for stock buybacks reminiscent of his days as a corporate raider in the 1980s. But Icahn also owns or controls 11 companies that he’s trying to fix. When the private equity crowd found there were limits to financial engineering (for one thing, companies started doing it on their own), they began to focus on operational excellence.

Hedge funds and other shareholder activists have taken cues from the private equity playbook. Some of the more noteworthy examples of successful shareholder activism have been episodes in which the activist arrived intent on overhauling the operations of the company in ways that would boost its long-term value.

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Activist investors are a plus for firms they target – not just for days but for years, new research finds

Are activist investors mainly out to make a fast buck or are they a long-term plus for the companies they target? A paper that can lay claim to being the largest and broadest investigation of this hotly debated issue finds the latter to be generally the case.

Presented this month at the annual meeting of the American Accounting Association in New York, the study by Edward Swanson and Glen Young of Texas A&M University, essayed the largest sample of activist events yet examined – some 5,000 initiatives over 21 years. They report that the interventions not only occasioned a short-term boost in stock price but, on average, superior stock performance and strengthened company fundamentals over the long term.

In all, the study embraces 4,870 activist campaigns involving 2,652 unique firms, with the researchers monitoring indicators from two years before interventions to two years after. Most of the sample came from activism-monitoring website SharkRepellent.net. Ironically, the activists turned out to be less like sharks than friendly dolphins.

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The reasoning over short-term orientations is deeply flawed, writes Alfred Rappaport

Why do companies obsess over quarterly earnings and fail to invest adequately in long-term growth? And why would a company such as Volkswagen lie to its customers and government emission testers? Conventional wisdom places the blame squarely on the pursuit of shareholder value which, it is claimed, has fuelled pernicious short-term thinking and irresponsible behaviour.

That is wrong. The culprit is not shareholder value but rather corporate executives, investment managers and the business press who incorrectly believe that the governing objective of shareholder value is to boost a company’s near-term stock price by meeting the market’s quarterly earnings expectations. This misguided thinking has hijacked the good name of “shareholder value”. Consequently, companies commonly “talk” shareholder value but “walk” quarterly earnings in their everyday operations.

Let us be clear what managing for shareholder value really means. It means focusing on cash flow, not earnings. It means managing for the long-term, not the short-term. And it means that managers must take risk into account in their capital allocation decisions. Properly implemented, there is no better cure for short-termism than managing for shareholder value with its long-term orientation.

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Fallacy One: The terms short-term and long-term are used confusingly to mean different things at different points in the discussion.

Frequently, the terms short-term and long-term are used to refer to the period of time activists are reputed to maintain their ownership stake in a company. The implication (and frequently outright assertion) is that because activists are mere short-term holders, they are not entitled to the same voice in a company’s governance as obviously more virtuous and deserving long-term holders.

There are two fatal flaws in this reasoning. First, many studies have demonstrated that, on average, activist investors maintain their position for a matter of years, not months. Second, there is no rational reason to think that long-term shareholders have special insights into or understanding of corporate decisions and strategy. Indeed, if the long-term holder is, as increasingly is the case, an index fund, by hypothesis its investment has nothing to do with a company’s strategy or business decisions, and the investment manager has no basis to claim any knowledge or insights.

Confusingly, critics of activist investors also conflate the putative holding period of the activist with the implementation period for the program advocated by the activist investor. Castigating a corporate strategy as short-term, rather than long-term, simply misses the point. The issue is not the duration of time required for implementation, but rather the value creation potential of the program.

No rational investor, or company manager, would (one would hope) advocate adoption of a longer-term strategy over a shorter one, if the shorter one had a higher value creation opportunity. The confusing use of the terms short-term and long-term lead directly to the second major fallacy of the anti-activist literature.

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The head of the Humane Society, with the help of Carl Icahn, got McDonald’s to change its policy toward pork. Sixty brands followed.

In 2011, Wayne Pacelle got a phone call from a man he didn’t know. Mr. Pacelle is president of the United States Humane Society, the animal-protection group. The caller was Carl Icahn, the activist investor. “I understand you are working against animal cruelty,” he said, “and I’d like to help.” The Humane Society had many supporters in business, politics and the arts, but Mr. Icahn was a step above: He could get the attention of powerful CEOs anywhere in the world.

After several meetings with Mr. Icahn, Mr. Pacelle decided to aim high. He asked Mr. Icahn for his help in changing the policy of McDonald’s, one of the world’s greatest brands.

The Humane Society had already urged McDonald’s to adopt a more humane approach to the treatment of animals and had won some public support during a yearslong campaign. Still, as Mr. Pacelle writes in “The Humane Economy,” he suspected that the company “might need an extra kick in the pants that only [Carl Icahn] could deliver.”

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The “meh” economy that accounts for some of the sourness in the American electorate is partly due to a design flaw in the US corporate governance system. One proffered diagnosis is that companies invest for the short term and are too quick to return cash to shareholders through stock repurchases.

Why? It’s the attack of hedge funds, shareholder activists looking for short term gain even at the expense of investments that would produce higher returns over the long run, and, along the way, would lead to employment gains and then wage gains. What follows, then, is a prescription for changes in tax policy and legal rules that would hamper the activists, all to promote the “long run.”

But this is a misdiagnosis, which fails to realize that the shareholders activists’ success reveals a major shortfall in corporate governance for large public corporations.

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It looks as if hedge fund activists engineer not just a short-term pop in target firms’ stock prices but also long-term improvements in innovation.

While studies have shown that news of an activist position in a stock leads to a 5 to 7 percent pop, some have argued that hedge funds are simply creating a short-term share price gain at the expense of long-term competitiveness and productivity.

That’s partly gainsaid by data showing no decline in share or operating performance in the five years after an initial intervention by an activist investor. It’s also true that activist campaigns often, if not always, lead to cutbacks in the size of firms and of their research and development efforts.

A new working paper finds benefits to innovation at firms which get picked on by hedge fund activists, benefits which may extend to other firms not directly involved.

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The activists are taking on Washington.

Billionaire investors Paul Singer, Carl Icahn, Barry Rosenstein, William Ackman andDaniel Loeb are setting aside their political differences to launch a Washington-based lobbying group to fight mounting attacks on shareholder activism.

Dubbed the Council for Investor Rights and Corporate Accountability, or Circa, it is the first coordinated effort by activists to make their case to lawmakers and the American public that their investment strategy helps, rather than harms, companies and the U.S. economy.

The lobbying push comes as debate over the merits of activist investing spills over into the presidential campaign. Hillary Clinton last year proposed changing the tax code to crack down on “hit and run” activists. In March, Bernie Sanders, Mrs. Clinton’s rival for the Democratic presidential nomination, co-signed legislation aimed at their ability to buy stakes and influence companies.

Activist investors have targeted some of the biggest companies in the U.S., from Apple Inc. to Procter & Gamble Co. to Dow Chemical Co., agitating for an array of changes designed to boost shareholder value.
Circa’s five backers together manage about $90 billion. The group’s message to lawmakers: Activist investors, as owners of the companies they target, are spurring a debate about corporate decision making that has the potential to benefit all shareholders and, by extension, the broader economy.

“We’re telling a story about an ecosystem and how they help America and make it a competitive system,”

said Rob Collins, a political strategist who is advising Circa.

 

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Co-authors of “Top Hedge Funds: The Importance of Reputation in Shareholder Activism,” which found that

“The most reputed hedge funds have more assets under management, a longer track record of activism, a history of obtaining board seats, and invest in targets with the intent of making board changes.

Top activists’ reputations prove to have been deserved: their targets enjoy superior operating performance post intervention.”

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