is “tenure voting” the answer?

tenure voting

The weapon institutions are currently discussing to combat the potentially negative influence of activists on company management plans is called “tenure voting.

Under a tenure voting scheme, a shareholder accrues more voting power the longer he holds a given stock.  On day one, for example, the shareholder might have one vote to cast on proposals at a shareholder meeting.  This might rise to three votes after three years of continuous ownership and peak, say, at five after five years.

This heavier voting power given to long-term shareholders would, in theory at least, make it much more difficult for an activist investor with a hit-and-run strategy to coerce favorable action from a timid CEO.

the arithmetic of influence

An activist can have leverage over company management at present by buying, say, 3% of the outstanding shares to obtain 3% voting power.  If the typical institutional holder bought his core position five years ago and if institutions overall hold 60% of the outstanding stock, then with tenure voting in place the activist wouldn’t achieve the same amount of clout until he had accumulated at least 10% of the target firm’s stock.  Of course, the activist could also wait for a half-decade for his stake to achieve maximum voting power, but none strike me as having that much patience.

an effective deterrent

So tenure voting would likely insulate many of the large firms potentially under activist attack from such predation.

But…

–there’s a practical issue of implementation.  Instituting tenure voting at a firm would presumably require rewriting corporate bylaws.

–it doesn’t stop activist action.  It just changes the game.  Activists would have to adopt a two-step strategy, the first of which would be to court one or more big long-term institutional holders of a target firm’s stock.  Of course, this is arguably the intent of proponents of tenure voting–the presumption being that professional portfolio investors would rebuff the activists.  Maybe so.  But maybe not.  However, the obvious place to start would be index funds.  It’s not really clear what unintended consequences this might produce.

–tenure voting has been a traditional practice in places in Continental Europe like France.  In my view, it has been a disaster there, cementing in place an elitist old boy network of corporate managements that have had little regard for ordinary shareholders.  More than that, the French government’s move last year to make tenure voting mandatory for all publicly traded firms met with violent opposition from investors who know this system the best.

All in all, although I’m not necessarily a fan of activists, I think in this case the cure is worse than the disease.

breaking companies apart

corporate activism/raiding

Lots of activist hedge funds–or corporate raiders, as they used to be called–have been taking small stakes in publicly traded companies and then beating the drum for management either to articulate, or to change, corporate strategy.

Why do this?

…to make money for themselves and their backers, of course.  Also, the targets they’re attacking nowadays are very big.  So the prior tactic of taking control of the company through a takeover and forcing change isn’t possible.

How will change create value?

There are two main ways:

–a company may consist of several parts that have virtually no connection with each other.  A firm might, say, own office buildings and an airline, or make medical devices and lease airplanes.

Many times, these are family controlled firms that following the whims of the patriarch/matriarch.  They can also be small divisions whose growth had skyrocketed (think:  ESPN in Disney).  Or the firms might be holdovers from the 1960s, when, unlike today, the world believed there “pure” management skills could be applied to any field–and that, therefore, the best corporate form was the conglomerate.

People don’t think that way anymore.  We believe that the best companies are ones run by top management deeply skilled in one particular area.  Also, today’s professional stock market investors want to create a portfolio of stocks themselves.  They don’t like or want a corporate management that will create a portfolio of subsidiaries and offer it as a take-it-or-leave-it package.  The result:  a heavy discount applied in today’s world to conglomerates.

Put in a different way–n theory, and in practice, there are investors with differing investment styles and different investment objectives who will pay a higher price for some of the corporate components, provided they don’t also have to take the ones they don’t particularly want.  So breaking the package up creates value.

In the case of the airline/office building company I mentioned above (Swire Pacific of Hong Kong), announcement of plans for a separate listing for Cathay Pacific shot the stock price up by 40%.

–Sometimes companies are dysfunctional.  Internal political fiefdoms get created, preventing cash flows generated by operations from being reinvested sensibly.  Sometimes, companies are clueless about where their profits come from, so that some parts run horribly sub-optimally in order to make other parts look good.  This was the concept behind the activist interest in J C Penney–that the retail operations were being propped up by the property division, which was collecting below-market rents to the department stores.  The idea was to fix the retail and then break up the company into retail and real estate parts.

I once studied a publicly traded, family owned department store in Hong Kong.  I found the stores I visited to be completely unappealing, with dated merchandise at high prices–and stronger competitors a short walk away.  Yet the company, which owned all the property where its stores were located,  made a hefty profit each year.  How could that be?  When I began to work out how much rent the locations would command from third parties, I realized that profits would easily be 50% higher if the firm shuttered its stores and simply rented the properties to other.  But that would have meant that all of the relatives  who “worked” in retail would be out of jobs.  So the idea was a non-starter.

In most instances, management is unlikely to disturb the status quo without being educated/forced by outside parties.  That’s where the activists come in.

Sometimes activism doesn’t work, however.  That topic on Monday.

thinking about big integrated oils

hedge funds attacking Big Oil?

Over the weekend I read a blog post (which I can no longer find) in the Financial Times pointing out that activist investors are getting set to attack the large integrated oils.

Why?  

They persist in investing in massive long-term, risky, low-return oil exploration and development projects.  It’s what they do.  In the view of the hedge funds, this makes no sense.  The oils would be better off finding better things to do with their cash flow, returning it to shareholders if nothing else.

I doubt that this will happen   ..not that hedge funds may not try to change oil company investing plans, but I don’t think they’ll be successful.

Big Oil is important in developed countries because the companies spend a ton of money securing access to petroleum.  Nations are heavily dependent on oil to fuel industry.  The oil firms get huge tax breaks for finding and developing oil deposits because these nations are heavily dependent on oil to fuel commerce and for heating.  This is especially true in the US, which is unique among richer nations in not responding to the oil shocks of the 1970s by taxing oil to control consumption.  We do this to support our globally non-competitive, but politically powerful, auto industry (most of which went bankrupt in the Great Recession anyway).

Given the strategic importance of oil,

why are the returns to oil exploration low?

A generation ago, they weren’t.  Drilling took place mainly in the developed world, often on parcels leased to the driller by the government.    The landowner got an initial payment plus a modest percentage of any finds.  Projects that made good economic sense when oil sold for $7 a barrel are bonanzas today.  Big Oil got most of that.

In contrast, major exploratory drilling today is done in emerging economies, where the big untapped pools of oil are.  But ever since the first nationalizations of drilling projects in the Middle East in the 1970s showed how one-sidedly favorable production agreements were to the oil majors, terms have been tilted much more heavily toward the host nations.  Today’s production agreements provide little more than a specified return on capital to the oil explorer.  Price hike windfalls go to the host, not the big oil.

In the face of less favorable economics,

why continue to drill?

Three reasons:

–it’s still profitable

–it’s what the oils do best.  The last round of oil company diversifications, admittedly a long time  ago, were unmitigated disasters, and

–the home countries of the major oils need a steady supply of oil to keep industry humming and citizens warm in winter.

It’s this third reason that I don’t think activists see.   

At some point, shale oil may change the situation.  Even so, I figure it would be politically unacceptable for any big integrated to dismantle, or even substantially curtail, its exploration and development efforts.  The worry would be that in times of shot supply, oil would go solely to project developers.  In fact, Asian countries are concerned about this possibility that they’ve designated their big oils as “national champions,” whose job is to secure oils supplies for the home country.  Profits are secondary.

I don’t think Washington, or London, or Paris would allow its oil exploration firms to drop out of the race, even if short-term economic returns to the companies and their shareholders might be better if they did so.