Seven Deadly Fallacies of Activist Investing’s Critics
Posted by Charles Nathan, Finsbury LLC,
on Wednesday, June 29, 2016
Attacks on activist investing often tread
a familiar and well-worn road, long on inflammatory rhetoric and
specious arguments and short on reason and respect for the facts. A
recent example is a commentary by two Wachtell Lipton lawyers entitled
“Corporate Governance Update: Holding Activists and Proxy Advisory
Firms Accountable,” published in the New York Law Journal on
May 26, 2016 (and discussed on the Forum
message, like so many criticisms of activist investing, is built on
seven fatal fallacies.
Fallacy One: The terms short-term and long-term are
used confusingly to mean different things at different points in the
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.
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.
Fallacy Two: There is nothing inherently good or bad
about short-term or long-term.
nothing innately virtuous about long-term, whether it be the duration
of a portfolio position or a company strategy, nor is there anything
innately evil about a short-term holding period or implementation
period for an alternative company strategy. It is ludicrous to claim
(or worse, believe) that anything long-term is by its very nature
good, while anything short-term is by its very nature bad.
Notwithstanding this obvious truism, anti-activist shareholder critics
consistently assume short-term is bad and long-term is good.
Repetition of these baseless assertions may have its purposes, but
describing reality is not one of them. The reality, of course, is that
there are both good and bad short-term strategies, just as there are
good and bad long-term ones. The only relevant issue is determining
which strategy will create more net present value for the company and
its constituencies, not which one will take longer or shorter to
Fallacy Three: Activist investors do not possess
“unprecedented influence” or “immense financial power.”
The truth, of
course, is that as large as some activist funds may be, they are
utterly dwarfed by the size of the equity investor universe. A few
activist funds may exceed $10 billion and total activist funds may
approach $150 billion in the aggregate, but activists are hardly a
blip when compared with the $18,668 billion size of the US equity
market. Another way to measure the relative insignificance of activist
investors is to compare the size of their funds (say, $10-15 billion
for the largest) to the leading asset management firms in the US,
starting with BlackRock ($4,770 billion under management), Vanguard
($3,148 billion), State Street ($2,448 billion) and Fidelity (a mere
investors simply do not have the financial resources or desire to own
vast portions of the stock of any company. It is rare that an
activist’s holding in a company exceeds 10% and many are well below
5%. While activist holdings are not insignificant and surely entitle
the activist to be heard, activists simply do not have the power or
share ownership to compel a company to take any action, good, bad or
Fallacy Four: Activists do not use “unscrupulous”
tactics nor do they “hijack” the system, as is so often alleged.
not alchemists who nefariously transmute relatively small share
ownership positions into the power to compel companies to adopt
wrong-headed policies rightly opposed by their boards and managers.
Rather, activists are ultimately dependent on the support of at least
a majority of a company’s other shareholders to achieve their goal of
changing some aspect of a company’s business or strategy. The activist
investor’s typical game plan is simple and consistent.
identify a company that is undervalued in the market because it is
not fully realizing its potential.
propose a solution to management that the activist believes will
unlock the full value of the company.
management is unwilling to work with the activist to improve the
company’s operations or strategy, bring the activist’s proposed plan
to the company’s shareholders who own the company and have the final
say on company policy though their ability to vote at shareholder
nothing nefarious about giving the owners of a company a choice
between competing strategies or alternative business plans. Nor is
there anything wrong if a majority of shareholders agree with the
activist, rather than management. To suggest the contrary is to
advocate a corporate system in which management has the final say on
all matters, and shareholders have no power to vote managers out of
office—a model that might be conventional in Russia but is
antithetical to the very premises of our corporate system.
Fallacy Five: There is nothing wrong with shareholders
deciding an activist’s program has more merit than management’s.
the argument against activist investing boils down to a classic case
of blaming the messenger. Activists don’t possess some magical power
which allows them to bewitch shareholders. Rather, they present a case
for their proposed solution to what they perceive as a company’s
shortcoming, and management presents its case. Whether management’s
case is in defense of a long-held strategy adopted in good faith by
the board, or a recently created attempt to “be your own activist,”
the bottom line is that shareholders are the ones who get to decide.
If they decide against management, it is hardly the fault of the
activist. Viewed rationally, it is the fault of management, either
because their program is not as persuasive or because they fail to
articulate it successfully.
In the same
vein, if shareholders opt for a shorter-term program and reject
management’s longer term proposal, the outcome is not wrong because
management disagrees. Even if shareholders are predisposed to favor
shorter-term programs for extraneous reasons (such as concern for
quarterly and annual performance rankings on the part of active money
managers), it is not because of something inherently bad about
activists. Nor is the solution to penalize activists for their success
in harnessing shareholder wishes.
Fallacy Six: Activist investors do not selfishly line
their pocketbooks at the expense of workers, communities and, more
generally, the entire American public.
investors cannot prosper unless the other shareholders prosper. To be
successful, an activist investor’s program must produce sufficient
value to increase the price of the company’s stock. This is not to say
that every activist program will raise the price of the company’s
stock, but only that to make money the activist has to be right more
often than wrong. As a result, the value created by an activist
investor is shared among all shareholders. Indeed, this is the reason
why shareholders so often support activist investors’ initiatives.
shareholders are, largely, institutional investors who manage a very
large part of the combined wealth of the American public. The funds
institutional investors manage comprise the largest part of the life
savings of our nation held in countless public and private pension
funds and innumerable 401K and Roth plans. Put simply, activist
investors succeed only when institutional investors likewise benefit,
thereby increasing the value of the holdings of the various pension
plans and individually owned accounts managed by institutional
Fallacy Seven: Company management and their experts do
not have a monopoly on wisdom entitling them to prevail over the views
of a majority of shareholders.
fallacy of the anti-activist mantra is that somehow, for some reason,
it shouldn’t matter that a majority of shareholders often embrace
activist campaigns. There is no principled reason to believe that
boards, management and their advisers know better and should be freed
from the distraction, stress and risks of a debate over their
corporate stewardship. The paternalistic and patronizing view that
management always knows best is simply an inversion of the reality of
shareholders’ ownership and rights under our corporate governance
system. Defenders of management against activist investing all too
often dismiss the reality that boards and management are accountable
to shareholders on at least an annual basis and that our corporate
governance model is based on the fundamental principle that
shareholders are the owners of the company with the ultimate right to
decide their company’s future.
Harvard Law School Forum
on Corporate Governance and Financial Regulation
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