Friday, June 10, 2022
Not Everything is About Stakeholders
The battle for Spirit Airlines is fascinating. Frontier offered to buy Spirit at a price of roughly $22 per share, payable mostly in Frontier stock. Then JetBlue swooped in with a topping bid of $33 per share in cash. Spirit's board maintained its preference for Frontier's bid, and Glass-Lewis recommended in favor of Frontier, but ISS recommended against. ISS's argument was, in part, that if shareholders liked the sector, they could take JetBlue's cash and reinvest it.
Spirit's argument was that the combination with Frontier not only stood a greater chance of surviving antitrust review, but there would be substantial operating synergies such that the combined entity would be expected to outperform the sector in the long term.
There was some interesting jousting over the reverse break fees if DoJ refused either combination - including Jet Blue's highly unusual offer to pay part of the break fee in cash as a special dividend to Spirit shareholders as soon as they voted for a deal between Spirit and JetBlue (I mean, it's kind of complicated given the numbers floating around, JetBlue offered $33, then lowered it to $30 when it made a tender offer for Spirit, and then added back $1.50 as a prepay on the break fee, which means one has to query whether the current JetBlue structure counts as vote-buying) - but ultimately, leaving aside antitrust risk, the fundamental question to shareholders is whether they can reinvest the extra cash offered by JetBlue (including potentially in the Jet Blue/Spirit combination itself) more profitably than whatever long term appreciation in the stock price they could expect from a combined Frontier/Spirit entity.
Which is why this column in the Wall Street Journal stood out for me:
The bidding war over Spirit Airlines shows why “stakeholder capitalism” is a hard sell for investors.
On Wednesday, the U.S. carrier postponed a shareholder meeting scheduled for Friday that would have included a vote on the acquisition bid made by its competitor Frontier Airlines. Spirit’s board of directors retains a strong preference for this merger, which seems like a perfect cultural fit, over a rival one proposed by JetBlue Airways. But the board’s latest move betrays hesitation that shareholders might not put the same value on non-pecuniary factors.
…[S]haring DNA is precisely what could make a Spirit-Frontier combination successful. Both carriers’ networks are similar and complementary: Only in 2% of routes did they compete fiercely for market share in 2021, a data analysis shows. Conversely, JetBlue’s higher-cost model is a harder fit.
Spirit shareholders might still get their cake and eat it too if the company wrangles more concessions out of Frontier before the rescheduled June 30 vote. If not, they face a dilemma between more money in the short term and a stake in a merged company that could, speculatively, offer higher longer-term returns.
The situation illuminates two distinct ways of understanding capitalism. First is the standard “shareholder theory” popularized by Milton Friedman, which gives primacy to measurable investment returns and laments the “agency problem” of executives serving other priorities. The second, sees professional managers wresting control from shareholders—a phenomenon documented by business historian Alfred Chandler, among others, since at least the 1920s—as necessary for the survival of corporations. It links with the “stakeholder theory” in which firms should serve all involved parties.
Literally nowhere in Spirit’s pitch to investors does Spirit suggest that the Frontier transaction is anything but shareholder value-maximizing. Nothing in Spirit's argument has anything to do with the merger's effect on nonshareholder interests. In fact, Spirit’s position is not unlike the position of the Time board when it rejected Paramount’s bid in favor of a merger with Warner – and in that case, the Delaware Supreme Court famously gave the Time board leeway to pursue a long term strategic vision. So, you know, unless you believe the Delaware courts are stakeholderists now, the mere fact that corporate directors want to reconstitute the entity rather than cash out does not a stakeholder-merger make.
What does the columnist mean by "stakeholderism," then? Apparently, he means something like the idea that managing for the long term is, in fact, value-maximizing for shareholders, in part because the long-term view theoretically includes building relationships with, and thereby benefitting, other constituencies. That version of stakeholderism is often used to defend managerial control against shareholder interference (while staving off business regulation). The irony of this concept of "stakeholderism" is that it is often opposed by other stakeholderists, including stakeholderists who share a vision of long-term value creation as benefitting all parties, because they object to giving management that much discretion.
Professor Steve Bainbridge chimed in with a different definition of stakeholderism. He pointed out that the JetBlue flight attendants’ union opposes a merger with Spirit on the ground that it will cost jobs, while the union that represents both Frontier and Spirit favors a merger between those companies, and he concludes that a true stakeholder investor would follow the union recommendation. He predicts that shareholders are only motivated by profit and won’t pursue the union position, which he implicitly associates with the absence of shareholder wealth-maximization.
Notice, then, that Prof. Bainbridge's definition of stakeholderism is very different than the one offered in the Wall Street Journal. In his view, it's not about managerial control or long-term value maximization; it's about whether shareholders are willing to sacrifice profits in order to benefit nonshareholder constituencies. But whatever the unions' position, this is not really the choice that the shareholders in this instance are being asked to confront. I.e., this is not a salient part of the pitch to investors.
That said, it's possible the reason the union position is not part of the pitch to investors is because no one thinks investors would find the unions' preferences persuasive (or, worse, they think that shareholders would do the opposite of what unions want). But that's entirely consistent with the stakeholderism-as-profit-sacrificing theory, because profit-sacrificing stakeholderism is a movement for change; the whole point is that it functions as an objection to the way the current system operates. In a case like this, the argument often concludes there is an actual agency problem between the institutional investors who vote the shares, and the retail shareholders who they represent. If that’s right, the fact that the institutions who own Spirit Airlines – 70% of the stock - may vote for the JetBlue deal tells us very little. That’s precisely why so many academics argue that institutions should determine retail preferences before voting, and why the SEC wants greater disclosure from funds that market themselves as ESG. I mean, at this point I'd kind of be remiss if I didn't mention that Prof. Bainbridge just recently signed a letter arguing that institutional investors do not share the preferences of their own beneficiaries, and recommended that those beneficiaries be polled as to their true preferences, so he's familiar with this line of reasoning.
Now, to be fair, I share Prof. Bainbridge's view that, faced with a takeover bid at a premium that favors shareholders over everyone else, shareholders as a group are unlikely to reject it in order to benefit nonshareholder constituencies. That dynamic is, in fact, is why we're losing local news coverage in this country. But to give the stakeholder argument its due, if shareholders really did force companies to operate with a view to benefitting nonshareholder constituencies, consistently and across the board, we'd also see fewer rapacious takeover bids in the first place, because the acquirer would expect that its own shareholders would refuse to let it enact its rapacious wealth-maximizing plans.
Which means, there's not a whole lot in the Spirit battle that sheds light on the stakeholderism debate. This fight is more of a throwback to Paramount: as between the board and the shareholders, who gets to decide the future of the company, and the timeline for achieving it?