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	<title>IGOPPColumbia Law School Blog &#8211; IGOPP</title>
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		<title>Dow Jones Erred By Going Nuclear on Dual-Class Shares</title>
		<link>https://igopp.org/en/dow-jones-erred-by-going-nuclear-on-dual-class-shares/</link>
		<comments>https://igopp.org/en/dow-jones-erred-by-going-nuclear-on-dual-class-shares/#respond</comments>
		<pubDate>Thu, 07 Sep 2017 19:27:55 +0000</pubDate>
		<dc:creator><![CDATA[IGOPP Site web]]></dc:creator>
				<category><![CDATA[News Articles]]></category>
		<category><![CDATA[American governance]]></category>
		<category><![CDATA[Columbia Law School Blog]]></category>
		<category><![CDATA[Dual-class shares]]></category>
		<category><![CDATA[Institutional investors]]></category>
		<category><![CDATA[Risk management]]></category>

		<guid isPermaLink="false">https://igopp.org/?p=8880/</guid>
		<description><![CDATA[In July 2017, Dow Jones, goaded by the reaction to Snapchat having gone public with a class of shares without voting rights, announced that, after extensive consultation, it had decided to henceforth eliminate companies with dual-class shares from its indices, in particular the S&#38;P 500 Index. Over the last 10 years, putting money in passive [&#8230;]]]></description>
		<content><![CDATA[In July 2017, Dow Jones, goaded by the reaction to Snapchat having gone public with a class of shares without voting rights, announced that, after extensive consultation, it had decided to henceforth eliminate companies with dual-class shares from its indices, in particular the S&#38;P 500 Index.

Over the last 10 years, putting money in passive index funds has become a popular form of investment. An index fund is a pool of money invested in a way that is proportional to the composition of an overall index, the S&#38;P 500 being the most popular. Already in 2016, index funds managed some $506 billion in assets, accounting for 29 percent of all shares traded on American stock exchanges.

For a company to be excluded from the indices means that none of this large pool of money will be channeled into its shares, reducing demand and possibly depressing its share price. Of course, Dow Jones quickly grand-fathered such notable large dual-class companies as Alphabet (Google), Facebook, Berkshire Hathaway (Warren Buffett’s company) and so on.

Targeting family companies and entrepreneurs
The Dow Jones decision is actually meant to scare budding entrepreneurs when the time comes for their companies to go public. It is a well-known and important fact that entrepreneurs want to keep control of their businesses so that they can implement their strategic visions unhindered by short-term shareholders and their financial coterie.

As tapping into public markets to finance their growth usually meant listing their companies on a stock exchange, entrepreneurs sought to keep control of their companies by issuing two classes of shares, one with multiple votes, which they retained and through which they would control their companies over time.

Entrepreneurs usually found very receptive investors who did understand that dual-class shares were the price to pay to ride the value creation of these entrepreneurs. Actually, some 11 percent of all traded companies on U.S. exchanges have adopted two classes of shares.

In 2015, according to Prosoaker Research (2016), 24 percent of all new share offerings (IPOs) in the U.S. were made with a dual-class structure, a sharp increase from 15 percent in 2014 and 18 percent in 2013. So, young companies such as Alphabet (formerly Google), Facebook, LinkedIn, TripAdvisor (and, in Canada, Cara, BRP, Shopify, Spin Master, Stingray) have issued two classes of shares to assure unassailable control over their companies and relative imperviousness to the short-term gyrations of earnings and stock price.

The surging popularity of this type of capital structure has agitated institutional investors and other types of shareholders that pretend, with no legal support, to be the owners of the companies. Skirmishes about dual-class shares then turned into an all-out war led by index fund managers, some institutional investors, influential academics, the governance industry, and investment bankers. They allege that dual-class shares result in a discounted value and a poor relative performance. They are prone to claim that the one share-one vote principle is the moral equivalent of the sacrosanct one person-one vote of electoral democracy.

Of course that equivalence between electoral democracy and shareholding is totally bogus. The real equivalence would call for one shareholder-one vote. In a democracy, the fact that one pays $1 million in taxes does not translate into 1,000 votes, or 1,000 times more votes given to someone who pays $1,000 in taxes.

Furthermore, in an electoral democracy, newcomers have to wait for a considerable period of time before being granted citizenship and thus the right to vote; and certainly visitors and tourists who happen to be in a foreign country on its election day do not get to vote. That’s how democracies work. But “corporate democracy” gives the right to vote immediately upon purchase and share-swappers, tourists in effect, do get the right to vote if they happen to be around on the record date.

What about the performance of companies with dual-class shares?
The Canadian evidence, as the following table suggests, is overwhelming that dual-class companies actually perform well.

Performance of Canadian dual-class firms, compared with single-class firms (or reference index) over 5, 10, and 15 year periods



As for the U.S. case, it is ironic that at virtually the same time Dow Jones was issuing its edict, a team of respected authorities on family firms and dual-class shares released the results of a vast study based on 2,379 industrial firms (non-financial and non-utility) over the years 2001 to 2015.

What do they conclude?
“Striking, we find a very strong association between founding family ownership and dual-class firms. Founders or their descendants control nearly 89% of dual class firms but only about 28% of single class firms.”….“[W]e find that a buy-and-hold strategy of dual class family firms earns excess returns of about 350 basis points [3.5%] more per year relative to our benchmark (single class nonfamily firms). Results from the matched sample suggest an even greater excess return – about 430 basis points more per year versus the reference firms. After controlling for time, industry, and a wide variety of firm-specific factors, our analysis does not lend support to the notion that dual class structures harm outside investors.” (Anderson, Ronald, Ezgi Ottolenghi and David Reeb, “The dual class premium: a family affair”, SSRN July 19, 2017)

Who really gains from the Dow Jones decision?
Clearly, short-term investors and activist hedge funds stand to gain from the Dow Jones decision to push emerging family companies to undertake financial engineering maneuvers, or sell their companies in order to produce quick gains in share price. Thus, an additional group of companies that were out of their reach will now become potential targets.

How will entrepreneurs of the future react to this threat?
Future entrepreneurs may shun public funding and stock market listings, curtailing their growth or finding alternative modes of financing. They may resist trading their control for inclusion in an index.

They may correctly surmise that passive investors in index funds will complain bitterly to sellers of these funds about the exclusion of new, high-tech, high-performance companies from their indices.

Some enterprising fund manager may well create an index strictly reserved for dual-class companies.

Unfortunately, too many entrepreneurs may give up their control under threat of exclusion from indices. Dow Jones’ short-sighted, poorly grounded decision will be responsible for this outcome.

Conclusion
It would have been far wiser for Dow Jones to use its leverage to get dual-class companies to abide by some simple rules in order to be included in their indices, such as was proposed by the Canadian Coalition for Good Governance and IGOPP:

 	Ban any company with a class of shares without voting rights;
 	Impose a mandatory pro rata distribution of change-of-control consideration, what is called a “coattail” provision in Canada
 	Cap the ratio of multiple votes so that a controlling shareholder must hold a substantial economic interest to maintain absolute control of the corporation;
 	Demand some form of acceptable sunset provision from a variety of choices. As Andrew William Winden wrote, “Careful selection of such provisions can satisfy both the desire of entrepreneurs to pursue their idiosyncratic visions for value creation without fear of interference or dismissal and the need of investors for a voice to ensure management accountability. Prohibition [of dual-class shares] and strict time-based [sunset clause] are neither necessary nor appropriate given the plethora of other alternatives.”

This post comes to us from Yvan Allaire, executive chair of the Institute for Governance of Private and Public Organizations (IGOPP) and emeritus professor of strategy. He is solely responsible for the opinions expressed in this post.
]]></content>
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		<item>
		<title>Making Say-on-Pay Vote Binding: A Good Idea?</title>
		<link>https://igopp.org/en/say-on-pay-binding-good-idea-2/</link>
		<comments>https://igopp.org/en/say-on-pay-binding-good-idea-2/#respond</comments>
		<pubDate>Tue, 13 Sep 2016 15:04:06 +0000</pubDate>
		<dc:creator><![CDATA[mlamnini]]></dc:creator>
				<category><![CDATA[News Articles]]></category>
		<category><![CDATA[Columbia Law School Blog]]></category>
		<category><![CDATA[Proxy Advisors]]></category>
		<category><![CDATA[Say on Pay]]></category>
		<category><![CDATA[Shareholders]]></category>

		<guid isPermaLink="false">https://igopp.org/?p=6470</guid>
		<description><![CDATA[The practice of a non-binding say-on-pay vote by shareholders spread quickly and broadly. It seemed that, finally, shareholders would be given the opportunity to express their dissatisfaction with outrageous or ill-conceived compensation packages. The practice, at first, was voluntary with companies agreeing to submit their compensation policies to a vote. Then, as the number of [&#8230;]]]></description>
		<content><![CDATA[The practice of a non-binding say-on-pay vote by shareholders spread quickly and broadly. It seemed that, finally, shareholders would be given the opportunity to express their dissatisfaction with outrageous or ill-conceived compensation packages.

The practice, at first, was voluntary with companies agreeing to submit their compensation policies to a vote. Then, as the number of volunteers remained small, investors submitted proposals whereby shareholders were to vote for or against the company having to carry out a non-binding vote on pay.

In some jurisdictions (the U.S. for instance), non-binding say-on-pay votes were made mandatory. In Canada, say-on-pay vote is not mandated but 80% of the largest companies have adopted the practice voluntarily or as a result of pressures by investors.

Now that say-on-pay has been around for a few years, what does research tell us about its effectiveness? Academic studies provide a mixed view at best. It would appear that say-on-pay has led to more dialogue between the company and large shareholders but did not stop the rise in executive compensation.

Some findings are disturbing as they point to unintended consequences. For instance, studies tend to show that shareholders vote according to the company’s recent share return rather than relying on an analysis of its specific compensation policies and practices. If the company’s stock performs well compared to its peers, almost any compensation package will be approved. This perverse result tends to increase the pressure on management to focus on short-term stock performance, sometimes through decisions that may impact negatively future performance.

But this result is not surprising. The challenge of reading and understanding the particulars of executive compensation has become far more daunting. Indeed, for the 50 largest (by market cap) companies on the TSX in 2015 that were also listed back in 2000, the median number of pages to describe their compensation went from 6 in 2000 to 34 pages in 2015, ranging all the way up to 66 pages. Investors with holdings in dozens or hundreds of stocks face a formidable task. The simplest way out is either to vote per the stock’s performance or, more likely, rely on the recommendation of proxy advisory firms (which also base their “advice” on relative stock market performance)

Thus, 66% of corporate directors do not agree that say-on-pay resulted in a “right-sizing” of CEO compensation; yet 83% of these directors very much agree or somewhat agree that say-on-pay increased the influence of proxy advisors. (Source: PwC and Cleary Gottlieb 2016, Boards, shareholders, and executive pay)

Boards of directors, compensation committees and their consultants have come to realize that it is wiser and safer to toe the line and put forth pay packages that will pass muster with proxy advisory firms. The result has been a remarkable standardization of compensation, a sort of “copy and paste” across publicly listed companies.

Thus, most CEO pay packages are linked to the same metrics, whether they operate in manufacturing, retailing, banking, mining, energy, pharmaceuticals or services. For the companies on the S&#38;P/TSX 60 index, the so-called long term compensation for their CEO in 2015 was based on total shareholder return (TSR) or the earnings per share growth (EPS) in 85% of cases. The proxy advisory firm ISS has been promoting these measures as the best way to connect compensation to performance.

In spite of, or perhaps because of, the limited usefulness of non-binding say-on-pay votes, various parties are promoting a binding shareholder vote on pay. That is, rejection by shareholders of pay packages or policies would force the board to change them and re-submit the package or policy to a shareholder vote. Promoters of this measure are a bit hazy on the details and particulars. But the notion is alluring to many investors and government policy makers.

Indeed, the UK has already adopted a form of binding say-on-pay and France has recently enacted a compulsory and binding say-on-pay for French listed companies. Shareholders of UK companies, every three years, will hold a binding vote on the remuneration policy of the company. Rejection of said policies would force the company to continue to operate according to the previous remuneration policy, or to call a general meeting and present a new remuneration policy to shareholders for approval.

UK shareholders will also vote yearly and in a non-binding way to approve the total pay (single figure) awarded to company executives.

The French government is seeking to adopt a system of shareholder votes similar to that of the UK. The enabling act is now stalled by the French senate but some version akin to the UK’s should emerge soon.

Conclusion

Should Canada go the way of the UK and France? A binding vote on executive compensation raises many technical issues: given the manifold complexity of compensation programs nowadays, what are shareholders voting on, what does a negative vote really mean? In case of a negative vote, will the company carry on with its current policies, which may be worse than the proposed and rejected policies?

At a more fundamental level, the setting of pay policies should be the preserve of the board, as Canadian corporate law clearly states. When egregious pay packages are given to executives, a say-on-pay vote, compulsory or not, binding or not, will always be much less effective than a majority of votes against the election of members of the compensation committee. But that calls upon large investment funds to show fortitude and cohesiveness in the few instances of unwarranted compensation which occur every year.

That is as it should be, notwithstanding the indirect benefits claimed for the practice of say-on-pay.
]]></content>
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		<title>Hedge Fund Activism: A Guide for the Perplexed</title>
		<link>https://igopp.org/en/hedge-fund-activism-a-guide-for-the-perplexed/</link>
		<comments>https://igopp.org/en/hedge-fund-activism-a-guide-for-the-perplexed/#respond</comments>
		<pubDate>Tue, 26 Jan 2016 15:08:34 +0000</pubDate>
		<dc:creator><![CDATA[mlamnini]]></dc:creator>
				<category><![CDATA[IGOPP in the Medias]]></category>
		<category><![CDATA[IGOPP in the medias]]></category>
		<category><![CDATA[Activism]]></category>
		<category><![CDATA[Columbia Law School Blog]]></category>
		<category><![CDATA[Hedge funds]]></category>
		<category><![CDATA[Institutional investors]]></category>
		<category><![CDATA[Securities and Exchange Commission]]></category>

		<guid isPermaLink="false">https://igopp.org/?p=5917</guid>
		<description><![CDATA[The message of the Dow/DuPont merger and split up is simple: No firm is today “too big to target.” Activists can see the transaction as evidence that, even in the rare case where they lose a proxy fight (as they did at DuPont last year in a squeaker), the handwriting is still on the wall, [&#8230;]]]></description>
		<content><![CDATA[The message of the Dow/DuPont merger and split up is simple: No firm is today “too big to target.” Activists can see the transaction as evidence that, even in the rare case where they lose a proxy fight (as they did at DuPont last year in a squeaker), the handwriting is still on the wall, and their game plan, if appealing, will ultimately prevail. Even though Trian could not win a majority vote to seat its candidates on the DuPont board, it held onto its stake, and the DuPont board quickly ditched their CEO in the wake of that fight and then approved the offer from Dow. Dow also was under pressure (from Third Point, an even more aggressive and short-tempered activist fund). The result was a marriage made somewhere other than in heaven.

Nor does this case stand alone. Lion Point Capital has now engaged Ally Financial (the former GMAC, which did fail in the wake of the 2008 crash), notwithstanding that Ally has been classified as a “systemically important financial institution” (or “SIFI”) by the FSOC. As soon as it became clear that even a SIFI could be stalked, AIG’s stock price began to soar, as market watchers predicted that it also would be targeted by activists seeking to downsize it. Lastly, MetLife downsized itself, beating activists to the punch in its effort to avoid being also classified as a SIFI [...]

Some data about the impact of hedge fund activism is clear: namely, its impact on research and development (“R&#38;D”).  One study by Allaire and Dauphin used the FactSet database to track the impact of a hedge fund “engagement” on R&#38;D expenditures and found that over the four-year period following a hedge fund engagement, R&#38;D expenditures at “surviving” target firms declined by more than 50% (expressed as a percentage of sales).  This statistic likely understates the full impact, as not all target firms “survive” (i.e., they are acquired in a merger or they are broken-up in a restructuring), and in these cases the decline in R&#38;D expenditures (although not measurable from financial reports) is almost certainly greater.  This study did use a control, and in the control group R&#38;D expenditures actually rose (modestly) over the same period, thus suggesting that causation is clear.

Read more [1]

&#160;

[1] http://clsbluesky.law.columbia.edu/2016/01/25/hedge-fund-activism-a-guide-for-the-perplexed/]]></content>
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		</item>
		<item>
		<title>Who Should Pick Board Members?</title>
		<link>https://igopp.org/en/who-should-pick-board-members-2/</link>
		<comments>https://igopp.org/en/who-should-pick-board-members-2/#respond</comments>
		<pubDate>Mon, 30 Nov 2015 20:58:44 +0000</pubDate>
		<dc:creator><![CDATA[mlamnini]]></dc:creator>
				<category><![CDATA[News Articles]]></category>
		<category><![CDATA[Chairman of the Board]]></category>
		<category><![CDATA[Columbia Law School Blog]]></category>
		<category><![CDATA[Institutional investors]]></category>
		<category><![CDATA[Proxy Advisors]]></category>
		<category><![CDATA[Risk management]]></category>

		<guid isPermaLink="false">https://igopp.org/?p=5852</guid>
		<description><![CDATA[There is a frenzied rush for shareholders to get a new ‘right”, the right to put up their own nominees for board membership. Boards of directors, so goes a dominant opinion, are not to be fully trusted to pick the right kind of people as directors or to shift the membership swiftly as circumstances change. [&#8230;]]]></description>
		<content><![CDATA[There is a frenzied rush for shareholders to get a new ‘right”, the right to put up their own nominees for board membership. Boards of directors, so goes a dominant opinion, are not to be fully trusted to pick the right kind of people as directors or to shift the membership swiftly as circumstances change.

In 2014/2015, proposals from institutional investors (or even from management) to give shareholders access to the board nomination process have proliferated. No less than 74 U.S. corporations[1] [1] have now inserted (or soon will) in their by-laws the “right” of shareholders to nominate members of the board, among which GE, Coca Cola, McDonald’s, Chevron, Citigroup, Verizon, and so on. And a tsunami of similar proposals is visible over the horizon.

Of course, this agitation started In August 2010 when the Securities and Exchange Commission (SEC) introduced Rule 14a-11 giving shareholders having owned at least 3% of a public corporation’s shares for at least 3 years, the right to propose nominees to the board (for up to a maximum of 25% of the members of the existing board).

This new regulation was immediately challenged in the courts and had to be withdrawn when it was struck down. However, an amendment to Rule 14a-8 (amendment made by the SEC to accommodate its proposed regulation on proxy access) remained in force; its purpose was to allow shareholders to submit proposals on proxy access rules, which, if adopted by a majority of shareholders, were to be made part of the corporation’s by-laws.

This access to voting proxies is fast becoming a part of the governance landscape in the United States; the only issues that are still debated are qualifying ones: the level of shareholding, the holding period, the maximum number of shareholders which may band together to achieve the admission criteria and various aspects of its implementation.

It is very unlikely that major corporations will try to oppose the movement as many institutional investors are fiercely supportive of this measure. However, the eventual impact of this initiative on corporate governance raises important issues that seem totally absent from the discussions around this new “right” of shareholders.

Proxy access may have adverse effect on internal board dynamics

Among the arguments supposedly supportive of shareholder access to the nominating process, one is particularly noxious: the notion that “fear” among board members of being singled out for replacement would lead them to raise their game.

The consequences for an individual director being voted out of a board would be very significant and painful, both in economic and reputational terms; this is true for both incumbent nominees and the new nominees proposed by the shareholders.

Faced with the risk and arbitrary nature of a contested election, the directors would try to promote their personal contributions with institutional investors (and proxy advisors), thus generating an unhealthy competition among colleagues. In any event, how would the thousands of shareholders, called upon to choose between several nominees, decide for which nominee to vote, which nominee to dismiss when the voting proxy contains more nominees than available seats?

Smaller institutional funds may well come to rely on proxy advisors (such as ISS or Glass Lewis), again increasing by tenfold the influence of these outfits on the governance of public corporations. These proxy advisors will propose, as per their usual practice, some obvious, measurable criteria to make this choice: age of the directors, number of years as a member of the board, which are, in fact, arbitrary criteria, uncorrelated with actual performance.

Once these criteria are well understood, it is likely that corporations will try to preventively replace directors to avoid conflicts with large shareholders and to make rooms for their nominees. Therefore, directors would be shown the way out because they no longer satisfy the arbitrary criteria selected by proxy voting advisors without taking into account their actual contribution.

Even more likely, boards of directors will initiate discussions and negotiations with institutional investors who have indicated their intention to propose their own nominees in an effort to reach common ground. These secret negotiations are likely to result in some of the nominees proposed by institutional investors becoming the nominees of management and some current directors presumably viewed, more or less deservedly, as being weaker (older, longer tenure) forcibly retired.

Anyone believing that this process is likely to produce stronger boards in the long run needs to consider anew the calculus of current and prospective board members, the actions, likely dysfunctional, of people facing the humiliation (and economic loss) of an electoral rejection.

Shareholder access to the director nomination process brings forth a host of other issues related to the logistics of its application and the potential adverse effects on board dynamics including:

 	the usurpation of a responsibility historically and legally devolved exclusively on the board;
 	the implicit, yet false, postulate whereby directors are only accountable to the shareholders and are only responsible for the interests of shareholders;
 	the reputational issues of the directors submitted to a contested election and the self‑protective behaviour this would bring about;
 	the actual risk of secret negotiations being held between management and investors who are intending to propose nominees;
 	the overwhelming influence accruing to proxy voting advisory firms, whose clients would expect their voting recommendations on the nominees;
 	the risk that the independence of directors nominated by shareholders would be compromised or so perceived;
 	the risk of creating factions and a poisonous atmosphere within the board, which would compromise the proper functioning of the board;
 	the risk of ending up with a board deficient in relevant experience or competence;
 	the risk that the process be hijacked by single-issue groups of shareholders.

These unfortunate outcomes of granting shareholders the right to propose their nominees for the board should merit careful consideration before jumping on the bandwagon.

[1] [2] Data from SharkRepellent.net, as of September 8th, 2015.

This post comes to us from Yvan Allaire, Ph.D. (MIT) and Executive Chair of the Institute for governance of private and public organizations (IGOPP), and François Dauphin, Chartered Professional Accountant (CPA, CMA), MBA and Director of Research of IGOPP. The post is based on the authors’ Institution Policy Paper, entitled “Who should pick board members? Proxy Access by Shareholders to the Director Nomination Process” and is available here [3].

[1] http://clsbluesky.law.columbia.edu/2015/11/30/who-should-pick-board-members/#_ftn1
[2] http://clsbluesky.law.columbia.edu/2015/11/30/who-should-pick-board-members/#_ftnref1
[3] https://igopp.org/en/who-should-pick-board-members/]]></content>
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		<title>The Game of &#8220;Activist&#8221; Hedge Funds: Cui Bono ?</title>
		<link>https://igopp.org/en/the-game-of-activist-hedge-funds-cui-bono-3/</link>
		<comments>https://igopp.org/en/the-game-of-activist-hedge-funds-cui-bono-3/#respond</comments>
		<pubDate>Wed, 14 Oct 2015 14:34:50 +0000</pubDate>
		<dc:creator><![CDATA[mlamnini]]></dc:creator>
				<category><![CDATA[News Articles]]></category>
		<category><![CDATA[Activism]]></category>
		<category><![CDATA[Columbia Law School Blog]]></category>
		<category><![CDATA[Hedge funds]]></category>

		<guid isPermaLink="false">https://igopp.org/the-game-of-activist-hedge-funds-cui-bono-3/</guid>
		<description><![CDATA[Over the last few years, hedge fund activism has received a great deal of coverage in financial media (and in the mainstream press), has triggered heated debates and been the focus of much academic research. Saviour of capitalism for some, for others, activist hedge funds are but mongers of short-term tactics which eventually damage business [&#8230;]]]></description>
		<content><![CDATA[Over the last few years, hedge fund activism has received a great deal of coverage in financial media (and in the mainstream press), has triggered heated debates and been the focus of much academic research. Saviour of capitalism for some, for others, activist hedge funds are but mongers of short-term tactics which eventually damage business corporations[1] [1].

Academic research on the topic mostly focused on the short-term returns surrounding the intervention date, and the few ones that examined the longer-term relationship with performance were often marred by various methodological issues. Coffee and Palia (2014), among others, beseeched researchers on activism for a change of focus: “Future research needs to focus more specifically on where activism causes real changes in firm value and where it does not.”[2] [2] We took on the challenge and explored, among other things, the consequences of activism over time when compared to a random sample of firms with similar characteristics at the time of intervention.

Focusing on activist events of the years 2010 and 2011, we obtained a sample of 290 campaigns initiated by 165 activist hedge funds which targeted 259 distinct firms. To map out the actions and performance of these 259 targeted companies, we have set up a random sample of 259 companies selected to match the targeted companies at the intervention year in terms of industry classification and market value.

This study brings to light a number of facts and some compelling evidence.

We found that the best way, bar none, for the activists to make money for their funds is to get the company sold off or substantial assets spun-off. No less than 81 targeted companies (or 31%) were sold off, a much larger percentage than occurred in the matched random sample (14%). Figure 1 shows a survival rate for the targeted firms of 63% four years after the intervention, as compared to 84% for the random sample of firms.

Figure 1. Survival rate of firms at year end: activist vs. random, base 100 at t-1

 [3]

Survival rate of firms at year end: activist vs. random, base 100 at t-1. The survival rate represents the percentage of firms that were still actively listed at year end (thus excluding firms that were delisted, liquidated of filed for chapter 11, and firms that were either sold or merged).

The evidence is pretty clear that the much vaunted “improvements” in operating performance (ROA, ROE, Tobin’s Q) result mainly from some basic financial manoeuvres (selling assets, cutting capital expenditures, buying back shares, etc.).

However, there is no evidence of deterioration in performance over a three-year period. That is not a result that owes much to the forbearance of activists. Business firms tend to be resilient and their management adaptive to the new reality of activists’ requirements. If the targeted firm can survive the holding period of the activist (more than a third will not), then, and only then, will they be able to start managing again for the longer term.

In general, the stock’s performance of targeted companies over a three-year span barely matches the performance of a random sample of companies[3] [4]. But the activist hedge funds, by timing their entry and exit of a stock, by using derivatives and leverage on occasion to enhance their yield, by benefiting from the “control” premium on getting companies sold off, may well achieve highly positive results.

For targeted companies, the most immediate consequence is the likelihood of being sold off. For other targeted companies, this hedge fund episode often results in change of senior management and board members (Figure 2), stagnation of assets (Figure 3) and R&#38;D.

Figure 2.  Turnover Rate of CEOs

 [5]

Figure 3. Median Results (surviving firms), Total Assets (t-2 = 100)

 [6]

While not lethal over the short period of time that these hedge funds hang around, many companies may come out of the experience as shrunken firms that may have lost a couple of years to their competitors.

The most fundamental issue raised by the phenomenon of hedge fund activism is the crucial assumption that underpins their activities (or at the very least underpins the arguments of their supporters), that is: “Outsiders analyzing financial data from afar can determine that a company is not managed so as to maximize value for its shareholders and that some specific actions they have identified should be taken that would benefit shareholders and would be in the long-term interest of the company.”

Indeed, the argument is made that the cuts in R&#38;D and capital expenditures are applied only to those projects that have no economic justification, that the allocation of cash resources to buy back shares is a better use than some misguided capital investment; of course selling the company (or splitting it up) provides the best outcome for the company and contributes to the overall efficiency of the economic system.

An essential corollary of this “argument” has to be that, in many instances which activists are particularly adept at spotting, management and boards of directors are incompetent, complacent, lack foresight and are unable to act in a manner that serves the best interest of their company. Given the very small size of most companies targeted by hedge funds, that may occur more readily.

But to accept that occurrence as a general rule would be misguided. It would seem a bit unusual that managers, despite their large stock-related compensation, would, with the blessing of their board of directors, waste or misspend R&#38;D funds and capital; until, that is, a wise, better informed activist hedge fund manager comes around to point out the errors of their way.

Either that concept of the business world is accurate, then the whole system of governance of publicly listed businesses must be scrapped and shareholders should call the shot directly and give their marching orders to management; or that view is wrong and management and boards of directors know best what is in the long-term interest of the company. That is a clear choice and one that underpins much of the divergent views on the role and impact of activist hedge funds.

While activist hedge funds (and a number of academics, sheltered by reams of data) have a stake in the first point of view, business people and those whose jobs bring them in close contact with the real world of business tend to partake of the second point of view.

This research does not provide any evidence of the superior strategic sagacity of hedge fund managers but does point to their keen understanding of what moves stock prices in the short term. Indeed, in none of the 259 cases studied here did hedge funds make proposals of a strategic nature to enhance the long-term performance of the firm.

That should concern society, governments, pension funds and other institutional investors with pretension of a long-term investment horizon.

ENDNOTES


[1] [7] See “The case for and against activist hedge funds [8]”, by Yvan Allaire (2015), for a detailed discussion.

[2] [9] See John C. Coffee, Jr., and Darius Palia, “The Impact of Hedge Fund Activism: Evidence and Implications”, ECGI Law Working Paper, No. 266/2014, September 2014, p.82.

[3] [10] We found no statistically significant mean differences between the two groups.

[1] http://clsbluesky.law.columbia.edu/2015/10/14/the-game-of-activist-hedge-funds-cui-bono/#_edn1
[2] http://clsbluesky.law.columbia.edu/2015/10/14/the-game-of-activist-hedge-funds-cui-bono/#_edn2
[3] https://igopp.org/wp-content/uploads/2015/10/Figure-1-CLS-blog-Activist.jpg
[4] http://clsbluesky.law.columbia.edu/2015/10/14/the-game-of-activist-hedge-funds-cui-bono/#_edn3
[5] https://igopp.org/wp-content/uploads/2015/10/Figure-2-CLS-activistJPG.jpg
[6] https://igopp.org/wp-content/uploads/2015/10/Figure-3-CLS-activist.jpg
[7] http://clsbluesky.law.columbia.edu/2015/10/14/the-game-of-activist-hedge-funds-cui-bono/#_ednref1
[8] https://igopp.org/en/the-case-for-and-against-activist-hedge-funds-2/
[9] http://clsbluesky.law.columbia.edu/2015/10/14/the-game-of-activist-hedge-funds-cui-bono/#_ednref2
[10] http://clsbluesky.law.columbia.edu/2015/10/14/the-game-of-activist-hedge-funds-cui-bono/#_ednref3]]></content>
		<wfw:commentRss>https://igopp.org/en/the-game-of-activist-hedge-funds-cui-bono-3/feed/</wfw:commentRss>
		<slash:comments>0</slash:comments>
		</item>
		<item>
		<title>The Lessons of DuPont: Corporate Governance For Dummies</title>
		<link>https://igopp.org/en/the-lessons-of-dupont-corporate-governance-for-dummies/</link>
		<comments>https://igopp.org/en/the-lessons-of-dupont-corporate-governance-for-dummies/#respond</comments>
		<pubDate>Mon, 01 Jun 2015 20:43:16 +0000</pubDate>
		<dc:creator><![CDATA[mlamnini]]></dc:creator>
				<category><![CDATA[IGOPP in the Medias]]></category>
		<category><![CDATA[IGOPP in the medias]]></category>
		<category><![CDATA[Activism]]></category>
		<category><![CDATA[American governance]]></category>
		<category><![CDATA[Columbia Law School Blog]]></category>
		<category><![CDATA[Hedge funds]]></category>
		<category><![CDATA[Institutional investors]]></category>

		<guid isPermaLink="false">http://igopp.org/?p=5156</guid>
		<description><![CDATA[&#8220;Among practitioners, it is a customary cliché to say that all proxy contests—just like all trials—are unique and idiosyncratic. There is some truth to that easy generalization, but it also misses the forest for the trees. Some obvious truths stand out in the recent battle between Trian Fund Management and DuPont that will apply to [&#8230;]]]></description>
		<content><![CDATA["Among practitioners, it is a customary cliché to say that all proxy contests—just like all trials—are unique and idiosyncratic. There is some truth to that easy generalization, but it also misses the forest for the trees. Some obvious truths stand out in the recent battle between Trian Fund Management and DuPont that will apply to future contests:

1. What explains DuPont’s Victory? DuPont won only a narrow victory, despite enormous advantages. Press accounts have reported that DuPont won 52% of the vote. This close margin may seem surprising, given (1) DuPont’s very large market capitalization (over $68 billion), (2) DuPont’s very successful recent performance (it has beaten the return on the S&#38;P 500 index for a number of years); and (3) DuPont’s large retail ownership (over 30%, which shareholders usually support management). Add to this the further fact that DuPont’s CEO (Ellen Kullman) ably portrayed herself an “agent of change,” responsive to shareholder concerns, rather that the defender of a Maginot Line. Early on, she agreed to spin off DuPont’s major chemical division (now called Chemours). Finally, Trian Fund did not own that much stock (only about 2.7%). All in all, this was the largest public company ever subjected to a proxy fight for board seats. Hence, the question lingers: given DuPont’s size, success, and flexibility, and the absence of any “wolf pack” with a sizeable stake, why was the margin of victory so close?

One answer has to be that the governance professionals at pension funds and mutual funds now favor (or at least are open to) the idea of a divided, factionalized board. Putting Nelson Petz on DuPont’s board struck many of them as a low-cost means, with little downside risk, of keeping DuPont “in play” and signaling the shareholders’ desire for more spinoffs and less investment in long-term capital projects, including research and development. Consistent with this attitude, two new studies this year show that activists have achieved over 75% success in recent proxy contests, electing at least one director.[1] [1] Indeed, the odds are so stacked in favor of activist investors who run a “short slate” of director nominees that the number of proxy contests has recently fallen. Why? Managements would much rather negotiate with activists over the identities of their nominees (and the size of any stock buyback) than become involved in a hostile fight that they are likely to lose. The activists may obtain a little less in these negotiations than they would win in a proxy fight, but they correspondingly save the $10 million or so in expenses that the proxy contest would cost them. As a result, both sides would rather settle and increasingly do so. Even Martin Lipton, the staunchest of the critics of shareholder activism, has recognized in a recent memo to his clients that if you can’t beat them, you need to join them.[2] [2] "

Read more [3]

[1] http://clsbluesky.law.columbia.edu/2015/06/01/the-lessons-of-dupont-corporate-governance-for-dummies/#_edn1
[2] http://clsbluesky.law.columbia.edu/2015/06/01/the-lessons-of-dupont-corporate-governance-for-dummies/#_edn2
[3] http://clsbluesky.law.columbia.edu/2015/06/01/the-lessons-of-dupont-corporate-governance-for-dummies/]]></content>
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		<slash:comments>0</slash:comments>
		</item>
		<item>
		<title>The DuPont Proxy Battle: New Myths, Old Realities—and Even Newer Data About Hedge Fund Activism</title>
		<link>https://igopp.org/en/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/</link>
		<comments>https://igopp.org/en/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#respond</comments>
		<pubDate>Mon, 20 Apr 2015 20:55:57 +0000</pubDate>
		<dc:creator><![CDATA[mlamnini]]></dc:creator>
				<category><![CDATA[IGOPP in the Medias]]></category>
		<category><![CDATA[IGOPP in the medias]]></category>
		<category><![CDATA[Activism]]></category>
		<category><![CDATA[Columbia Law School Blog]]></category>
		<category><![CDATA[Hedge funds]]></category>
		<category><![CDATA[Hostile takeovers]]></category>

		<guid isPermaLink="false">http://igopp.org/?p=5163</guid>
		<description><![CDATA[A watershed moment is coming for shareholder activism and corporate governance generally, as the proxy contest brought by Trian Management Fund, seeking effectively to break up DuPont, enters its final stages (with the vote being less than a month away). Technically, the contest is to elect four Trian Fund nominees to the DuPont board, but, [&#8230;]]]></description>
		<content><![CDATA[A watershed moment is coming for shareholder activism and corporate governance generally, as the proxy contest brought by Trian Management Fund, seeking effectively to break up DuPont, enters its final stages (with the vote being less than a month away). Technically, the contest is to elect four Trian Fund nominees to the DuPont board, but, as a column in the New York Time’s Dealbook put it more bluntly, the real fight is over whether to break DuPont into three parts and “shut down DuPont’s central research labs.”[1] [1] Much about this contest is unusual: unlike other targets of activism, DuPont has regularly outperformed the S&#38;P 500 Index and virtually all other metrics for corporate profitability. Its stock price has risen over 185% since its CEO, Ellen Kullman, took office six years ago (while the S&#38;P 500 Index rose only 122% over the same period).[2] [2] The Trian Fund owns only a small stake (less than 3%), but still the contest is close. This column will use this episode as a stalking horse by which to approach a key issue in corporate governance today and also as a case study that illustrates both what we know and still do not know about hedge fund activism.

Let’s start with what we know. Hedge fund activism dates back for at least a decade to the appearance of proactive hedge funds that bought stocks specifically to challenge the management.[3] [3] With that development, institutional activism moved to the offense, departing from a prior history of largely being defensive in nature (i.e., opposing managerial initiatives). What caused this development? Some of the answer lies in deregulatory SEC rules, but probably more of the answer stems from the inability of a hedge fund to consistently beat the market. If the market is efficient (or even approximately so), a hedge fund cannot outperform it for long as a stock picker—unless it buys stocks intending to change existing management policies and thus enhance firm value. Intense competition and thin returns probably drove some hedge funds into becoming pro-active. Relatively quickly, a consistent pattern emerged to characterize this new activism: on the filing of a Schedule 13D by an activist investor, the stock price of the target shows an immediate abnormal return of around 6 to 7%.[4] [4] Whether this short-run price improvement later dissipates has long been debated,[5] [5] but now there is newer data. The latest study, just released in March, shows that long-run returns to shareholders depend on the outcome of the activists’ engagement with the target.[6] [6] If the activists fail to achieve their desired outcome, the long-term return is modestly negative.[7] [7] If, however, the activists succeed, everything depends on what outcome they were seeking. The market largely ignores changes in corporate governance and “liquidity events” (such as special dividends or stock buybacks),[8] [8] but jumps with alacrity in response to takeovers and restructurings.[9] [9] This suggests that the real source of the gains to pro-active hedge funds is not superior corporate strategy, but increases in the expected takeover premium for the target. Apparently, the market perceives most corporate governance issues as important only as a signal of an impending takeover battle. Still, if nothing more materializes, the target’s stock price will stabilize or decline. Even if activists present themselves as superior business strategists or marketing gurus, their success comes largely from jump-starting a takeover or a bust-up.

Read more [10]

[1] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#_edn1
[2] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#_edn2
[3] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#_edn3
[4] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#_edn4
[5] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#_edn5
[6] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#_edn6
[7] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#_edn7
[8] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#_edn8
[9] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/#_edn9
[10] http://clsbluesky.law.columbia.edu/2015/04/20/the-dupont-proxy-battle-new-myths-old-realities-and-even-newer-data-about-hedge-fund-activism/]]></content>
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		<slash:comments>0</slash:comments>
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