Session Two HighlightsShareholder Activism -The struggle for corporate influence
Moderator: Stephen M. Davis, Executive Director, Yale
University School of Management’s Millstein Center for Corporate Governance and
Performance
Panelists:
·
- Jay Eisenhofer, Managing Director, Grant &
Eisenhofer P.A.
- Charles Elson, Director, John L. Weinberg Center
for Corporate Governance at the University of Delaware
- Richard Ferlauto, Director of Corporate
Governance and Pension Investment, AFSCME
- David Katz, Partner, Wachtell, Lipton, Rosen
& Katz
·Anne Sheehan, Director Corporate Governance,
CalSTRS
The following is a
synopsis of the panelists’ discussion and responses to questions from the live
and internet audiences. On the Cusp of a Major Transformation
Ancient China, in the Shang Tze Period, had a very effective tool for preventing fraud, according to Moderator Stephen Davis. They’d take officials’ wives and children hostage – and sell them into slavery if fraud was committed. Interestingly no fraud was ever found. Dr. Davis then proceeded to contrast the current American and European efforts to improve corporate governance.
Moderator Davis: Just a few hours ago in Stockholm, a European commission conference on corporate governance concluded… and the discussion was on what role shareowners played in the crisis. The overall view is that the shareholders are culpable. In some respects, Europe is moving to restrict shareholder rights. In this country, as we speak, legislation is being formed about shareowner rights, and we’re talking here about expanding them. We’re possibly on the cusp of a major transformation of the balance between boards and investors.
If corporate governance had been better, could we have prevented this economic crisis?
Jay Eisenhofer: The idea that shareholders are responsible simply doesn’t hold water. Shareholders are not responsible for the system of incentives that caused the crisis. We saw the bursting of a massive asset bubble. Could the crisis have been prevented with more shareholder control, could boards have been more focused on the long term? Yes – that could have limited the extent of the crisis – but not averted it. A more interesting question is to look at the larger historical context - a hollowing out of US industry, and increasing reliance upon the financial sector in our economy. Had shareholders had more control during this time period, would that trend have occurred as it did? That’s a more interesting question, and I think the answer is ‘yes.’
How Culpable Are Shareholders?
David Katz: Shareholders have a responsibility. My difficulty is the focus on the short term. A lot of the incentives are driven by short term outlooks – measuring corporations by quarterly performance. The short term focus means that you’re sacrificing longer term growth. As long as decisions by shareholders are pushed by short term measurement, they’ll continue to push management to measure things by the short term. A lot of the changes that we’re talking about to increase shareholder rights will in fact increase the power of people to push for the short term, not the long term. I think that had shareholders had a bigger say in the past decade, things might even have been worse recently.
Ann Sheehan: Shareholders have some culpability, because we enjoyed the run-up just like everyone else. At CalSTRS, we’re looking at our own internal processes. If I go into a corporation and say ‘we don’t like what you’re doing,’ we should make sure we’re doing what we should in terms of transparency and accountability. I think America and the world were lulled into complacency and were not as diligent as we should have been. I am a strong believer in some of the rights that are being discussed. They will give us the tools to help some of the companies in our portfolio think about the decisions they make. Did we have some already in our toolkit that we could have used? Absolutely.
Shareholders Were Shellacked
Charles Elson: Shareholders were shellacked - shellacked by bad management, by bad boards, and they’re now being shellacked by the government. To suggest that they’re responsible for their own shellacking is beyond me. Certainly there were shareholders who were short term in focus, but the vast majority of shareholders are in it for the long haul. They’re institutional investors. What surprised them was the risks that the companies were taking that they were invested in. No one ever in their imagination would have viewed Wachovia as a highly risky operation. Their P&E never reflected it. It reflected the view that it was stable, staid commercial bank. Shareholders had no knowledge of the assets these institutions had invested in.
It‘s Hard to Be Responsible If You Have No Rights At All
Richard Ferlauto: I believe there should be both investor rights and investor responsibilities, but it’s hard to be responsible if you have virtually no rights at all. The struggle up until this point is to have rights similar to what shareholders have in Europe, including the rights to hire and fire directors and having enough power to ensure well functioning boards and directors can robustly discharge their duty. We need the tools to ensure that our agents can be held accountable for the decisions they make. Part of the failures we’ve seen are failures of management; strategic mismanagement, of boards not understanding risk profiles, and directors frankly being asleep at the switch.
Not All Shareholders Think Alike
Richard Ferlauto: We also need to clarify what shareholders we’re actually talking about. We’re currently representing AFSCME, beneficial owners who rely on shareholder return for retirement and the payout of benefits. Do the investment intermediaries that many of us are investing through in mutual funds have the same ownership interest? With the increasing financialization of our economy, large asset managers are removed from the underlying ownership. Even understanding how these institutions are structured, and how they make decisions, is very difficult. Nothing is black and white.
Moderator Davis: There are markets, such as in the UK, where a lot what we’re pressing for in this country – such as access, majority rule, independent chairs of corporate boards – all that is in place.
Richard Ferlauto: I make a distinction between the beneficial owners of capital – and the aggregators of capital who don’t have a real ownership stake. They work on ways to churn the money and be more profitable off of the manipulation of the money of the beneficial owners.
Moderator Davis: It seems that there’s some degree of agreement here, that it’s not so bad to have shareholder rights, but the critical point is that they’re used responsibly for the interest of long term investors.
David Katz: if you could adequately police it…if the focus is on the long term, and performance is measured on the long term, and incentives are dealt with appropriately, you’d have a much more stable corporate environment. When you create a push for short term results, you distort the picture. When longer term shareholders have a dialogue with directors or with management, it tends to be a good dialogue.
Only a Few Investors Can Really Fight Back
Jay Eisenhofer: The shareholders who are most empowered are those who are interested in the short term. The vast majority of shareholders ARE interested in long term returns, because most of the beneficial owners are people who saving for retirement. But the current system all but lacks any element of shareholder democracy. The situation is such that the shareholders who are able to influence management are the ones who can pressure for things like share buy-backs and run independent proxy fights. The shareholders who can’t run proxy fights have no way to influence directors.
Charles Elson: Management has long been able to hide behind the term ‘long-term.’ They can always justify a bad decision by claiming that at some point in the future, it will pay off. They can use the term to justify lousy returns and lousy management.
Ann Sheehan: We were involved in a recent proxy fight that resulted in some long term benefits for the company…governance changes, such as a simple one requiring that directors attend the annual meeting.
How Will Shareholders Exercise Their New Powers?
Moderator Davis: We may be at a tipping point, with the Dodd bill and what’s coming through Barney Frank’s committee, where there’s a potential of a substantial increase in shareholder power - through access, Say on Pay, required disclosures and majority rule. There’s going to a very different proxy season and a very different balance between boards and investors if most of those things pass. How will shareholders exercise those rights? Shareholders will have a lot more say about how boards are composed. Many board members will be subject to ouster for the first time in anyone’s memory. How are the shareowners now taking on this responsibility?
Ann Sheehan: Especially with the new legislation coming through, our responsibility as long-term shareholders is even more serious. We need not only the power to vote someone off the island but to put someone in their place. When CalSTRS engages with companies, we look at the issues and at where the boards need more expertise in certain areas. When we get proxy access, we actively develop a talent pool, a pipeline of candidates to bring forth.
Shareholder Access – A Double Edged Sword
David Katz: My experience is that very few companies receive suggestions, even when they’re approached. I don’t think proxy access will fix this. Delaware has put in a mechanism to allow shareholders to put forward bylaws that deal with shareholder access. I don’t see how this will change things for the better, because I don’t see how it will discipline boards or why shareholders believe they will ultimately be better able to pick the types of skill sets that people need. A good example is the huge push for independent directors – which often means people who know nothing about the business, nothing about the industry. So there is a huge learning curve. In Europe, you end up with several insiders on the board, balanced by outsiders. That leads to a better dynamic within the board room.
Leveling the Playing Field
Ann Sheehan: Yes, we’ve responded to companies that have reached out to us. Home Depot is a perfect example, one of the few that have reached out. Will it make a difference to have greater access? Yes it will give us the ability to put in our person, someone who we think will really be better for the company. Now our only choice is a proxy fight that requires calling up all my friends and spending a lot of money. We only do this normally after one or two years of engaging with a company. It does level the playing field in terms of giving us the ability to be listened to and really have a seat at the table.
Moderator Davis: Access is a very polarizing issue, as we all know. But it’s going to happen whether we like it or not. I’d like us to focus on is how this increased access will be used.
Charles Elson: It’s not access, but the threat of a real election that forces a board to be open and thoughtful about the people they put on the board. The problem with inside board members is that inside directors never challenge management. They know the company, but won’t challenge the CEO in a meeting. Independent directors are vital.
Richard Ferlauto: In at least half a dozen instances where we believed there was a critical failure on the part of a director, we could not come to an agreement through a negotiated process. The idea that you can use a voluntary mechanism for putting a name in just doesn’t work. A survey of directors revealed that they believed 30% of their peers were not fit to serve as directors on those boards - because they were deadwood, didn’t understand corporate strategy, didn’t put in enough time, a whole variety of reasons. Behind closed doors, they own up to the fact that there’s a problem with the vitality of boards. Having some appropriate dialogue with shareowners who are empowered would make all the sense in the world.
Moderator Davis: So your argument is that with access, and with majority rule, it will act in the same way as Say on Pay might do for compensation committees by making nominating committees pay more attention because they’ll be scrutinized more closely and because the elections will be much more meaningful. And I think Ann would argue that shareholder community will have to step up to the plate. The new rules may affect real change on the part of nomination committees, as well as investors.
Audience Questions:
Should there be real incentives and disincentives structurally imbedded in capital markets to create long termism – such as a transaction tax for short-term trades, higher dividends for long term holders, greater voting rights for long term holders, etc?
Moderator Davis: Great question, because it’s exactly the debate going on in Europe too.
David Katz: As someone who has represented a number of European companies that do have this weighted voting, it does work, it does give people a greater voice. I think it would further empower longer term holders. I think taxing the short term would have unintended consequences. The solutions being offered in federal legislation on the corporate governance side will fundamentally increase the power of individuals and institutional investors. But I don’t believe they will answer the problems that caused the crisis.
Moderator Davis: It’s worth noting that the recently released Aspen Statement on short-termism does make a suggestion about differential taxation. (Click here to download the Aspen Institute report)
Ann Sheehan: We are getting an element of that through the proxy access rule, with the long term shareholder having the greater rights. It’s an interesting academic consideration: what will be the long and short term impacts of those types of movements in the shareholder community.
In the wake of the recession and jobless recovery, what should the role and responsibility of the shareholder activist be?
Charles Elson: Unless you generate a sufficient return to those who invest with you, and respect their investment and respect them, you’re never going to get their investment and there will be no recovery. Recovery comes about through capital formation. The only way capital is formed is if those who supply capital, all of us, are treated respectfully and are entitled to a decent return on our investment. That’s what activism is all about at its core.
Jay Eisenhofer: I agree with Charles. Shareholder activism is the effort to increase returns through engagement. Active involvement on behalf of the shares you own. The time horizon over which you’re measuring returns varies from shareholder to shareholder.
Richard Ferlauto: There are two kinds of activists. There are balance sheet activists – who many times strip assets from a firm (talent, R&D, human capital) and that’s a real problem. And there are managerial activists who see management that’s broken, that doesn’t have a long term strategic plan for wealth creation. Those are the activists that need to be empowered. Corporate governance remedies and investor rights are an important part of the equation of fixing the economy and making it one that promotes long term growth and wealth creation.
David Katz: Shareholders are owners and they need to be heard and respected. But I don’t see a system that differentiates between the short term and long term activists.
Ann Sheehan: To me, shareholder activism is reminding the company who the owners are. Because the behavior of some activists focuses on the short term does not belie the need for either of us to have the rights to do those activities that we think are in the long term interests of the company.
Moderator Davis: What you’ve heard from this panel is that there are some new tools being developed - an inventory of board members, new responsibility over elections, board pools, the Walker Review in the UK, stewardship principles in Europe may migrate here too.
Audience Question: Re. the essence of shareholder responsibilities – the proper underwriting of companies they invest in. Even for long-term shareholders, moving capital away from companies that are not performing well.
Ann Sheehan: Because of our size, we can cut back on our exposure but it’s not always an option for us to pull out, and so we’ve got to engage with them to try to address shortcomings.
Audience Question: Have there been any studies that show that companies perform better where shareholders are involved in management?
Moderator Davis: There are a lot of studies that look at family dominated companies. They do reasonably well. If there’s a block holder with a stake in it and they rise or fall depending on how the company does, there’s good evidence to show that that’s effective.
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Session #2 Moderator
 Stephen M. Davis Panelists:
Jay Eisenhofer
Ann Sheehan
Charles Elson
Richard Ferlauto
David Katz
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