February 26, 2013

NY Times: Down With Shareholder Democracy

Populist movement masks hedge fund abuse, reporter claims

When is dictatorship preferable to democracy? In a corporate setting, apparently.

Recent controversies involving Herbalife and Apple are by no means coincidence, and could be related to abuses aided by the shareholder democracy movement, according to The New York Times.

Shareholder democracy refers to the push in recent years to make it easier for shareholders to have a direct say in matters once reserved for the board of directors, like CEO compensation, for instance.

But an idea that began with the best of intentions has been co-opted for other purposes, possibly nefarious, the paper reports.

It quotes Martin Lipton, a longtime counselor to the Fortune 500 and a partner at the law firm of Wachtell, Lipton, Rosen & Katz. Lipton said that long-term shareholders in public companies are being undermined “by a gaggle of activist hedge funds who troll through SEC filings looking for opportunities to demand a change in a company’s strategy or portfolio that will create a short-term profit without regard to the impact on the company’s long-term prospects.”

In a widely distributed memo on the subject of hedge fund manager David Einhorn’s lawsuit against Apple, titled “Bite the Apple; Poison the Apple; Paralyze the Company; Wreck the Economy,” Lipton wrote, “The activist-hedge-fund attack on Apple—in which one of the most successful, long-term-visionary companies of all time is being told by a money manager that Apple is doing things all wrong and should focus on short-term return of cash—is a clarion call for effective action to deal with the misuse of shareholder power.”

In the Times article, Andrew Ross Sorkin says the rise of shareholder democracy is leading, in some cases, “to a perverse game in which so-called activist investors take to the media to pump or dump stocks in hopes of creating a fleeting rise or fall in a company’s stock price.”

It’s not to say that shareholder democracy is a bad thing, Sorkin hedges, noting that shareholders have “successfully and properly brought pressure to bear on underperforming companies, pushed out entrenched directors and, in some cases, pressed for operational changes to address health and the environment.”

But academic literature provides a mixed and inconclusive assessment of the true effect of activism on shareholder value over the long term.

The paper counts Leo E. Strine Jr., the chief judge of the Delaware Court of Chancery, as a skeptic.

 “Many activist investors hold their stock for a very short period of time and may have the potential to reap profits based on short-term trading strategies that arbitrage corporate policies,” Strine wrote in a widely circulated essay for the American Bar Association. “Why should we expect corporations to chart a sound long-term course of economic growth, if the so-called investors who determine the fate of their managers do not themselves act or think with the long term in mind?”

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