Saturday, March 9, 2013

Marty Lipton: Shareholder Champion, Stakeholder Protector or Management Tool?

I do not personally know Marty Lipton, nor have I met him. Based on what I have read about him and by him (he is a prolific writer), he strikes me as an extremely competent lawyer and he is certainly a good friend and champion of New York University (the institution that I teach at), chairing the board of the trustees for the university. I have never, though, thought of him as a champion of long term shareholders in publicly traded companies, which is the role he plays in a recent article by Andrew Sorkin in the New York Times.

The article itself was precipitated by a post, titled "Bite the Apple, Poison the Apple", by Mr. Lipton in the Harvard Law School Forum on Corporate Governance and Financial Regulation, where he argued that the threat to the company from activist shareholders (and David Einhorn, in particular) should serve as a clarion call for action to deal with the misuse of shareholder power. I am not sure what powers Mr. Einhorn misused in making his case that Apple should do something with its cash, but knowing Mr. Lipton's views on corporate governance (which is to side with incumbent managers, no matter what), I was not surprised by the article, but I was that it was picked up in the New York Times by Sorkin. In his article, Sorkin implicitly accepts Lipton's view that activist investors are short term, that they do damage to companies by being vocal and that long term shareholders are not served by activism.  I think he is wrong on all three counts.

1. Activist Investors are no more short term than any other investor group
To address the question of whether activist investors are interested in the long term, Sorkin quotes Leo Strine, the Chief Judge of the Delaware Court of Chancery, who seems to have seen evidence to conclude that "the answer is usually no".  I consider myself to be a long term shareholder: I do my homework before buying the shares and I have a median holding period of eight years. I don't operate under any illusions about what drives activist investors to do what they do, which is the desire to make money on their investments (and who does not?). However, I have not seen any evidence that would lead me to believe that activist investors are any more short term than any other group of investors, and there is, in fact, evidence to the contrary. 
  • Holding period: The studies that I have seen of both institutional activists (holding period of about 20 months, on average) and individual activists provide evidence that they hold their investments for longer than their passive counterparts. In fact, Sorkin undercuts his argument that stockholders are short term by noting that Nelson Peltz has been a stockholder in Heinz for more than six years, Bill Ackman is a long term investor and director at JC Penney and David Einhorn has held Apple stock for many years. 
  • Cash focus: It is true that activist investors often push for companies to return more cash to stockholders, either as dividends or in stock buybacks, but why is this evidence that they are short term? Assuming that companies that reinvest money back into their own businesses are more long term than companies that return cash makes no sense, if these companies operate in bad businesses. The companies that are typically targeted by activists are mature companies that have cash surpluses and relatively few investments and returning cash back to their stockholders strikes me as exactly what investors would want them to do.
It is possible that Judge Strine was misquoted on his claim that activist investors are usually short term, and if so, he should set the record straight. It is also possible that he has evidence to back his claim, and if he does, I would love to see it. There is a third possibility that he was engaging in some casual empiricism, which we are all inclined to do now and then, but is a dangerous practice, if you are the chief judge in one of the most powerful courts (at least when it comes to business law) in the country.

2. Activist investors have every right to be vocal, even if they are wrong
Sorkin is disturbed by the use of the media by activists to make their case for change, and that the change that they are pushing for may not be the "right" change for other shareholders in the long term. I don't share his trepidation about either one. As a long term investor who is looking for price catalysts, I envy the megaphones that activist investors have to broadcast their views and be their own catalysts. Not also that activist investors are not alone in using the media to make their cases. In fact, the media's favorite long term investor, Warren Buffet, has never been shy about using the media to good effect to generate returns on his investments.

Do private equity investors push for changes that may not be in sync with long term stockholders? Sure! I have argued that activist investors are often too focused on "financial' value creation and too little on "operating" value creation. However, it is a leap from there to claim, as Mr. Lipton has, that David Einhorn does not have the right to make his argument or that doing it in public is somehow damaging to Apple. As a shareholder, he has every right to make his case and the rest of the shareholders have the right to decide whether they agree with his proposal or with incumbent managers (who may oppose it).  You don't have to believe that managers are always wrong and activist investors are always right to also believe that it is healthy for everyone concerned for managers to have to explain what they are doing to stockholders. If managers are credible (and their track record will play a role in this) and can make a good case that they are right (and activist investors are wrong), they stand a good chance of winning over stockholders to their side. If managers are not credible and/or refuse to make a case for their actions, I think that stockholders will and should be more receptive to activist investors' suggestions. 

3. Long term shareholders are well served by activism
As a shareholder in any company, I welcome the appearance of an activist investor (or two) into the shareholder ranks. The game, as it is structured, is tilted in favor on incumbent managers. Activist investors, motivated as they are by self interest, help to shift the balance back (even if it is only a little bit). In fact, in the absence of activism, you can rest assured that boards of directors will continue to be rubber stamps for  CEOs pushing through their own agendas, aided and abetted by an ecosystem of lawyers, bankers and consultants who make money of the status quo. And the status quo stinks at many companies, with about third of all publicly traded companies actively destroying value for their owners. (I will back this up in a future post) It is these companies that are disproportionately targeted by activist investors and deservedly so, and long term stockholders welcome them, for the most part. In fact, the evidence suggests that stock prices at companies targeted by activist investors go up on the announcement of the targeting, and stay up for the long term

As for Mr. Lipton, he has either created or had a hand in creating some of the worst abominations in corporate governance. From fathering the "poison pill" to arguing that  stockholders should have no say on CEO pay, he has been on the management's side of every corporate governance issue over the last three decades. In fact, reviewing his briefs over the years, it is clear that his problem is not with activist investors but with any investors who deign to question management motives or actions. To Mr. Lipton, the only good stockholders are masochists, who takes the punishment that is meted out silently, raise no protests and vote with their feet.  As a stockholder, I would rather have David Einhorn, at his worst, on my side than Mr. Lipton at his most magnanimous. To argue, as Mr. Lipton does in his brief on Apple, that his entreaties on part of management are in the best interests of long term stockholders is analogous to making a case that Marie Antoinette was really championing the cause of French bakers when she supposedly asked her starving populace to eat cake. 

What about the other stakeholders in the firm? When apologists for management use the interests of other stakeholders as their shield against accountability, I, for one, take it for it is, a smokescreen. I don't believe that managers who  insulate themselves against stockholder pressures care about protecting the interests of employees, customers or society. In fact, I will wager that these managers will use the same "other stakeholder interests have to be served" excuse with each of these groups, while the only interest group that is finally served is their own.

In fact, I think that the company that Mr. Lipton focused on, in his post, Apple, illustrates my point. I love the company and its products but as a stockholder, I have become increasingly frustrated with its managers, in general, and Tim Cook, in particular. In fact, I am not alone, since a third of the stockholders at the annual meeting a short while ago voted against his pay package. As I see Mr. Cook go from forum to forum, saying nothing of substance and wreaking havoc on the stock price almost every time he talks, I want more activism, not less. 

Bottom line
Managers at public companies are human, make mistakes, and are often unwilling to change their minds (or ways) without pressure from stockholders. The boards of directors at these companies, in spite of all of the corporate governance legislation passed in the last few decades (or perhaps because of the legislation) tend to go along with incumbent management, unless pushed to act. That push will not come from traditional institutional investors, who are too timid or lazy to challenge the status quo, and the small shareholders (long term or short term) have little chance of being heard. Without activist investors rocking the boat, who is left to challenge managers to explain their actions?  


Jb said...

Very well thought out article, Aswath. I couldnt agree wit you more. I guess the idea of an investor 'suing' a respected company like Apple is the reason of it attracting criticism from a few quarters inc. Mr. Lipton. We have got to realise Mr Einhorn, who I carry a great amount of respect for, had to go to court only because Apple's proposition seemed more to thwart the board's efforts to issue prefs in the future than any attempt at better Corporate Governance. Also, the second reason was the bundling of two propositions into one. If these reasons were baseless, as Mr. Lipton implies, somone as smart as Mr. Einhorn' would not have taken such a big step. And as we now know, the district judge did rule in Mr. Einhorn's favor. Surprised to see Mr Sorkin's implict support too.

Thanks for sharing your views. As always, its a pleasure to read them.


Anonymous said...

The irony here is the Einhorn is not even demanding that Apple return money to shareholders. He has come up with a clever idea for Apple to issue preferreds (paper) and part with a small portion of its future free cash flow to unlock value.

The fact that Tim Cook calls this a silly side show speaks to the man's undeservidly inflated ego. Jobs was cocky and egotistical but at least he created enormous value for shareholders. What has Cook done except watch share price drop forty percent in a strong bull market?

Cook is the silly side show.

Anonymous said...

You are right every bit here.

Every shareholder, however small or big, has a choice to be vocal about management and board actions. It is for the controlling shareholders (and/or management/board) to take it or leave it.

It is another matter that a small shareholder can only scream in ecstasy or pain; nothing worthwhile can come out of it, unless he has an activist (significant) shareholder who is being more vocal.

It is interesting to see some prominent people talking in support of management irrespective of their actions. Whatever happened to maximization of shareholder wealth.

$140 billion of cash (of which $85 billion is trapped) that belongs to the shareholders and earning mediocre rate of return. No reinvestments at sight, or debt to repay. Where else should it go if not back to the shareholders? Don't shareholders have a choice of making more (higher return than low risk-free) out of it?

Left long, management might even be tempted to make worse blunders, for instance, acquisitions; such is the pressure for growth.

Clearly there is no room in R&D activities to accommodate that much of cash. It surely is a trapped cash for shareholders.

Probably Apple's greatest crime is having grown outrageously in the last 10 years. Now it is paying for it. It has grown too quick, matured too quick; now it has to slow down, rather too quick.

Wilson said...

Excellent article as usual, Prof.

Is part of the last paragraph missing?

Rafa Tudela said...

... completely subscribe previous comments on the praise for your article Prof. Spot on.

Jason DaCruz said...

Great post professor --

I feel like activism tends to suffer from association with LBOs. Not that LBOs are necessarily bad, just that they've had their own trouble in the not so distant past.

I just finished reading Confidence Game, detailing how an activist Ackman tried to take down MBIA. Management had the upper hand in that instance, and it took Ackman years before the market came around to his way of thinking.

Lastly - I hope Einhorn reads your article!

Unknown said...

Marty Lipton is a participant in our legal system which is adversarial. That is to say he is paid to advocate a certain position whilst others are paid to oppose. ( I doubt very much that the lawyers defending OJ Simpson all thought he was innocent; rather the system works when the might of the government is opposed by counsel armed with discovery)

Marty only exists because Joseph Flom exists. ( he of the famous Skadden, Arps, Slate, Meagher and Flom now just Skadden) both would routinely take the opposite side in hostile takeovers and Marty was paid to advocate for management just as Flom was paid for the opposing side.

There is truly no freedom of speech in the US, except for tenured professors approaching retirement ( Milton Friedman I believe)

Aswath Damodaran said...

I entirely agree and fully support whatever Marty Lipton does in the courtroom to defend his clients, who happen to be managers. As I said at the outset, he is a very good lawyer.
Having said that, he should just spare us the nonsense about caring about other stakeholders and long term stockholders. It is not only hypocritical but it rings false.

Anonymous said...

Tremendous post.

Anonymous said...

Great Interview on CNBC.

Pls do more of these.

Kudos to you!

Especially to do with capital allocation plan and strategic vision!


Anonymous said...

Great post. We shouldn't be surprised that Lipton sides with management on all governance issues. He takes a pro-management approach to all issues as these are the guys that hire him and pay his fees! As Munger says, never underestimate the power of incentives...

Anonymous said...

As an institutional investor running a 4 star mutual fund I take umbrance with your generalized staement that we are "too timid or lazy" to change managements' ways. In the real world it is simply more practical for us to "vote with our feet" by selling the stock rather than running a long expensive proxy battle. This is largely due to our broader diversification than activists.

Anonymous said...

Dear four star investor
Why is there no middle ground between voting with your feet and running a lroxy fight? Ever heard of just voting? Most of you four and five stars are nothing more than rubber stamps on cruise control. Your ilk has outsourced everything from research to voting. Closet indexers in the asset gathering game rather than stock picking. Take umbrage all you want but yor type of investors are the biggest impediment to investor friendly governance.

The good news is that your business is rapidly being replaced by computers just as ezpass has replaced human toll collecting.

Anonymous said...

To DaCruz

Ackman wasn't an activist shareholder of MBIA. He shorted the stock and then conducted a public campaign to highlight MBIA's misdeeds thus driving the stock price down.

David said...

I'm really glad I came across this piece. I have slowly been getting into the investment scene. I was wondering if you would recommend I stay away from Dell stock?

Cashback said...

The way you explain inspires me a lot, simple to the point and easy to understand.....

EK said...
This comment has been removed by the author.
Anonymous said...

Dr. Damodaran,

In the article, you mention that you have a median holding period of eight years. I am wondering whether you still hold the stock even if the stock price becomes greater than your intrinsic value.

Anonymous said...

Hello professor Damoradan,

Thank you for sharing your thoughts.

I am wondering what your thoughts are on the Cyprus fiscal situation - The proposal to tax 10% of their savings.

How does it compare with the situation in our country?

The Cyprus govt cannot print Euros. USA can print abundant amount of dollars, and keep the interest rate low indefinitely. How does it affect the savings of common citizens?


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Mumbai Chartered Accountant said...

Very nice article sir.worth to read.

angky agani said...

Hello Prof,

I'm from Indonesia and I just wanna say thank you for your great work.


I would like to comment about the takeovers and buyouts of publicly traded companies. These deals are often done in private behind closed door. When a company is in play their should be plenty of chances for competing bids to make their way into the process. But most of the time their are not any competing bids. In order for the shareholders in a publicly traded company to get as high a price as possible for their shares this whole system must be changed or else the shareholders will continue to get the short end of the stick in so many of these deals.

Anonymous said...

People like Martin Lipton make me sick - the shareholders can do as they damn well please because they OWN the company. The fact that minority shareholders still don't have rights in the most advanced capitalist system in the world - even in the 21st century - is a crying shame.

Anonymous said...

Prof., what's your opinion on shareholder associations who defend the interests of small shareholders?
These asociations are quite vocal in Europe.


Gene said...

I really like those very critical article. Thank you.

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tai iwin said...

Mr. Lipton. We have got to realise Mr Einhorn, who I carry a great amount of respect for, had to go to court only because Apple's proposition seemed more to thwart the board's efforts to issue prefs in the future than any attempt at better Corporate Governance. Also, the second reason was the bundling of two propositions into one. If these reasons were baseless, as Mr. Lipton implies, somone as smart as Mr. Einhorn' would not have taken such a big step. And as we now know, the district judge did rule in Mr. Einhorn's favor. Surprised to see Mr Sorkin's implict support too.tai game iwin

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