Today’s Top Stories
- Taliban Set Stage for Peace Talks (WSJ.com: World News)
- Battle Brews Over E-Cigarettes (WSJ.com: World News)
- VIDEO: One-minute World News (BBC News - Home)
- Chrysler agrees to recall 2.7m Jeeps (BBC News - Home)
- Futures Movers: Oil climbs on Syria tensions, ahead of supplies (MarketWatch.com - Top Stories)
- Is it time for the 'mixer movement'? (Business News, Financial News, Business Headlines & Analysis - The Washington Post)
- Chuck Jaffe: Fox commentator paid $50,000 to tout stock (MarketWatch.com - Top Stories)
- U.S. says spy programs foiled NYSE bomb plot (Business and financial news - CNNMoney.com)
- Square Feet: As Coney Island Stirs, One Man’s Vision Is Unbuilt (NYT > Business Day)
- Farewell, Ben Bernanke? (Business and financial news - CNNMoney.com)
- DealBook: Icahn Buys Half of Southeastern’s Stake in Dell (NYT > Business Day)
Other Blog Headlines
- Lawler: Updated Table of Distressed Sales and Cash buyers for Selected Cities in May (Calculated Risk)
- 10 Tuesday AM Reads (The Big Picture)
- Free, Unregulated Markets are Not Always the Answer: Seven Important Examples of How Markets Can Fail (Economist's View)
- Twitter Digest: 2013-06-09 (Paul Kedrosky's Infectious Greed)
Category Archives: Business Strategy
The New York Times recently published an article on shareholder activists and how they can sometime abuse shareholder democracy for their own short-term gain (see ‘Shareholder Democracy’ Can Mask Abuses).
The article noted a recent conflict between activist/investor David Einhorn and Apple in which Einhorn has requested Apple distribute cash to investors. Marty Lipton criticized Einhorn’s actions and, more broadly, the practices of some activist investors. According to the New York Times:
Martin Lipton, one of the nation’s top corporate lawyers…wrote a scathing memo to his clients on his view that “shareholder democracy” has run amok…Mr. Lipton said that long-term shareholders in public companies are being undermined “by a gaggle of activist hedge funds who troll through S.E.C. filings looking for opportunities to demand a change in a company’s strategy or portfolio that will create a short-term profit without regard to the impact on the company’s long-term prospects.”
Although I don’t always agree with Marty Lipton (best known for inventing the poison pill), I think he’s onto something here.
Clearly, it can be problematic when the goals of short-term institutional investors don’t match those of the companies in which they invest, where the incentives should favor long-term outcomes.
I’ve written about these issues in the context executive compensation (see Revisiting Executive Pay: The Problem is Systemic), but given the prominence of institutional investors with short-term horizons, I think the overarching issues are worth revisiting.
In a previous article I mused:
Who are shareholders? Although seemingly a silly question, the answer has important implications…
Historically, shareholders were individual company owners (often dispersed) who held stock for long periods of time. Today, the picture is quite different. Shareholders are represented less and less by individuals and institutions holding stocks for the long-term, and more and more by individuals and institutions looking to make a quick profit – buying and selling shares with frequency. The rise of such traders who seek to profit from near-term volatility in stock prices has changed the nature of the system. These traders are inconsistent with the spirit of the view of the shareholder as a long-term owner. They are not really owners, and sometimes have little interest in the long-term survival of the firm. They often only care about micro-movements in share price in a very narrow window of time.
I think what really drives this point home is the fact that even the definition of “short-term” has gotten, for the lack of better words, shorter. In the 1960s, investors held stocks for an average of about 8 years. That number can now be counted in days (see Stock Market Investors Have Become Absurdly Impatient). Add in high frequency traders, and the average hold time can be counted in seconds (see How long does the average share holding last? Just 22 seconds).
I think we really need to ask ourselves: Given the decreasing shareholding periods, are current shareholders congruent with our vision of shareholders as long-term owners?
The short-term mentality now prevalent among a certain strata of shareholders is not only a troubling in its own right, but it can also have serious implications for companies and how they are managed on a day-to-day basis. How can the CEO and the company’s top management team focus on long term outcomes when they are forced to cope with a set of stakeholders who favor near-term performance? After all, according to theory, managers are supposed maximize profitability over an infinite time horizon.
So, how can we solve the problem of some institutions trying to game the shareholder democracy system? For me, one interesting possibility lies in differentiating between ownership classes of stock and trading classes of stock. For example, perhaps we could consider creating “ownership” classes of stock that must be held for longer periods of time and come with certain, enhanced voting privileges so as to better align the incentives of shareholder/owners with the company. We could also create “trading” classes of stock with fewer ownership and control rights that can be freely traded at will. I’ve written a bit about this idea in the blog post entitled “Different Stock Classes: Trading vs. Ownership Shares“. I’d encourage you to take a look if you have an interest in the topic.
Nevertheless, whatever the outcome, one thing is for certain –this issue hasn’t been getting nearly the attention it deserves.
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Apple Weakness Continues: Here Are The Important Levels (The Market Financial, 3/11/13)
Apple (NASDAQ: AAPL) No Longer Tablet King (Energy and Capital, 5/31/13)
Why Apple Should Follow IBM’s Successful Turnaround Story (Jutia Group, 3/8/13)
I recently read an article at the Baseline Scenario about CEO stars, CEO compensation, and firm performance (see One Hit Wonder). It is no secret that compensation packages for CEO’s are often quite lucrative. However, there is a common belief that CEO’s, as “star” executives, merit such compensation packages because they possess inalienable management skills that create value for shareholders. Moreover, the belief is that the managerial skills that “star” executives possess are transferable from one organization to another. For this reason, companies poaching CEO’s from one organization to another often lavish that individual with sweetheart deals. Such an outcome is rational if we believe that executive (CEO) compensation is the natural result of a competitive market for “talent,” and that the CEO will bring his or her talents to the new company, thereby increasing shareholder value.
However, James Kwak of the Baseline Scenario points out that there might not be such a tight coupling between pay and performance when star executives move from one company to another. According to a review of the academic literature on the topic by Charles Elson and Craig Ferrere (as summarized by Kwak),
Elson and Ferrere cite multiple empirical studies finding no relationship between a CEO’s performance at one company and his performance at the next company that massively overpaid to hire him. They conclude: “the empirical evidence suggests a negative expected benefit from going outside rather than pursuing an internal succession strategy, despite the ability to access an enhanced talent pool. In the aggregate, CEOs appear to be at their most effective only when they have made significant investments in firm-specific human capital.”
The argument is that “star” CEO’s lured from one company to another – i.e., the ones that everyone believes will succeed because they have succeeded in the past – don’t create value for the hiring company. Rather, it is likely that they appropriate most of the value that they generate by commanding higher pay packages than what should have been granted them. It is also quite possible that their “inalienable” management talent is not as “inalienable” as many believe. Otherwise stated, they are not as good as their pay suggests.
Although not in the context of CEO’s, Boris Groysberg (of Harvard) has a similar study of star analysts (see Chasing Stars: The Myth of Talent and the Portability of Performance). Like the CEO study, he finds that when star analysts move from one company to another, they usually under-perform and are overpaid for the privilege. They appropriate more value than they bring to the new company. In essence, they are likely not as good as most believe them to be, their prior performance depends upon the resources available to them at their former employer, and the teams they had in place while working for that company. In short, it’s less about individual, portable talent and more about a team of people working together.
I’ve written about executive compensation extensively in the past (see The Credit Crunch and Executive Pay, Revisiting Executive Pay, A New Approach to Executive Compensation and Are Managers Really Rational). I’ve previously pointed out other factors contributing to the complex issue of excessive compensation packages:
We can now add to that the “chasing stars” phenomenon.
Overall then, there are various reasons why executive compensation might not reflect such a “rational” process. And unfortunately, it is shareholders who end up bearing the real costs associated with any perversion in the compensation system.
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I recently stumbled upon the following graphic from the Economist that details corporate exposure to China (see Chindependence or click the screenshot below to take you to the original interactive graphic on the Economist’s site).
According to the Economist:
The index includes all of the firms in the S&P 500 index that provide a useable geographical breakdown of their revenues. This amounts to 135 firms. Each company’s weight in the index is supposed to reflect their China revenues…Some companies report their China revenues explicitly. Many others report only their revenues for Asia-Pacific, excluding Japan. In these cases, we assume that China’s share of those revenues matched China’s share of the region’s GDP.
In principle, I think creating such a graphic is a great idea. However, a true China dependence graphic should also include exposure to the supply side, not just the demand side. In most cases, S&P 500 companies have a greater dependence on China’s supply chain than its consumers…
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