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Sanjay Sanghoee

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Bad to Worse: Why Shareholder Activism Hurts Shareholders

Posted: 05/03/2013 12:45 pm

Last week I wrote about why the private sector should be accountable to the public. One of the ways (theoretically) in which businesses are held accountable by the public, or at least those with stock portfolios, is through shareholder activism. However, in practice, shareholder activism rarely has the effect that is attributed to it and can actually be a case of a disease being used to cure an illness.

The reason for this is that while some activism, through proxy agencies, is truly a populist enterprise which represents ordinary shareholders, more often it is the domain of large institutional investors like hedge funds, pension funds, and corporate raiders who own sufficiently large blocks and have the legal and financial firepower to force matters. These parties usually have very different goals than ordinary shareholders, and can even bring about change that is detrimental to the interests of those shareholders.

Of the examples mentioned above, hedge funds favor corporate actions that boost short term profits and create market sizzle rather than bolster long-term fundamentals. That type of strategy creates rapid stock appreciation in the near term but can damage a company's prospects in the future. This may lead to high trading profits for funds but can leave ordinary shareholders (at least those who are not active traders themselves) in the dust as short term thinking hampers long-term sustainable growth. Plus, those shareholders often own public stocks through mutual funds, who are longer term players and don't benefit from short term upticks.

Pension funds, on the other hand, have the opposite problem. Due to restrictive internal mandates and legal requirements, such funds are overly cautious and unwilling to let their portfolio companies take innovative risks that are sometimes necessary for their survival and long-term value creation. As long as the strategy fits cleanly into the funds' mandates, they are content to maintain the status quo and happy to boot any managers who want to blaze trails.

For sure there is a problem with corporate governance in America, and companies require outside agencies to monitor their actions and keep them honest, but shareholder activism by large investors can often make things worse by simply replacing one set of insular interests with another, and management greed with investor greed.

A perfect example of this is corporate raider Carl Icahn's disastrous intervention in the affairs of Blockbuster. Blockbuster lost its one critical chance to move away from the dying bricks-and-mortar model and prepare for the future when Icahn replaced the CEO, John Antioco, with a hatchet man who gutted the company's digital plans and allowed rival Netflix to take the crown in Internet rentals.

Even Netflix has acknowledged that had Blockbuster stayed its course, its iconic brand and name recognition with consumers would have been hard to beat, and would likely have saved the company from bankruptcy. Now, alarmingly, Icahn has beefed up his holdings of Netflix, which makes me worry what he will do next to boost short-term earnings -- eliminate instant streaming and add late fees to DVDs?

Power struggles between companies and large shareholders is nothing new, and neither is the disconnect between strategic and purely financial interests, but neither of them on their own protect the welfare of ordinary shareholders, and when one of them exerts an overwhelming amount of control, the long-term interests of the company are invariably compromised.

If shareholder activism is going to be constructive, then it needs to be driven by ordinary shareholders, not the big guys, and it needs to be directed at long term growth for a business, not the turning of short term profits.

SANJAY SANGHOEE has worked at leading investment banks as well as at a multi-billion dollar hedge fund. He has an MBA from Columbia Business School and is the author of a fast-paced thriller entitled "Killing Wall Street", which be released on June 1st,2013. Please follow him on Twitter @sanghoee and visit his website at www.sanghoee.com

 

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