Carl Icahn, in his recent Op-Ed piece published in The Wall Street Journal, points out the value of activist investing. He emphasizes that shareholders should have the right to hold management accountable for results and to oversee operations. Harvard professor Lucian Bebchuk and co-authors recently conducted a study of 2000 shareholder activist campaigns from 1994 to 2007. The study concluded that operating performance improves following activist interventions, and that such changes continue for years after the interventions.
Carl Icahn on Business Judgment Rule
Mr. Icahn highlights the fact that corporate boards can ignore shareholder votes under the “business judgment rule” backed by U.S. state laws and courts, undermining the voice of a majority. He writes,
“When things aren’t going well, citizens can vote the leaders out. A lot of blood has been shed for these rights, and while democracy isn’t perfect, to paraphrase Winston Churchill, it’s far better than any other system of government.”
This rule strips shareholders of having a say and recourse that holds management accountable and relegates them to “take it or leave it” status for their stakes in public firms. Laws favorable to management and corporate boards came about after years of lobbying by pro-management groups in state legislatures. Such laws may perpetuate the tenure of CEOs that are incompetent and fail to maximize profitability and resource use for the business they run. They also enable management and directors to dilute stakes of shareholders that could vote management out (usually 10 to 15 percent ownership) by issuing more shares, which in turn can result in preventing a management and director shake up. Such structural changes are usually necessary to turn around a failing business model by using new ideas and strategies.
Dell an example of dysfunctional governance
Icahn cites Dell Inc. (NASDAQ:DELL) as an example of dysfunctional corporate governance. The company has lost millions of dollars in market capitalization as its CEO Michael Dell failed to adapt the company’s strategy to the changing dynamics in the PC market. Instead of giving shareholders options to choose new management to turn the company around, the Dell board froze out shareholders and voted last week to allow Michael Dell to buy the company at a bargain price using shareholder funds. The board’s decision deprived shareholders of potential price appreciation that could result from Michael Dell’s establishment of new businesses. Shareholders voted down the transfer to Michael Dell earlier in 2013, and Dell’s board not only ignored the vote’s outcome but also changed the voting rules and the voting dates. The voting for the leveraged buyout by Silver Lake Partners and Michael Dell was concluded on Wednesday, with a winning outcome for the CEO.
The performance record at Icahn Enterprises LP (NASDAQ:IEP) is an example of success in activist investing. If an investor maintained a position in the IEP from January 1, 2000 through September 10, 2013, he would have a return of 1116 percent versus the 49 percent earned by the S&P 500 in the same period. Additional, Mr. Icahn notes that the cumulative total return of the IEP hedge fund was 254 percent from November 1, 2004 to September 10, 2013, which is equivalent to a 16 percent annualized return. In contrast, the S&P 500 earned 80 percent in the same period resulting in a 7 percent annualized return.
Activism at companies depends on making the right choice
Carl Icahn concedes that activist investing is very challenging, and success depends on both choosing the right companies, i.e. companies that have good fundamentals and business profitability potential, and in investing in underperformers. The latter includes forcing the firms to change and often this is done by replacing management and demanding accountability for results. Implementing management changes through activist campaigns can prove to be costly and challenging, as CEOs do lash out at activists through negative media campaigns and legal action in courts. The process is time consuming and capital intensive, meaning funds may be tied up for years before meaningful results can be achieved.
Mr. Icahn exhorts shareholders to stand up for their rights, and he is using Twitter and other media to make them aware of the means to exercise such rights. He calls for institutional investors such as mutual funds and index funds to exercise their power against incompetent boards and management. Finally, Mr. Icahn believes that laws shall be changed to provide shareholders with voting power that can be used by a broad base of activists to hold management and directors accountable for the long term, as opposed to narrow voting rights that are not strong enough to drive management changes when necessary to improve businesses.
