Aurelio Gurrea Martínez , socio de Dictum Abogados, publica un artículo en el blog de gobierno corporativo de la Universidad de Columbia, donde examina el auge del activismo accionarial a nivel mundial,analizando si suponen un beneficio o una amenaza para la economía real.
Shareholder Activists: A Threat for the Global Economy?
The rise of shareholder activism has become a global phenomenon. Shareholder activists are not only present–as they started–in the US, but also in European and Asian Markets.[1] This situation has generated a vast literature about the desirability (or not) of shareholder activism. [2] In essence, there are two main positions: (i) those who argue that shareholder activists improve the corporate governance of the firm, and therefore they help increase the value of the firm;[3] and (ii) those who claim that shareholder activists only improve the value of the firm in the short-term, and they encourage managers to cut investment in research, development and other long-term projects with higher profitability (but less liquidity) that may best contribute to the promotion of social welfare.[4]
Unlike other topics in corporate law, the discussion about shareholder activism has gone beyond the academic debate. Politicians have started to discuss about the desirability of shareholder activists, and some legislations (particularly in Europe) have even taken steps to prevent the “short-terminism” that activists investors are supposed to generate.[5] Therefore, shareholder activism has become a hot topic even for the public opinion.
Despite the disagreements about the impact of shareholders activists, most corporate law scholars seem to accept that shareholder activists help improve the corporate governance of the firm,[6] at least, if we understand corporate governance as those mechanisms consisting of aligning incentives between managers and investors.[7] Therefore, shareholder activists help increase the value of the firm, at least in the short-run. The immediate questions to be asked, then, are: (1) Does shareholder activism harm the long-term value of the firm? (2) If so, should we be worried from a policy perspective? (3) If so, what should policy-makers do?
The first question is an empirical one. So far, it is not clear the impact of shareholder activism on the long-term value of the firm. Some studies have shown that hedge fund activism does not harm the long-term value of the firm,[8] while other studies have found the opposite result.[9] However, while this question will remain empirical, what would it happen if it were confirmed that shareholders activists harm the long-term value of the firm? Should we be worried from a policy perspective? Unlike the previous question, this is a theoretical question, and it depends on the concept, nature and role of the corporation. Is the corporation a private contract among a group of investors that just creates a nexus of contracts to efficiently operate in the market? Or is it something else that should benefit a variety of stakeholders? In the former case, it is clear that the managers should act in the interest of the investors –no matter what interest is, provided that, of course, it is within the limits of the law, and minority shareholders are properly protected.[10] Therefore, if the group of investors collectively agrees to give an instruction to the managers, they should be able to do so. Nevertheless, if we argue that a corporation is “something else” that should maximize the interest of a variety of stakeholders, it becomes more unclear to whom the directors are accountable. According to this latter perspective, a director could make a decision even when it is unwanted by the shareholders, provided that, according to its own view, it can be beneficial for “society”[11].
To solve this dilemma, let us use a simple example. Let´s suppose that a person is the sole proprietor of a business. This person decides to hire an employee. Let´s assume that the employee will help maximize, as nobody else can, the best interest of “society”, or even the long-term value of the firm. Even if this assumption were hypothetically met, should the sole entrepreneur of the business be prohibited from firing his employee? Would it change the answer in a corporation where, as it may happen in many countries, there is a single shareholder? And what about in a corporation where the shareholders as a whole or, with the due protection of minority shareholders, the majority of the shareholders decide to fire the employee? In our opinion, denying the right to fire the employee to any of these actors may threaten some of the most elemental foundations of a modern economy: private property, liberty of freedom, and liberty of enterprise. Therefore, unless the legislator clearly defines the primary role of a corporation, and parties can adjust ex ante their business decisions, denying to the shareholders the right to decide their own interest may be harmful for society.
Indeed, a corporation is, or at least it is created by, a (private) contract. Therefore, the parties that originally (or subsequently) enter into (or join) this contract (i.e., the shareholders), should be allowed to agree, among other aspects, the goal of this contract within the limits of the laws.[12] If the parties’ will is not respected, they may be discouraged to enter into these contracts, and if so, one of the greatest inventions of modern times for the promotion of social welfare (i.e., the corporation) may be put at risk.[13] In other words, the imposition of a goal potentially unwanted by the shareholders may discourage the formation and financing of corporations. Therefore, this solution may be harmful for society.
In our opinion, several reasons justify the imposition, as a default rule, of the maximization of the long-term value of the firm as the legitimate goal of the corporation.[14] However, shareholders should be able to opt out this rule.[15] Hence, by allowing investors to change the rule whenever their expectations may differ from the maximization of the long-term value of the firm, policy makers would incentivize, in a better way, the creation and financing of enterprises, and therefore the promotion of economic growth.[16]
However, this theoretical argument based on the contractual nature of a corporation is not the only one to support the empowerment of shareholders, even if they were short-term investors. Many other arguments have been convincingly made to support this view. First, markets should be evaluated as a whole, and therefore including all type of firms and investors.[17] Thus, whereas a potential short-term problem may be local, does not seem to be systemic.[18]Indeed, markets are formed by many types of investors, with different preferences in terms or risks and returns. Therefore, some investors may indeed prefer short-term profits and therefore less risky (and less profitable) projects with more liquidity, while other investors may prefer highly profitable (and highly risky) investment projects with less liquidity. Hence, a regulatory intervention imposing one type of market participants (e.g., long-term investors) may reduce the firms’ ability to raise capital, and therefore the size of the market, since there could be many investors (e.g. short-term investors) who might be reluctant to provide funds.[19]
Second, managers serving long-term shareholders may have incentives to destroy economic value in the short-term, especially in firms which heavily buy and sell their own shares.[20] Therefore, by favoring long-term shareholders, value can be destroyed in the short-term, at the expense of the firm´s ability to generate cash flows, to repay debts (and salaries), and to reinvest benefits in new investments opportunities that may contribute to the promotion of social welfare. Third, while it is not clear that hedge fund activism harms the long-term-value of the firm, it is generally accepted that activist shareholders reduce managerial agency costs, and therefore lead to a better alignment of incentives between managers and investors.[21] Therefore, as shown by several studies, shareholder activists increase the value of the firm –at least, in the short-term.[22] Fourth, some managerial mechanisms inside the corporation, such as compensation schemes, may encourage short-term profits. Therefore, insulating boards from markets would actually exacerbate, rather than mitigate, short-term profits.[23]
Thus, several conclusions can be made regarding the role of activist investors. First, they improve the corporate governance of the firm –at least, if, as it is generally accepted, corporate governance is understood as those mechanisms consisting of aligning incentives between managers and investors. Second, hedge fund activism help maximize the short-term value of the firm. Third, it is unclear that activist investors harm the long-term value of the firm. Finally, and perhaps more importantly, even if it were hypothetically proved that hedge fund activists (on average) encourage short-terminism, should not they be allowed, as any other investor (sole proprietor, single shareholder or shareholders as a class) to pursue their own legitimate interest, no matter what interests is, provided that it is within the boundaries of law? In our opinion, a negative answer to this question would be the real threat for the global economy.
ENDNOTES
[1] For an international study of shareholder activism in the US, Europe and Asia, see Marco Becht, Julian R. Franks, Jeremy Grant, and Hannes F. Wagner, The Returns to Hedge Fund Activism: An International Study, European Corporate Governance Institute (ECGI) – Finance Working Paper No. 402/2014 (available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2376271).
[2] John Armour and Brian Cheffins, The Past, Present and Future of Shareholder Activism by Hedge Funds, 37 Journal of Corporation Law 51 (2012); John C. Coffee, Jr. and Darius Palia, (2016), The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance, 1 Annals of Corporate Governance 1 (2016).
[3] Lucian A. Bebchuk, Alon Brav and Wei Jian, The Long-Term Effects of Hedge Fund Activism, 115 Columbia Law Review 1085 (2015).
[4] Martijn Cremers, Erasmo Giambona, Simone M. Sepe, and Ye Wang, Hedge Fund Activism and Long-Term Firm Value (2015) (available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=2693231).
[5] These legislative proposals include the creation of ‘loyalty shares’ or tax benefits to long-term investors. See Jesse M. Fried, The Uneasy Case for Favoring Long-Term Shareholders, 124 The Yale Law Journal 1554, 1571-1575 (2015).
[6] Marcel Kahan and Edward B. Rock, Hedge Funds in Corporate Governance and Corporate Control, 155 University of Pennsylvania Law Review 1021 (2007); Alon Brav, Wei Jiang, Frank Partnoy, and Randall Thomas, Hedge Fund Activism, Corporate Governance, and Firm Performance, 63 Journal of Finance 1729 (2008); Lucian A. Bebchuk, Alon Brav and Wei Jian, The Long-Term Effects of Hedge Fund Activism, 115 Columbia Law Review 1085 (2015).
[7] Klaus Hopt, Comparative Corporate Governance: The State of the Art and International Regulation, 59 American Journal of Comparative Law 1 (2011); Jonathan R. Macey, Corporate Governance: Promises Kept, Promises Broken (Princeton University Press, 2008); Michael C. Jensen and William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 Journal of Financial Economics 305 (1976). However, see Martin Lipton and Steven A. Rosenblum, A New System of Corporate Governance: The Quinquennial Election of Directors, 58 The University of Chicago Law Review 187 (1991).
[8] Lucian A. Bebchuk, Alon Brav and Wei Jian, The Long-Term Effects of Hedge Fund Activism, 115 Columbia Law Review 1085 (2015).
[9] Martijn Cremers, Erasmo Giambona, Simone M. Sepe, and Ye Wang, Hedge Fund Activism and Long-Term Firm Value (2015) (available athttp://papers.ssrn.com/sol3/papers.cfm?abstract_id=2693231).
[10] It could be argued that shareholder activism may harm the interests of those shareholders who want to maximize their investments in the long-run. However, this is not a new problem in corporate law. The conflict among shareholders have been mainly studied in jurisdictions with controlling shareholders, and several mechanisms to protect both minority shareholders and, under some circumstances, majority shareholders, have been used in corporate law. The question, then, turns out to whether these mechanisms to protect minority shareholders (no matter the time-horizon of their investments) should be used to protect those (minority) shareholders who might want to maximize their investments in the long-run, or new mechanisms (such as loyalty shares, tax benefits, etc.) should be used to protect these latter type of shareholders. Regardless of this policy decision, we do not think this problem is as frequent as it could be thought. In our opinion, since minority shareholders are not usually the founders of the corporation, and they do not have the chance to extract private benefits of control, there are reasons to believe that many (if not most) minority shareholders’ interests will be aligned with the interest of these hypothetical short-term activists who might want to maximize profits in short-term. Therefore, the debate, once again, would be focus on determining whether the manager should maximize other interests beyond the interests of the shareholders.
[11] This leads us to one of the most critical issues of the ‘stakeholder view’. What is best for society? Some people may argue that it is to reinvest benefits in new projects than can generate more economic development. Other people may claim that hiring more people or increase salaries to the current staff may be more desirable. It could also be argue that making cheaper products for the benefit of consumers or paying more taxes or even using some profit to invest in the protection of the environment can generate the socially optimal outcome. In our opinion, the role of the managers is not to decide what it best for society but just to run a corporation for those parties that create (or subsequently join) this contract, that is, the shareholders. Deciding what is best for society should be stated by the legislator, and managers should maximize the interest of the shareholders within the boundaries of law.
[12] The legislator, then, should be the one in charge of establishing the limits of the parties’ freedom of contracts. But once the legislator has established these boundaries, the parties should be able to agree any legitimate goal in their contract.
[13] In a famous speech in 1911, President Nicholas Murray Butler of Columbia University stated that «the limited liability corporation was the greatest single discovery of modern times (…). Even steam and electricity are far less important than the limited liability».
[14] It seems efficient to presume this goal for several reasons. First, it is probably the most accepted goal among the shareholders. Second, an increase in the long-term value of the firm probably benefits other stakeholders. Third, it is a clear goal. Therefore, it reduces uncertainty for the managers. Final, and perhaps more importantly, it makes clear to whom the directors are accountable.
[15] Jonathan R. Macey, Corporate Governance: Promises Kept, Promsies Broken (Princeton University Press, 2008), p. 2.
[16] Emphasizing the supremacy of this shareholder-model, see Henry Hansmann and Reinier Kraakman, The End of History For Corporate Law, 89 Georgetown Law Journal 439 (2000), reprinted in Jeffrey Gordon and Mark Roe (eds.), Convergence and Persistence in Corporate Governance (2004). According to these authors, managers should do what the shareholders, as a group, would prefer them to do. Against this shareholder approach, see Martin Lipton and Steven A. Rosenblum, A New System of Corporate Governance: The Quinquennial Election of Directors, 58 The University of Chicago Law Review 187 (1991). According to these latter authors, the corporation is not a private property like any other private property. They argue that, since a corporation may affect the destiny of employees, communities, suppliers, and customers, all of these constituencies should take into account in the way managers run a corporation. For this reason, a corporate governance system should not be exclusively designed to ensure that the actions of a corporation’s managers and directors accurately reflect the wishes of its stockholders. Instead, they propose a system of corporate governance in which the actions of a corporation´s managers and directors should promote the long-term value of the firm for the interests of a plurality of stakeholders. For a traditional discussion about the primary role of a corporation, see Adolf Berle, Corporate Powers as Powers in Trust, 44 Harvard Law Review 1049 (1931); E. Merrick Dodd, For Whom Corporate Managers Are Trustees: A Note, 45 Harvard Law Review 1365 (1932). Summarizing the debate, see William Allen,Our Schizophrenic Conception of the Business Corporation, 14 Cardozo Law Review 261 (1992); Mark J. Roe, The Shareholder Wealth Maximization Norm and Industrial Organization, 149 University of Pennsylvania Law Review 2063 (2001); William W. Bratton and Michael L. Wachter, Shareholder Primacy’s Corporatist Origins: Adolf Berle and The Modern Corporation, 34 Journal of Corporation Law 99 (2008); Martin Gelter, Taming or Protecting the Modern Corporation? Shareholder-Stakeholder Debates in a Comparative Light, ECGI Law Working Paper No. 165/2010 (2010); Michael C. Jensen,Value Maximization, Stakeholder Theory, and the Corporate Objective Function, 12 Business Ethics Quarterly 135 (2002).
[17] This argument comes from Mark J. Roe, Corporate Short-Terminism-In the Boardroom and in the Courtroom, 68 The Business Lawyer 977 (2013).
[18] Mark J. Roe, Corporate Short-Terminism-In the Boardroom and in the Courtroom, 68 The Business Lawyer 977 (2013).
[19] It would be more unclear, however, if, instead of imposing one type of investors, the legislator decides to give more incentives to long-term investors. Proposing this solution through the implementation of ‘loyalty shares’ as, in fact, several European countries have already done, see Patrick Bolton and Frédéric Samama, L-Shares: Rewarding Long-Term Investors, 25 Journal of Applied Corporate Finance 86 (2013). A summary of the proposals generally made by academics and legislators to favor long-term investments can be found in Jesse M. Fried, The Uneasy Case for Favoring Long-Term Shareholders, 124 The Yale Law Journal 1554, 1571-1575 (2015). This author, however, warns that «long-term shareholder interests are better (that is, better aligned with economic value creation) than short-term shareholder interests in a particular firm: one that does not transact in its own shares. However, it is far from clear that long-term shareholder interests are better than short-term shareholder interests in the typical U.S. firm, which heavily buys and sells its own shares. In such a firm, long-term shareholders may have worse interests. Therefore, shifting power to long-term shareholders might actually reduce the value generated by the firm over time».
[20] For a full analysis of this argument, see Jesse M. Fried, The Uneasy Case for Favoring Long-Term Shareholders, 124 The Yale Law Journal 1554 (2015).
[21] Marcel Kahan and Edward B. Rock, Hedge Funds in Corporate Governance and Corporate Control, 155 University of Pennsylvania Law Review 1021 (2007).
[22] Alon Brav, Wei Jiang, Frank Partnoy, and Randall Thomas, Hedge Fund Activism, Corporate Governance, and Firm Performance, 63 Journal of Finance 1729 (2008).
[23] Mark J. Roe, Corporate Short-Terminism-In the Boardroom and in the Courtroom, 68 The Business Lawyer 977 (2013).
The preceding post comes to us from Aurelio Gurrea Martínez, Executive Director of the Ibero-American Institute for Law and Finance. The post is partly based on his paper, which is entitled “New Agency Problems, New Legal Rules: Rethinking Takeover Regulation in the US and Europe” and availablehere.
