Tuesday, March 31, 2015

More Beliefs: Director Primacy and Public and Private Companies

Yesterday, Prof. Bainbridge annotated my "creed" on corporate governance, and I appreciated his take. In fact, many of his chosen sources would have been mine.

In a later footnote, he noted that he was not sure what I meant by my statement: "I believe that public companies should be able to plan like private companies . . . ." I thought I'd try to explain. 

My intent there was to address my perception that there is a prevailing view that private companies and public companies must be run differently.  Although there are different disclosure laws and other regulations for such entities that can impact operations, I'm speaking here about the relationship between shareholders and directors when I'm referencing how public and private companies plan. 

Public companies generally have far more shareholders than private companies, so the goals and expectations of those shareholders will likely be more diverse than in a private entity. Therefore, a public entity may need to keep multiple constituencies happy in a way many private companies do not.  However, that is still about shareholder wishes, and not the public or private nature of the entity itself.  A private company with twenty shareholders could crate similar tensions for a board of directors.

As an example, consider Investopedia's description of Advantages of Privatization in an article called "Why Public Companies Go Private" (emphasis added):

Private-equity firms have varying exit time lines for their investments depending on what they have conveyed to their investors, but holding periods are typically between four and eight years. This horizon frees up management's prioritization on meeting quarterly earnings expectations and allows them to focus on activities that can create and build long-term shareholder wealth. Management typically lays out its business plan to the prospective shareholders and agrees on a go-forward plan. 

This is often a practical reality, but I disagree (or at least believe it should not be the case) that a company must be private to "free up management's prioritization on meeting quarterly earnings expectations and allows them to focus on activities that can create and build long-term shareholder wealth."  

This, I think, connects with Prof. Bainbridge's point in his footnote annotation 4, where he says, "I think too many hedge funds are pressing too many boards to pursue short-term gains at the expense of sustainable long-run shareholder wealth maximization and, accordingly, that boards need more insulation from shareholder pressure." I agree completely with his point there, and that's the kind of issue facing public companies that I was intending to address in my assertion.  

Ultimately, director primacy means ensuring a large measure of director autonomy (or insulation). This works in both directions, whether it relates to short- versus long-term planning or providing workplace benefits (or not). Ensuring a robust business judgment rule as an abstention doctrine preserves director primacy, and in the long run, will benefit corporate governance and shareholder choice.  

https://lawprofessors.typepad.com/business_law/2015/03/the-privatepublic-divide.html

Business Associations, Corporations, CSR, Delaware, Joshua P. Fershee, Securities Regulation | Permalink

Comments

A comment on the following:

"This, I think, connects with Prof. Bainbridge's point in his footnote annotation 4, where he says, "I think too many hedge funds are pressing too many boards to pursue short-term gains at the expense of sustainable long-run shareholder wealth maximization and, accordingly, that boards need more insulation from shareholder pressure." I agree completely with his point there, and that's the kind of issue facing public companies that I was intending to address in my assertion."

You know, a lot of people think that way but I am not sure why. I have yet to find empirical evidence that contradicts all the empirical studies that finds hedge fund activism to be both wealth enhancing for investors and performance enhancing for companies. Moreover, denying the value of hedge fund activism is really denying important signals provided by the stock market on the existence of managerial inefficiencies. Why would you want to deny that kind of information being incorporated into the decision making of public companies? I don't think Henry Manne would be very pleased with that approach, a great figure in corporate law whose thinking appears to be both revered and ignored at the same time. I suggest you read two articles I recently posted, "Activist Hedge Funds in a World of Board Independence: Creators or Destroyers of Long-Term Value?" and "A Theory of Shareholder Activism and its Place in Corporate Law."

Best,

Bernie

Posted by: Bernard S. Sharfman | Mar 31, 2015 7:23:12 AM

Thanks for the comment, Bernie.

My issue is not that hedge funds wield some power or promote an agenda. My concern is that hedge funds are able to wield such power to promote short-term earnings in excess of their ownership share because boards are not sure they have the insulation they need to protect their decision making adequately.

If the hedge fund is a majority owner, then their influence is clear. If the board actually agrees with the hedge fund, even without a majority ownership, then the board gets to make that call, too. A dissenting majority of shareholders can deal with the board through other mechanisms.

It’s thus not that a hedge fund can’t be right. It’s that the directors need to be appropriately protected in making their decisions. As for empirical data, as to this issue, I don’t care one way or the other because I think it's the board’s decision. (To be clear, I am very interested in such data for other purposes.) As a director I would want the data, but I would also want to be sure my power was there to interpret the data and decided whether to follow what it suggests or choose another path.

To me, that’s the key. I think director primacy allows for creativity and both short-term and long-term growth because it protects risk taking, while allowing for more cautious paths. It’s my sense that most public companies have shifted to short-term planning over long-term planning due to external pressures because of eroded director primacy. So, I’m not inherently anti-hedge fund; I’m just more pro-director.

Posted by: Joshua Fershee | Mar 31, 2015 7:50:15 AM

I understand where you are coming from and am very sympathetic to your approach. I strongly believe that the "preservation of managerial discretion should always be the null hypothesis.” (This is an incredibly insightful statement by Steve Bainbridge.) However, I find hedge fund activism to be unique, shareholder action that actually rejects the null hypothesis. The evidence is in the empirical studies and the theoretical argument I provide in "Activist Hedge Funds in a World of Board Independence: Creators or Destroyers of Long-Term Value?" .

Posted by: Bernard S. Sharfman | Mar 31, 2015 8:09:59 AM

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