At the International Corporate Governance Network’s annual meeting in New York, panelists debated whether activism produces long-term benefits for companies and other shareholders.
Is activism by hedge funds with mainly shorter-term interests able to generate long-term benefits for companies and other shareholders?
That was one of the key concerns on a panel, titled ‘Engagement – a triumph of activity over action?’ at the International Corporate Governance Network’s annual meeting in New York on June 27. The panel was moderated by former New York Governor Eliot Spitzer.
Institutional investors still rely more on access to management than analysts’ reports for most of the information that drives their decisions; as a result they run the risk of being shut out by management if they are overly vocal in opposing management positions, according to Roy Katzovicz, chief legal officer at Pershing Square Capital Management.
Because hedge funds are generally interested only in short-term gains, they play a less critical role in shareholder activism than traditional institutional investors, which invest in companies for the long term, said Harlan Zimmerman, senior partner at Cevian Capital, a leading activist investor in Europe. He laments the fact that institutional investors’ large portfolios and the limited resources they have to devote to governance force them to carefully pick their battles with management. These investors have been approaching Cevian to better focus their activist efforts, he added.
Even though hedge and private equity funds may not be long-term owners of a stock, their activism spurs beneficial effects that far outlast their presence, argued Katzovicz. He cited an academic study of large block holders that found that while the average holding period between 1994 and 2005 was just two years, stocks targeted for activism tended to outperform other names according to various metrics for a further three years after the block holders’ exit.
He also argued that a pop in a stock’s value over a relatively short time frame due to shareholder activism doesn’t mean the idea behind the activism is a short-term idea. As an example, he cited Wendy’s International spinning off of the fast-growing Tim Hortons chain of doughnut and coffee shops in 2005 to maximize the value of the separate brands. One result was that Wendy’s market cap doubled to $10 billion within 18 months; but Katzovicz said the idea of splitting the two very different businesses to realize the full value of both remained valid long after the major market price effects had occurred.
Zimmerman noted how governance is evolving from shareholder goading of management to be more focused on board alignments, incentives and accountability. ‘It’s no longer just binary issues like CEO pay, which are more representative of a board’s failure to fulfill its fiduciary duties,’ he said. ‘Bad executive pay [policies are] a symptom of a bigger problem. Increasingly, governance is being directed at root causes,’ he believes, such as board dynamics and accountability.
Sweden and Finland are examples of two countries where shareholders not only have a forum to discuss critical issues but also have full responsibility for nominating board members. ‘The beauty of the system is that directors really understand they’ve been put there by shareholders and they know what shareholders want and are more empowered to act on shareholders’ behalf,’ he said.
During the question and answer session, an investment manager from Germany criticized the Swedish model for putting too much responsibility on shareholders and not enough on other stakeholders, such as employees and the public. He also argued against annual board elections, saying directors need to serve three years before they are familiar enough with a company’s issues to be able to exercise their talents fully.
Takuya Fukumoto, director of the corporate accounting, disclosure and CSR policy office in Japan’s Ministry of Economy, Trade and Industry, said that pension funds have been the most active investors in terms of pushing management to improve business strategies, but insurance firms are increasingly becoming more vocal.
A poll taken during the session showed that nearly 70 percent of attendees believe mutual fund managers shy away from activism because they’re unwilling to do anything that might pose risks for the performance of their beneficiaries’ retirement accounts.
In response, Katzovicz said most mutual fund managers either use conflicts of interests as an excuse for never voting against management or, when they disagree with management’s strategy, would rather sell the stock than raise a ruckus. There is, however, a small but growing group of fund managers who are now open to engagement with management. Although unlikely to initially push for change, they are approaching Pershing Square with ideas and seeking help to organize their efforts. He expects to see a lot more action by this group in the next 10 years.
Spitzer concluded the discussion by saying that activism needs to be directed toward long-term investment objectives.