The largest asset managers, led by BlackRock, are elbowing activists out of the spotlight on the topic of corporate governance. This blog has tracked tracked how mutual funds are putting distance between their priorities and the activist agenda (see here, here, here, here and here). The rift widened earlier this month when BlackRock, Fidelity, Vanguard and T. Rowe Price met with Warren Buffet and JPMorgan to create guidelines for best practice on corporate governance. Discussions have focused on issues such as the role of board directors, executive compensation, board tenure and shareholder rights, all of which have been flashpoints at US annual meetings.
This effort appears to be in direct response to the prominence of activist hedge funds (now managing in excess of $100 billion) and the success they have had in forcing share buybacks and other financial moves by corporations to increase returns to shareholders.
On the heels of the meeting, BlackRock CEO Larry Fink sent another letter to chief executives of S&P 500 companies urging “resistance to the powerful forces of short-termism afflicting corporate behavior” and advocating they invest in long-term growth. Make no mistake, “short-termism” is code for activist hedge funds and paragraph two of the letter takes aim at common goals of activists:
Dividends paid out by S&P 500 companies in 2015 amounted to the highest proportion of their earnings since 2009. As of the end of the third quarter of 2015, buybacks were up 27% over 12 months. We certainly support returning excess cash to shareholders, but not at the expense of value-creating investment. We continue to urge companies to adopt balanced capital plans, appropriate for their respective industries, that support strategies for long-term growth.
The letter asks CEOs to develop and articulate long term growth plans and move away from quarterly earnings guidance. “Today’s culture of quarterly earnings hysteria is totally contrary to the long-term approach we need,” writes Fink. Without a long term plan and engagement with investors about the plan, “companies also expose themselves to the pressures of investors focused on maximizing near-term profit at the expense of long-term value. Indeed, some short-term investors (and analysts) offer more compelling visions for companies than the companies themselves, allowing these perspectives to fill the void and build support for potentially destabilizing actions.”
With respect to “potentially destabilizing actions,” Fink acknowledged that BlackRock voted with activists in 39% of the 18 largest U.S. proxy contests last year, but says “companies are usually better served when ideas for value creation are part of an overall framework developed and driven by the company, rather than forced upon them in a proxy fight.”
With this letter and the group of large investors that is in formation, traditional fund managers are giving corporate America a buffer against activists. If a company were to explain to the largest asset managers “how the company is navigating the competitive landscape, how it is innovating, how it is adapting to technological disruption or geopolitical events, where it is investing and how it is developing its talent,” and had their support, it would be more straightforward to resist an activist campaign, particularly one based on a financial strategy like buybacks. “Companies with their own clearly articulated plans for the future might take away the opportunity for activists to define it for them,” writes Matt Levine in Bloomberg View.
If the pendulum is to shift from activists to traditional fund managers, are they ready to be proactive on governance matters? The AFL-CIO’s key vote survey which tracks institutional voting on proposals to split the roles of chairman and CEO, curb executive compensation, give shareholders more say in board appointments and improve disclosures about lobbying, found many of the largest mutual/index fund companies to be in the bottom tier of firms in their support for these governance-related votes.
The FT suggests that the size of these institutions may limit their involvement, “any governance principles that emerge from a consensus of the large managers are likely to fall short of those typically supported by the powerful proxy advisory services ISS and Glass Lewis, which offer voting recommendations to pension funds and other investors.”
However, a research paper entitled Passive Investors, Not Passive Owners finds that ownership by passively managed mutual funds is associated with significant governance changes such as more independent directors on corporate boards, removal of takeover defenses and more equal voting rights.
Investing for the long term is an issue in the Presidential campaign and is becoming more relevant in corporate America as the US adjusts to globalization, technology that is disrupting many sectors and the continuing shift from manufacturing to service and knowledge-based industries. The practice of quarterly reporting limits disclosure and discourse about long term objectives. As Matt Levine notes, “If you are an investor, you might want to know your company’s plans, no? It is odd that corporate disclosure is so backward-looking; like so much in corporate life, it is probably due mostly to the fear of litigation…Also, notice that Fink’s list of “what investors and all stakeholders truly need” is exactly what isn’t (for the most part) in companies’ public disclosures.”
In the UK, quarterly earnings reports are optional and more companies are giving them up. “I am surprised that more people haven’t stopped,” Mr Lis [of Aviva Investors] says. “For long-term investors it really wouldn’t matter whether there are quarterly reports or not in any sector.”
The investor group and the BlackRock letter are more examples of fund managers pursuing a governance agenda independent of activists. It remains to be seen how wide the rift between index/mutual fund managers and activist hedge funds will become, but it is clear that some major asset managers have seen limitations in today’s forms of activist investing, been put off by regular overreach by activists and maybe concluded that activists have jumped the shark.
- T. Rowe Price voted with dissident shareholders 52% of the time in in board contests between 2009 and 2013. Fidelity voted with dissidents 44% of the time.
- Institutional Investor reports that from January through September last year, hedge funds were “somewhat victorious” in 19 of 24 proxy contests they initiated.
- The Shareholder Rights Project at Harvard Law School, in just one proxy season, succeeded in getting about a third of all the S.&P. 500 companies that had a staggered board to eliminate it.
- Even PR firms, law firms and the legendary Martin Lipton (inventor of the poison pill) whose bread is buttered by corporations acknowledge that it is getting harder to fight activists.
Corporate defenders like Mr. Lipton are trying to frame the debate around the issue of long term value. Hedge funds, they argue, are short term opportunists that interfere with corporations’ ability to manage for the long term.
This week Larry Fink, CEO of BlackRock, sent a letter to CEO of every S&P 500 company advocating for greater focus on creating long term value. While the letter doesn’t specifically reference activist hedge funds, it does call into question why companies raise dividends and buy back shares — some of the low hanging fruit that a company use to placate an activist. BlackRock, though, is working all angles. It also is a member of the recently formed Shareholder-Director Exchange which aims to formalize how corporations engage with institutional shareholders. (The Conference Board also has developed a set of principles to increase public trust in big business.) Yet, despite these efforts to work within the system, BlackRock voted with dissident shareholders 34% of the time last year.
There is a real issue tied to short vs long-termism. The ratio of corporate cash to capex is almost at all time low (click to see chart), raising the important question of whether corporations are investing enough to be competitive in the future. It appears disingenuous, though, to suggest that activism is the cause.
If defenders of the status quo are really concerned with long term growth and corporations delivering on long term strategy, they should be as vocal about the myriad of other factors that work contrary to those principles. Take the issue of quarterly earnings guidance. Most companies still provide earnings guidance and presumably manage based on that guidance. I would argue that is a greater short term pressure on corporate America than any group of hedge funds.
In order to capitalize on the tailwinds that are helping activists, they must realize that their reputation is the most powerful weapon in their arsenal. Funds that strike an effective balance between quiet advocacy and calibrated confrontation with boards, establish working relationships with pension funds, and become viewed as positive agents for change by the media, proxy advisory firms and others in the corporate governance arena will be the ones who translate the golden age of activism into riches for their LPs.
It used to be that pension funds and other real money asset managers were passive investors. If they didn’t like a stock or management at a corporation, they sold their positions and moved on. Things are changing, though, and these “sleeping giants” are stirring. Indeed, they are being forced to wake up because they are being pulled in two opposite directions.
On one side are the activists, who have learned that it’s better to have allies among institutional shareholders than go it alone when trying to pressure boards and management. On the other side is management, which realizes that if they keep their institutional shareholders close, they have a better shot at resisting or event deterring activist campaigns.
Corporations have stepped up their IR game and a pension plan like TIAA-CREF can meet with as many as 450 companies in the span of one year. On the corporate agenda: getting support for pay packages, board members and other governance issues that are frequently the target of agitation by hedge funds.
Furthermore, a new working group among pension funds and corporate boards intends “to establish more open lines of communication between companies and institutional investors, allowing companies to get their message out, and investors to express concerns, more frequently.” Called the Shareholder-Director Exchange, the working group developed a 10-point protocol to facilitate more productive interaction between boards and investors. Activist hedge funds are not part of the SDX group. This shows a preference, at least among several influential asset managers, like BlackRock, to to give the system a chance — to focus on evolution rather than revolution.
So, which way is the pendulum swinging? Are boards regaining firmer footing? Or are activists finding support among firms that didn’t historically advocate for corporate change?
It appears that the corporate strategy of engagement is having mixed results. A report last year by Institutional Shareholder Services called said that 2013 witnessed a “pivot point where the central focus of shareholder activism shifted” to “direct challenges to board members.”
Put your money on the activists. The SDX is a nice idea and formalizing how large shareholders engage with boards is probably overdue. But, corporations don’t like change and their first instinct is to resist outside pressure, regardless of the source. The SDX was formed in part by law firms and consultancies closely aligned with the corporate status quo and they may find that their plan backfires if pension funds follow the protocol but corporations don’t effectively engage or dismiss shareholders’ concerns. That would have the effect of driving pension funds into the waiting arms of activists.
Good for the Icahns of the world, right? Not so fast. Not all activist hedge funds are created equal and the question is which activist funds are positioned to win the support of real money funds? It will take a special kind of activist to effectively enlist the heretofore reluctant support from pension funds. The activist has to demonstrate a strategy and culture that is acceptable to the more conservative world of pension funds. The activist winners will have the brands that a) pension funds feel comfortable supporting and b) enhance the pension funds own brand by affiliation.
It boils down to reputation, but reputation and brand management are relatively new to the activist world. Today, there is no IBM, no safe partner in activist investing. The big firms have uneven reputations and the small firms might be too small to be seen as effective partners for big pension funds. There is much work to be done.
With the economy stuck in neutral and companies struggling to grow, it is open season for activist investors. The Bulletproof Blog notes that Ralph Whitworth of Relational Investors won a board seats at HP and that there is very public agitation for change at Yahoo! and E*Trade. Commenting to Bulletproof, the National Investor Relations Institute counsels corporations to use social media to “begin a real dialog with these investors.”
Really? C’mon! By the time a serious activist is publicly agitating, it’s probably too late for the target company. First, the company will be saddled with its own track record of underperformance. Second, the company is probably doing a poor job at communication and will be ill-equipped to effectively engage using social media. They’ll be too slow, too defensive, too controlled by lawyers and bureaucracy. Third, it’s much easier to get attention with a negative message and activists know this. The company – because of its own track record – has a hard time rebutting and has limited credibility in advancing an alternate roadmap to what is advocated by the activists.
With deer season recently open in the New York State, hunters of all sorts are taking aim. The fact is that it is much easier to take a shot at Yahoo!, E*Trade or a host of other companies that have disappointed Main Street for years than it is to sight that eight pointer.
At the Wall Street Journal‘s recent CFO Network Conference, Glenn Hutchins, CEO of PE firm Silver Lake, said the expectations of analysts and shareholders created resistance for companies wanting to invest in new businesses and technologies. CFOs, he said, find it hard to make transformative investments because “making a short-term diminution for the purpose of a long-term gain is very difficult to do” in the equity markets. Pardon me, but bullshit.
If companies feel constrained by short-term expectations, it is their own fault. If a CEO/CFO wants to focus on long term and get shareholder support for a series of large investments, he/she needs have a sound strategy and get to work selling it to investors, analysts, journalists and the board. Stop giving earnings guidance and start talking about the long view, your growth plan and how investments will pay off. Make sure employees understand and buy into the strategy.
The problem Hutchins identifies is not with the markets, but with management and their lack of the vision thing. There is a difference between setting financial objectives and creating the strategy that leads to growth. Investors will buy into a solid strategy — just ask Amazon, ExxonMobil, drug companies, Apple, and others known for heavy capital expenditures and R&D.
If a company is getting pressure from shareholders they have a communications breakdown or a strategy breakdown. Don’t shoot the messengers, Mr. Hutchins. Oh, and is it surprising that an LBO firm might be making an argument for the benefits of being a private company?
Silver Lake and Mr. Hutchins have been very active on the media front recently. A live interview with Charlie Rose and opinion piece in the FT cover his views on the economy, the deficit, education, innovation, and other macro issues. Is a run for political office in the works? You heard it here first.
Glencore’s pending IPO has generated much speculation about how the firm will stand up to the scrutiny of life as a public company. However, two more common names are also making headlines for their IR/PR and they demonstrate different approaches to managing reputation under the glare of the spotlight. First up, Google. Investors and analysts were miffed after CEO Larry Page spent only three minutes on the company’s recent earnings call and did not participate in Q&A. Unconventional, but remember that Google is the same company that did its IPO via dutch auction and deprived Wall Street banks of millions in guaranteed fees. Google has never given earnings guidance and its “Owner’s Manual for Google Shareholders” states that Google is “not a conventional company [and doesn’t] intend to become one.” The challenge of IR is getting Wall Street to buy into the long-term vision, especially in times, like now for GOOG, when the short-term expectations of investors are not being met. GOOG trades around $525, so most are trusting Page’s vision thing. But, Therese Poletti at MarketWatch wonders if the “company still merits its unconventional stance toward Wall Street.”
While Google seemingly thumbs its nose at the conventional way of doing things, Goldman Sachs is sitting on its thumbs and other fingers as it tries to convince the world that it is the kindler, gentler vampire squid. Andrew Sorkin of the New York Times is bewildered by Goldman’s continuing spin about their mortgage market investments and hedges during the housing meltdown. “Goldman Sachs did not take a large directional ‘bet’ against the U.S. housing market,” said Goldman last year. For some, that doesn’t square with the fact that it was $3.8 billion short the housing market and $3.3 billion long housing market in 2007. Sorkin says Goldman should stop tap dancing and “be proud of its prescient call about housing. It was better for its shareholders, and frankly better for the taxpayers, that the firm was smart enough to short the mortgage market.”
Goldman also downplays trading in its latest earnings news release. In fact the word “trading” does not appear in the news release and related materials for Goldman’s Q1 earnings announced on April 19. I repeat, no mention of trading. CNBC points out that last year, the announcement mentioned “trading” nine times and in 2006, “trading” popped up 11 times in one quarter. Truth is in Q1, Goldman’s equities and fixed income traders hauled in more than $2 billion in revenue. Not bad for the business no one wants to talk about.
As it deals with media and investors and uncomfortable truths, will Glencore emulate Goldman and play by the rules but try to keep the truth obscured by sleight of hand? Or will it follow Google and give a more decipherable, perhaps Swiss, hand gesture to those who want transparency about their business? Hang loose, we’ll find out soon enough.