Tuesday, June 30, 2015

It May Be Dumb, But Short-Termism Can Be A Valid Business Strategy

Last week, S.E.C Commissioner Daniel M. Gallagher, gave a speech, Activism, Short-Termism, and the SEC: Remarks at the 21st Annual Stanford Directors’ College. I agree with many of Commissioner Gallagher's views on short-termism, and (I will semi-shamelessly note) he cited one of my earlier posts about the role of activists on board decision making. In his remarks, he said, with regard to short-termsim (i.e., companies operating for short term rather than long-term gains):

The current picture is bleak . . . 

Clearly, there’s a way for all the parties . . . to co-exist peacefully. The SEC sets a level playing field; companies manage themselves for the long-term with the vigorous oversight of the board; and activists put pressure on those companies that fall short of that ideal.[47] Unfortunately, we are not in that happy place. Rather, there seems to be a predominance of short-term thinking at the expense of long-term investing. Some activists are swooping in, making a lot of noise, and demanding one of a number of ways to drive a short-term pop in value: spinning off a profitable division, beginning a share buy-back program, or slashing capital expenditures or research and development expenses. Having inflated current returns by eliminating corporate investments for the future, these activists can exit their investment and move on.

. . . .

[47] See, e.g., Joshua Fershee, Shareholder Activists Can Add Value and Still Be Wrong (Apr. 28, 2015) (positing that activists can signal to boards when the company’s strategy may be inefficient; it is then the board’s responsibility to “use the tools before it to make decisions in the best interests of the entity” — that shareholder activists can improve long-term value even if following their recommendations blindly would not).

I absolutely agree with the Commissioner that too many companies are using a short-term philosophy to guide their decision making and that directors are allowing non-controlling institutional investors too much influence in the boardroom.  But, as a believer in director primacy, I see that as a director failure, not an S.E.C. failure or an institutional investor/activist failure. Directors need to make the decisions for the entity based on their view of what is best for the entity, not on someone else's  view. 

Commissioner Gallagher is spot on when he notes his concern "that some institutional investors are paying insufficient attention to their fiduciary obligations to their clients when they determine whether to support a particular activist’s activity."  

That concern, though, has nothing to do with how the board of a company responds to its activist institutional investors that urge short-termist actions.  The institutional investor activist in that case should be held accountable to its clients, and perhaps it should not be urging such behavior, but that is not relevant to how a board of a company in which an institutional investors owns stock responds to such pressure.  

It could be that some boards really believe that short-termism is how best to run a company.  The level of complaining about activists suggests otherwise, but then it is up to boards to reject the activist's requests.  If boards are being unduly influenced by non-controlling outside forces, then shareholders need to take a break from their rational apathy, and do something.  If controlling shareholders are pushing short termism to the detriment of non-controlling shareholders, boards should not follow the controlling shareholder's request or (again) non-controlling shareholders need to push back to ensure the board and the controlling shareholders are honoring their fiduciary obligations.  

If it's just that directors like short termism as a strategy, though, and it's not a decision made for any other reason than directors think it's the right one, I believe those directors are wrong.  But that's not my call. I'm not on the board. 

https://lawprofessors.typepad.com/business_law/2015/06/it-may-be-dumb-but-short-termism-can-be-a-valid-business-strategy.html

Corporate Governance, Corporations, Joshua P. Fershee, Securities Regulation | Permalink

Comments

Short-termism WAS a consistent strategy, particularly in the 1990s before Enron-WorldCom-Tyco stuff of accounting manipulation that triggers the NYSE governance reforms in the listing standards and Sarbanes-Oxley. Companies got punished for missing their estimates by merely pennies, in part because the culture was that financial engineering was so prevalent and so easy that if you missed by even a penny a share, it must have been a signal.

In my experience, activist strategy tends to be a strategy either to make money for the activist, or is connected to another social or political agenda (like union pension fund investment), because except in a few cases, the easiest thing to do is to sell your shares and find a better investment! The exceptions are certain funds that are bound to hold a company’s stock because the company is part of an index that is the basis of the fund, or cases where the investor’s holdings are very large, and a quick sell-off would cost a lot of money. As to the latter, my experience is that those investors know how to exit efficiently and quietly.

Posted by: Jeff Lipshaw | Jul 1, 2015 4:55:50 AM

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