A Wachtell Lipton memorandum by Martin Lipton, Steven A. Rosenblum, and Sabastian V. Niles
Current Thoughts About Activism, Revisited
We published this note last August. Since then there have been several developments that prompt us to revisit it; adding the first three paragraphs below.
First, Delaware Supreme Court Chief Justice Leo E. Strine, Jr. published a brilliant article in the Columbia Law Review, Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law in which he points out the serious defects in allowing short-term investors to override carefully considered judgments of the boards of directors of public corporations. Chief Justice Strine rejects the argument of the academic activists and activist hedge funds that shareholders should have the unfettered right to force corporations to maximize shareholder value in the short run. We embrace Chief Justice Strine’s reasoning and conclusions.
Second, almost simultaneously with Can We Do Better, Laurence Fink, Chairman and CEO of BlackRock, one of the largest and most successful investment managers, expressing another policy position we embrace, wrote to the CEOs of the S&P 500:
Many commentators lament the short-term demands of the capital markets. We share those concerns, and believe it is part of our collective role as actors in the global capital markets to challenge that trend. Corporate leaders can play their part by persuasively communicating their company’s long-term strategy for growth. They must set the stage to attract the patient capital they seek: explaining to investors what drives real value, how and when far-sighted investments will deliver returns, and, perhaps most importantly, what metrics shareholders should use to assess their management team’s success over time.
It concerns us that, in the wake of the financial crisis, many companies have shied away from investing in the future growth of their companies. Too many companies have cut capital expenditure and even increased debt to boost dividends and increase share buybacks. We certainly believe that returning cash to shareholders should be part of a balanced capital strategy; however, when done for the wrong reasons and at the expense of capital investment, it can jeopardize a company’s ability to generate sustainable long-term returns.
We do recognize the balance that must be achieved to drive near-term performance while simultaneously making those investments—in innovation and product enhancements, capital and plant equipment, employee development, and internal controls and technology—that will sustain growth.
BlackRock’s mission is to earn the trust of our clients by helping them meet their long-term investment goals. We see this mission as indistinguishable from also aiming to be a trusted, responsible shareholder with a longer term horizon. Much progress has been made on company-shareholder engagement and we will continue to play our part as a provider of patient capital in ensuring robust dialogue. We ask that you help us, and other shareholders, to understand the investments you are making to deliver the sustainable, long-term returns on which our clients depend and in which we seek to support you.
Third, we have added three additional academic articles supporting the policy positions we embrace, and we have minor changes in the text.
We believe that a long-term oriented, well-functioning and responsible private sector is the country’s core engine for economic growth, national competitiveness, real innovation and sustained employment. Prudent reinvestment of corporate profits into research and development, capital projects and value-creating initiatives furthers these goals. Yet U.S. companies, including well-run, high-performing companies, increasingly face:
challenges in trying to balance competing interests due to excessively empowered special interest and activist shareholders; and
significant strain from the misallocation of corporate resources and energy into mandated activist or governance initiatives that provide no meaningful benefit to investors or other critical stakeholders.
These challenges are exacerbated by the ease with which activist hedge funds can, without consequence, advance their own goals and agendas by exploiting the current regulatory and institutional environment and credibly threatening to disrupt corporate functioning if their demands are not met. Activist hedge funds typically focus on immediate steps, such as a leveraged recapitalization, a split-up of the company or sales or spinoffs of assets or businesses that may create an increase in the company’s near term stock price, allowing the activist to sell out at a profit, but leaving the company to cope with the increased risk and decreased flexibility that these steps may produce.
The power of the activist hedge funds is enhanced by their frequent success in proxy contests when companies resist the short-term actions the hedge fund is advocating. These proxy contest successes, in turn, are enabled by the outsized power of proxy advisory firms and governance reforms that weaken the ability of corporate boards to resist short-term pressures. The proxy advisory firms are essentially unregulated and demonstrate a general bias in favor of activist shareholders. They also tend to take a one-size-fits-all approach to policy and voting recom-mendations without regard for or consideration of a company’s unique circumstances.
This approach includes across-the-board “withhold votes” from directors if the directors fail to implement any shareholder proposal receiving a majority vote, even if directors believe that the proposal would be inconsistent with their fiduciary duties and the best interests of the company and its shareholders. Further complicating the situation is the fact that an increasing number of institutional investors now invest money with the activist hedge funds or have portfolio managers whose own compensation is based on short-term metrics, and increasingly align themselves with the proposals advanced by hedge fund activists. In this environment, companies can face significant difficulty in effectively managing for the long-term, considering the interests of employees and other constituencies, and recruiting top director and executive talent.
Although there is no single solution to these problems, the following perspectives and actions would help to restore a more reasonable balance:
Recognize that the proper goal of good governance is creating both long-term and short-term sustainable value for the benefit of all stakeholders, rather than reflexively placing more power in the hands of activist hedge funds or often-transient institutional shareholders who are themselves measured by short-term, quarterly portfolio performance;
Resist the push to enact legislation, regulations or agency staff interpretations that place more power in the hands of activist hedge funds and other investors with short-term perspectives, and that thereby weaken the ability of corporate boards to resist such short-term pressures; and
In any new legislation or regulation that is enacted, provide appropriate protections to companies, as opposed to focusing only on new rights for shareholders who already have significant leverage to pressure companies.
Specific examples of possible steps to implement these general principles include the following:
K.J. Martijn Cremers, Lubomir P. Litov and, Simone M. Sepe, Staggered Boards and Firm Value, Revisted
Jillian Popadak, A Corporate Culture Channel: How Increased Shareholder Governance Reduces Firm Value
Jing Zhang, Why Are Bad Loans Securitized, the Impact of Shareholder Rights in the Banking Industry
Pavlos E. Masouros, Corporate Law and Economic Stagnation: How Shareholder Value and Short-Termism Contribute to the Decline of the Western Economies
Lynn Stout, The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public
Colin Mayer, Firm Commitment: Why the corporation is failing us and how to restore trust in it
David Larcker and Brian Tavan, A Real Look at Real World Corporate Governance
directly and convincingly rebut the statistics relied on by Professor Bebchuk, reflect the true effects of activism and establish that it is in the national interest to reverse the legislation and regulation that promote activism and short-termism.
Steven A. Rosenblum
Sabastian V. Niles