Will The New Shareholder-Director Exchange Achieve Its Potential?

Carl Icahn is the majority shareholder of Icahn Enterprises. The following post is based on a commentary featured today at the Shareholders’ Square Table.

The recent announcement of the formation of the Shareholder-Director Exchange, a new group that aims to facilitate direct communication between institutional shareholders (namely, mutual funds and pension programs) and non-management directors of the U.S. public companies they own, has been accompanied by a flurry of articles regarding the purposes and possibilities of this new group. From my perspective, the Shareholder-Director Exchange has tremendous potential to help improve corporate governance and performance in this country.

Today, over 70% of the shares of U.S. public companies are owned by large institutional shareholders, and for many years these shareholders have been sleeping giants with respect to corporate governance. They have often elected to “vote with their feet” (by selling shares in underperforming companies) rather than using their votes and their voices to push companies to make the often difficult changes necessary to improve performance. However, more recently some institutional investors have been taking note of, and adding their support to, various criticisms of corporations that have been raised by activist shareholders in proxy fights and precatory solicitations. Indeed, the formation of the Shareholder-Director Exchange is consistent with the observations of Mary Jo White, Chairwoman of the Securities and Exchange Commission, who recently made the following statements:

“Over the years, shareholders have become increasingly engaged with the companies in which they invest in order to influence boards and management. Much of this increased engagement can be traced to campaigns that used shareholder proposals to address corporate governance practices that were viewed as entrenching management and preventing growth, such as supermajority voting, classified boards and anti-takeover devices.”

“The nature of the practices and objectives associated with shareholder engagement is changing. More and more, investors have become comfortable with being called an ‘activist’ in part because of the support they have received for their goals and, in some cases, even the tactics that they use….[T]here is widespread acceptance of many of the policy changes that so-called ‘activists’ are seeking to effect.”

It is, of course, incumbent upon institutional shareholders to be responsible stewards of the funds they manage, and the Shareholder-Director Exchange has the potential to create an open path for these shareholders to engage in meaningful dialogue with the directors who oversee their investments. However, as highlighted by Kenneth Squire, publisher of The Activist Report, there are some troubling aspects of the 10-point protocol for engagement that was released by the Shareholder-Director Exchange. For example, I see no reason why a director should consider a shareholder’s voting history when deciding whether or not to hear that shareholder’s concerns. No shareholder should ever be penalized for exercising their inherent right to vote how they see fit.

Nevertheless, the formation of the Shareholder-Director Exchange is in and of itself a positive development if for no other reason than to stand in stark contrast to the hawkish approach that has for years been championed by firms, such as Wachtell, Lipton, Rosen & Katz LLP (“Wachtell Lipton”) and Goldman, Sachs & Co., who have made fortunes from corporate conflicts by spreading the implementation of entrenchment devices, like the poison pill and staggered board. Just recently Wachtell Lipton promoted a new entrenchment scheme whereby incumbent directors unilaterally amend a company’s bylaws to disqualify certain individuals from challenging their positions on the board—a move that was widely criticized and quickly discredited.

Despite the emergence of a sea change in support for shareholder engagement, Martin Lipton, a founding partner of Wachtell Lipton, continues to champion his most pernicious invention—the poison pill (which, in a bit of Orwellian double-speak, is named the “shareholder rights plan”). Just recently, in The Wall Street Journal, he referred to the poison pill as “an essential tool for boards fulfilling their duties in the interests of stockholders.” But the notion that the poison pill—which has been the subject of massive shareholder and academic criticism [1]—is a tool to fulfill duties to shareholders is totally misguided. The effect of the poison pill is to disproportionately shift power to management and away from shareholders, and the ongoing reduction of the trigger point for poison pills (which began at 20% and has recently been reduced to 10% and even 5% at certain companies) results in a tremendous chilling effect on shareholder involvement, as it prevents shareholders from building stakes sizable enough to justify conducting (at their own expense) the costly, time-consuming campaigns necessary to unseat and replace inept management and directors.

Another value-destroying tactic in vogue with members of the Business Roundtable and legal and financial advisors of entrenched management and boards is the allegation that shareholder activists are all “short-term” investors. According to these folks, all of the corporate world’s ills can be laid at the feet of the mythical and evil “short-term” investor, while incompetent management teams and passive shareholders who ignore the fiduciary duties they owe to their own investors are exalted and assumed to be benevolently focused on “long-term” growth and prosperity. Although this baseless attack has been exposed by commentators as a mere public-relations technique, [2] it continues to be used to defend boards and management teams.

Let me be clear—we do not buy securities with the intention of agitating for a quick “pop” and then “flipping” them for a speedy profit. [3] Certainly this does happen on occasion when, for example, prices rise irrationally. But in reality, the opposite is true—we focus on the long-term. The holding period for many of our investments spans several years (and sometimes even decades). For examples, just see our investments in the following companies—

From To Years
American Casino & Entertainment Properties 1997 2008 11
American Railcar Industries 1984 Present 30
American Real Estate Partners (now Icahn Enterprises) 1990 Present 24
Federal-Mogul 2001 Present 13
Forest Laboratories 2009 Present 5
Hain Celestial Group 2010 2013 3
Mentor Graphics 2010 Present 4
Motorola 2007 2012 5
National Energy Group 1995 2006 11
Navistar International 2010 Present 4
PSC Metals 1998 Present 16
Take Two Interactive Software 2008 2013 5
Tropicana Entertainment 2008 Present 6
Vector Group 1999 2012 13
Viskase Companies 2001 Present 13
WebMD Health 2011 2013 2
WestPoint Home 2004 Present 10
XO Communications 2001 Present 13

We perform extensive financial and legal analyses prior to making any investment because our view is generally that we will not buy a single share of stock unless we are willing to own the entire company. A great recent example of that is CVR Energy, Inc. (“CVR”), where we started with a relatively small position but ended up acquiring the company. Today, CVR is an operating subsidiary of Icahn Enterprises L.P. (“IEP”). Based on the current trading price of CVR’s stock and the distributions since we acquired control, we have a gain of approximately $1.6 billion on our purchase of CVR.

Although our holding periods would generally place us in the “long-term” camp, we nevertheless evaluate each of our investments on a daily—sometimes hourly—basis. We do not sit on our hands and pray that boards and management teams will do the right things for shareholders. When we see things like mismanagement, poor capital allocation, wasteful spending and excessive compensation, we do not throw up our hands and sigh that our only remedy is to “vote with our feet.” We hope that the Shareholder-Director Exchange, and its direct shareholder/director dialogue, will provide institutional shareholders with an alternative to voting with their feet when they are not happy with an investment.

We believe that both the change of attitude by large institutional shareholders regarding ineffectual boards and the formation of the Shareholder-Director Exchange is due in large part to the fact that “activists” have had a strong and positive impact on the companies they invest in and have often produced outsized returns for investors. A recent study that was conducted at IEP showed that if an investor invested in every one of the 20 companies at which our designees became directors over the last 5 years and sold when those designees left the board (or continued to hold if our designee stayed on the board), the investor would have earned an annualized return of 28%, compared to only 2% if an investor invested the exact same way in the hedge fund index. Another IEP study showed that an investor in IEP who bought in 2000 and sold at today’s current price would have a 1,684% total return on equity, which would equate to an annualized return of 22.7%, compared to an annualized return of only 3.4% for the S&P Index. I believe that the primary driver of IEP’s results since 2000 is the fact we have been activists throughout the entire period.

Additionally, Professor Lucian Bebchuk at Harvard Law School studied approximately 2,000 interventions by activists occurring during the period from 1994 to 2007, and he concluded that activist interventions are typically followed by a five-year period of improved operating performance. (The study is discussed on the Forum here.) Professor Bebchuk thus refutes by empirical evidence those naysayers who allege (based on their self-interested, anecdotal observations) that activism only achieves short-term profit at the expense of long-term corporate improvement. Professor Bebchuk has confirmed, as we have always asserted, that activism forces lackluster boards and management teams to adopt and implement actions that lead to long-term corporate success.

Large institutional investors are now realizing that it is almost self-evident that if management teams and boards are held accountable for their actions it will not only enhance shareholder value but will also make companies more productive and competitive. I believe that U.S. public companies are finally beginning to understand the impact of the changes in shareholder sentiment, and I encourage members of the Shareholder-Director Exchange to use their unique and powerful positions to promote good corporate governance practices, including the elimination of entrenchment devices (especially poison pills with low share ownership triggers, which are particularly troubling), and the elimination of corporate waste and excess.

I have made a lot of money identifying poorly run companies and getting them back on track. It is not rocket science, but it requires finding the right directors and managers and keeping them focused on performance. Hopefully those participating in the Shareholder-Director Exchange will carry this philosophy forward, making U.S. public companies more profitable for all investors, thereby creating new employment opportunities and helping to fund the pension programs of retirees. That is the great potential of the Shareholder-Director Exchange—if our large institutional shareholders actively exercise their power to improve the companies they own and reverse the negative effects caused by years of management and board isolation from the influence of owners (i.e. if all shareholders take an interest in their investments and become “activists”), I believe the entire economy will reap the benefits.


[1] Over the years, commentators have argued, among other things, that poison pills: (i) diminish shareholder value by discouraging or thwarting takeover offers before they are made, instead of fostering negotiations with bidders that result in higher premiums; (ii) are simply a pretext for delaying tactics intended to stifle bids; (iii) depress a company’s stock price and promote poor corporate governance; and (iv) serve only to entrench, and deprive shareholders of the right to replace, boards and management (i.e., individuals whose primary source of income is derived from the company may have incentives to maintain a pill in place, even in the face of a value-creating offer, if they fear they would not have a continuing role at the company). See 2009 Governance Background Report: Poison Pills (RiskMetrics Group, September 24, 2009).
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[2] See Charles Nathan, Debunking Myths about Activist Investors, The Harvard Law School Forum on Corporate Governance and Financial Regulation, March 15, 2013 (“[T]he fact that activist investors understand IRR math does not make them slaves to short-term results. Many activist investors have advocated strategies that require significant time to implement. Moreover, most activist investors understand that there is an unpredictable time frame between an initial proposal for a change at the target company and acceptance and implementation of the change. Whatever the reasons, many activist investors have undertaken investments with durations measured in years not months.”); and Steven M. Davidoff, A Label for Activist Investors That No Longer Fits, The New York Times, July 9, 2013 (“Maybe it’s time to drop the rhetoric of short-term versus long-term shareholders. Instead, let’s just call it what it is. A disagreement over what direction and risk the company should take — with the hedge funds sometimes being right.”).
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[3] For one thing, we do not enjoy paying short-term capital gains tax rates.
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One Comment

  1. James McRitchie
    Posted Thursday, February 13, 2014 at 12:10 pm | Permalink

    Many excellent points. I like Icahn’s suggestion that all shareholders take an interest in becoming activists. However, that won’t happen.

    Large funds, such as Vanguard, Northern Trust, BlackRock and Fidelity have little incentive to monitor their portfolios and take an active role in challenging management and boards. Since they hold diverse portfolios, any benefit they could obtain through such actions would equally benefit competitors, while they would bear all the costs (free rider problem).

    The role of active monitoring to take corrective action has been taken up by activist hedge funds, such as Icahn Enterprises, who acquire a significant but non-controlling stake in a corporation. They do best for long-term holders when they focus on the company’s business strategy initially through persuasion but sometimes through proxy contests and board seats rather than pushing short-term extraction techniques such as stock repurchases.