Category Archives: agency problem

Silicon Valley backlash?

September 25, 2017 By in agency problem, internet, Technology, Uncategorized Tags: , , , 2 Comments

I think we may be at a watershed moment in terms of the acceptability of the corporate behavior of tech/internet-related companies.

Up until now, it has been enough for investors that Silicon Valley produce increasing profits.  Institutionalized poor behavior on the part of the firms’ managements–whether that be violation of some employees’ civil rights or less-than-ethical treatment of customers or shareholders–has made little difference to their stocks’ performance.

Uber is perhaps the poster child for this phenomenon, which has also been, aptly, I think, characterized as “fratboy” behavior.  But now Uber appears to be losing its license to operate in London, which holds 5% of the worldwide active users of the taxi service, because of its not being a “fit and proper” operator.

The case of Facebook (FB) is just as interesting.  Founder Mark Zuckerberg announced plans last year to give a large amount of his stock in FB to a charitable trust that he and his wife would run.  In order to preserve his majority control of FB despite divesting a large chunk of his shares, he proposed that each A share, the ones with super voting power that insiders like him hold, be “split” into one A + two C shares, the ones with no voting rights.  Zuckerberg could then give away the C shares, representing about 2/3 of his wealth, without any decrease in his 53% voting control of FB.

The board of FB appointed one of its members, Marc Andreessen, a developer of the Mosaic and Netscape browsers, to represent third-party shareholders in this matter–to ensure that this restructuring would be fair to them.

Institutional investors sued.  During discovery, they found among other things, emails between Andreessen and Zuckerberg in which, far from defending third-party holders,  Andreessen appears to be coaching Zuckerberg on how to present his proposal to the board in the most favorable light for him.

Today, FB announced it’s dropping the restructuring plan.

 

If I’m correct about a fundamental change in investor sentiment, what does this mean for us as investors?

At the very least, I think it means that the business-is-what-you-can-get-away-with attitude (borrowing from Andy Warhol) of many tech companies will be penalized with a discount valuation.  It may also prevent some early stage firms from being able to list–preventing employees from cashing in on what they’ve built.  On tech/internet’s notorious anti-woman bias, I’m not sure.  After all, the investment business isn’t that far ahead of tech in eliminating this form of prejudice.

 

 

extreme agency issues

November 13, 2015 By in agency problem, Portfolio management Tags: , , , , Leave a comment

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.

the agency problem

November 12, 2015 By in agency problem Tags: , , , , , Leave a comment

principal – agent

The principal – agent relationship arises when one person, the principal, hires someone else, the agent, to act on his behalf in some matter.

agency problem

The agency problem is that the agent may have a different set of economic interests from the principal and may act on them rather than do the best thing for the client.

examples

Studies seem to show that real estate agents behave differently when they sell their own houses than when they sell for a client.  Working for themselves, they take more time and achieve higher prices.  This is also the issue in the current discussion about whether brokerage financial advisors should be fiduciaries, that is, whether they should have a legal obligation to recommend the best investments for their clients.  At present, they aren’t   …and don’t.

for us as investors

If we hold shares of the common stock of individual companies, we are in some sense owners of the company.  (Note:  we can also hold shares of stock  in individual companies indirectly by buying shares of ETFs or mutual funds.  We can hold the shares in, say, a 401k account sponsored by our employer, too.  These create further layers of principal – agent relations.  In this post, I’m going to ignore them.)

The chief power we have as shareholder-owners of a company is that we vote to elect a board of directors to act as our agents.  The board, in turn, selects a management team (another set of agents) to run the operations of the company in our behalf.

an aside:  stakeholders

Management hires employees, makes ties with suppliers and customers and may borrow money from a bank.  The group comprised of this wider net of interested parties plus us as principals and the two sets of our agents is usually referred to as stakeholders.

potential stockholder – agent conflicts of interest

the board

Where do board members come from?  The slate we vote for is typically put together by the management of the company.  The list will consist of some members of top management, plus “outside” directors.  This latter group may include retired managers from other companies in the industry, or executives from suppliers or customers.  But it may also contain prominent political, military or academic figures, who have little knowledge of business generally–and still less of the particulars of the company on whose board they sit.

As agents, the board has its own set of interests and priorities.  More important, though, it can easily have a much closer attachment to the management that nominated them than the anonymous group of shareholders who voted for them and are technically their bosses.   And, of course, management may seek rubber stamps instead of gadflies.

If individual shareholders had a problem with the composition of the board, how would they take effective action?

management

Let’s say a CEO has spent 25 years rising to the top spot in a corporation, where he has, say, five years to collect high salaries and bonuses and cash in on stock option awards.

Suppose our CEO sees a severe structural problem with the business, which can be papered over for a while but which will begin to erode market share and profit margins within, say, six years.  The problem can be fixed, but only by a restructuring that will crush profits (and maybe the stock price) for at least the next two years but which will pay huge dividends toward the end of the decade.

What does he do?    …restructure and risk turning his $60 million five-year day in the sun into $25 million, or simply paper over and collect the higher sum?

 

Tomorrow:  the latest twist.