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Source: New York Times DealBook, March 8, 2013 commentary

Hedge Funds | Another View

Re-examining Board Priorities in an Era of Activism


Ira M. Millstein is the co-chairman of the Millstein Center for Global Markets and Corporate Ownership at Columbia Law School and a senior partner at the law firm Weil, Gotshal & Manges.

With the recent increase in activism, some on Wall Street are blaming shareholders for the short-term mentality of corporate boards.

But many of these activists represent a small subset of investors in publicly held companies. As a result, corporate boards around the country should re-examine their priorities and figure out to whom they owe their fiduciary duties.

One of the major problems of this newfound activism is the focus on short-term results. That is not to say that our economy isn’t gripped by a short-term mentality, whether it’s individuals saving less and seeking immediate satisfaction or corporations forgoing long-term sustainable growth and profitability to meet investor demands for quarterly stock market returns.

But as many commentators have pointed out, activist investors are manipulating the system without succeeding in increasing shareholder value or instilling better corporate governance practices. Some activists are using their newfound power to sway and bully management to focus on the short term, meet the quarterly targets and disgorge cash in extra dividends or stock buy backs in lieu of investing in long-term growth. In recent years, companies including Dell, Yahoo and others have faced proxy wars or shareholder proposals to merge, divest, change boards or management or undergo a drastic reorganization.

This focus on catering to activists has resulted in overlooking the importance of reasonable shareholder power. And that is leading to a stasis in corporate governance, rather than innovation and positive change.

On the flip side, shareholder power has resulted in some positive governance changes. One example is recent legislation that put forth “say on pay” rules, which is making management more aligned with shareholders when it comes to setting their compensation. Other positive changes have been better mechanics for voting, proxy contests and precatory proposals, the elimination of staggered boards and the advent of majority voting.

The great challenge for today’s boards in this new era of activism is catering to all the diverse “shareholders,” which includes those with a longer investment horizon like pension funds and mutual funds, as well as those who are seeking quick profits. The board should represent all shareholders, not any one region or philosophy.

Many companies are “owned” by both long- and short-term shareholders. The short-term investors surely have created an atmosphere of passion for immediate returns, but the board doesn’t have to succumb. It needs the courage to discover and communicate with long-term shareholders, shareholders who don’t necessarily agree with the tactics of their short-term counterparts.

Certainly, no one would go back to the era of the uncontrolled poison pill and no shareholder power. That world masked entrenchment, bad judgment and the inability of shareholders, long and short, to effect change. Happily, that era is long gone.

The problem is that many investors are apathetic, uninformed, locked into an index fund or don’t care to be informed, thereby giving the short-term activists a disproportionately strong voice. When board members are confronted with active and vocal shareholders rather than the silent majority, it’s as the adage goes: the squeaky wheel gets the grease.

Now, however, there are broader corporate policy questions that need to be examined. Are short-term investors truly diverting long-term sustainable growth? Are all or many long-term shareholders apathetic, locked in or worse in not resisting? What constitutes incentives or disincentives for both types of investors?

Academics and practitioners should be studying these questions intensely. This involves canvassing and analyzing the entire investment chain that boards face, including pension funds, mutual funds and hedge funds of hundreds of varieties and ordinary investors and advisers, which one project at Columbia Law School aims to do.

Columbia, along with studies at other institutions, is trying to learn what motivates short-term investing, why the longer-term shareholders are so often silent and why the investment chain either through apathy or the wrong incentives, has created the world of short-term investing in which we live. This undertaking will also examine the role of so-called proxy advisory firms and rating agencies in board policies.

In the end, we will all gain a better understanding of shareholder influence, and what incentives can turn this economy away from short-term investing and back to long-term sustainable growth. Corporations will be the ultimate beneficiaries of this knowledge, which will provide the understanding that will facilitate legitimate long-term planning.

Copyright 2013 The New York Times Company


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