extreme agency issues

The agents that we as shareholders hire to act for us can hurt us in a number of ways:

securities fraud

The 21st-century poster child here is Enron, which created the appearance of earnings growth by fabricating lots of energy trading profits.  A generation ago, the leading name would have been Equity Funding, an insurance company that had a division that made up people it “sold” insurance to.

Many times, such cases are hard to detect, since management has either corrupted or bamboozled its auditors, on whose yearly inspections of  a company’s financial accounts we, as investors, crucially depend.  There’s not much we can do to defend ourselves from fraud, other than to try to have an ear for market rumors and a nose for implausibility.

managers who do really stupid things

The name C. Michael Armstrong comes to mind.  As CEO of ATT, he attempted to diversify the company away from the Plain Old Telephone business.  By my count, however, he masterminded $100 billion worth of dud acquisitions that ultimately drained the company of its ability  to morph into something else (this “performance” earned him a seat on the board of Citigroup, however).

Then there are pets.com, whose signature achievement was its sock puppet mascot, and the gaggle of companies that all leveraged themselves to the sky to create gigantic fiber optic networks–all operating during the Internet Bubble.


I don’t think the Valeant Pharmaceuticals story has yet unfolded completely.  The company, a hedge fund favorite, has come under fire for acquiring mature drugs and raising their prices by huge amounts.  The attack on this practice by, among others, Charles Munger, a long-time associate of Warren Buffet, as “deeply immoral” has caused the stock price to plunge.


Mylan, a new twist

Drug maker Mylan completed a tax inversion early this year that transformed its country of incorporation from the US to the Netherlands.

In April it made use of a provision of Netherlands law to create a trust, called a stichting, supposedly staffed by completely neutral parties but arguably controlled by company management.  It issued the trust an option to buy new shares equal to all those previously outstanding, at a price of one euro cent each.  It then used this device to fend off a takeover bid, unwanted by management, from Teva Pharmaceuticals.

Subsequently, Mylan defended its actions by saying it had moved to the Netherlands because the US is “too shareholder-centric.”

In addition to the ability to create a stichting, moving to the Netherlands appears also to have insulated the board of Mylan from the possibility of removal by shareholder vote.

It appears to me that Mylan reincorporated in the Netherlands with the intention of disenfranchising shareholders.  In a highly technical sense what Mylan has done may be legal, although media reports suggest the SEC is investigating whether the company adequately disclosed to shareholders what it was doing.  Nevertheless, Mylan’s actions seem to me to be a massive breach of the bond of trust that should exist among business partners.  I’m not sure what the consequences will be.  I can’t imagine, though that they’ll be good for Mylan’s stock, or that any other US-listed company will be able to reincorporate into the Netherlands.

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