New Research: Shareholder Activism as a Corrective Mechanism in Corporate Governance

SHAREHOLDER ACTIVISM AS A CORRECTIVE MECHANISM IN CORPORATE GOVERNANCE

Paul Rose and Bernard S. Sharfman

Paul Rose is an Associate Professor of Law at The Ohio State University Moritz College of Law. Bernard S. Sharfman is a Visiting Assistant Professor of Law at Case Western Reserve University School of Law (Spring 2013 and 2014).

Abstract:

Under an Arrowian framework, centralized authority and management provides for optimal decision making in large organizations. However, Arrow also recognized that other elements within the organization, outside the central authority, occasionally may have superior information or decision making skills. In such cases, such elements may act as a corrective mechanism within the organization. In the context of public companies, this article finds that such a corrective mechanism comes in the form of hedge fund activism, or more accurately, offensive shareholder activism.

Offensive shareholder activism exists in the market for corporate influence, not control. Consistent with a theoretical framework where the value of centralized authority must be protected and a legal framework in which fiduciary responsibility rests with the board, authority is not shifted to influential but unaccountable shareholders. Governance entrepreneurs in the market for corporate influence must first identify those instances in which authority-sharing may result in value-enhancing policy decisions, and then persuade the board and/or other shareholders of the wisdom of their policies so that they will be permitted to share the authority necessary for the policies to be implemented. Thus, boards often reward offensive shareholder activists that prove to have superior information and/or strategies by at least temporarily sharing authority with the activists by either providing them seats in the board or simply allowing them to directly influence corporate policy. This article thus reframes the ongoing debate on shareholder activism by showing how offensive shareholder activism can co-exist with—and indeed, is supported by—Arrow’s theory of management centralization which explains and undergirds the traditional authority model of corporate law and governance.

Empirical studies have repeatedly shown that certain types of offensive shareholder activism lead to an increase in shareholder wealth. However, the results of empirical studies must be interpreted carefully so as not to overstate their informational value. Empirical research supports the argument that certain types of offensive shareholder activism have value, but it does not provide conclusive proof that they have value at any specific company at any specific time. Instead, the use of empirical evidence supporting offensive shareholder activism should be understood as providing proof that offensive shareholder activists may on occasion successfully rebut the presumption of the superiority of existing managerial strategies.

A full copy of this research report can be downloaded HERE

Schulte Roth & Zabel's 4th Annual Shareholder Activism Conference

Qualified Individuals Are Invited To Schulte Roth & Zabel's

4^th Annual Shareholder Activism Conference

Thursday, October 3, 2013

2:30 pm | Registration

3:00 pm | Program

6:00 pm | Cocktails

The W New York

541 Lexington Avenue

New York City

To apply for registration go to: http://www.srz.com/events/registration.aspx?event=1504.

Current Developments in Shareholder Activism

Chris Cernich, ISS
Damien J. Park, Hedge Fund Solutions
Michael E. Swartz, Schulte Roth & Zabel
Scott S. Winter, Innisfree M&A Incorporated

Institutional Proxy Voting

Donna F. Anderson, T. Rowe Price
Glenn Booraem, Vanguard Group, Inc.
Daniel H. Burch, MacKenzie Partners, Inc.
Zach Oleksiuk, BlackRock

Launching an Active Value Strategy

Scott Ferguson, Sachem Head Capital Management
J. Daniel Plants, Voce Capital Management
Daniel Silvers, Ader Investment Management
Darren C. Wallis, Active Value Investors

Current Activist Perspectives

Jesse Cohn, Elliott Management
Greg P. Taxin, Clinton Group, Inc.
David F. Trenchard, Knight Vinke

Keynote Presentation

Campaign Experience for a Non-Activist: TPG-Axon

Bloomberg Video: How Closely Should You Follow Activists?

Epic Battle of the Activists: Ackman vs. Icahn

There is no love lost between these two activist hedge fund managers:
Icahn and Ackman duke it out on CNBC.






http://finance.yahoo.com/video/personal-ackman-vs-icahn-live-173000194.html

Schulte Roth's 2012 Shareholder Activism Insight Report

In the second quarter of 2012 SRZ commissioned mergermarket to interview senior corporate executives and activist investors regarding their views with respect to shareholder activism and their expectations for the upcoming 12 to 24 months.  The result is a report that provides an in-depth review of emerging trends in shareholder activism, as well as insights into the changing corporate landscape investors and executives will face in the coming years.

Respondents were asked questions on key sectors for activism, primary drivers of activism, the most effective defensive tactics a company can use, attitudes toward shareholders in the boardroom and much more.  SRZ partners Marc Weingarten and David Rosewater were instrumental in providing commentary and insight throughout the report.

CLICK HERE TO READ THE FULL REPORT

Murphy Oil Takes Cue from Activist Third Point

Murphy Oil Corp. (Ticker: MUR) announced a reorganization of its business units, a special dividend and a stock buyback.  The actions can be viewed, at least partly, in anticipation of an activist push from Daniel Loeb's Third Point. 

The company said in a press release yesterday that it will spin off its downstream subsidiary Murphy Oil USA as a publicly traded company operating gas stations and distribution terminals.

The separation of the two units would allow each to focus its capabilities and capital on specific markets, while investors will be able to value each company separately and invest accordingly.

Shareholders will also receive a $2.50 per share dividend (amounting to $500 million), and the company plans to buy back as much as $1 billion in common stock.

These measures correspond fairly closely to suggestions Third Point made about Murphy in their third quarter letter to investors which mentioned discussions they've had recently with management regarding broad changes to the company's operating structure.

The letter said that Murphy's shares could rise around 60% if the company takes four steps. These comprise spinning off  the retail business, selling Canadian natural gas holdings, unloading a stake in Syncrude, and finishing a move out of U.K. refining activity.

These four steps, the letter said, could generate $8.4 billion to $8.9 billion pre-tax:

"Assuming 20% tax leakage on the two Canadian asset sales, we arrive at $7.3 - $7.8 billion in after-tax proceeds, or roughly $37 - $40 per share. Third Point estimates that the associated EBITDA with the assets sales is $750 million or ~20% of our 2013 EBITDA forecast for Murphy. Based on a current enterprise valuation of $10.4 billion, our analysis suggests investors are paying only $2.6 - 3.1 billion for the balance of Murphy’s assets, which we estimate could generate $2.9 billion in EBITDA in 2013."

On October 4 MUR issued a press release stating that they had recently met with Third Point and that, “The Board and management have been working to evaluate opportunities to illuminate the value in our stock price for the benefit of all of our shareholders.”

While Murphy did not mention Third Point in its release on the spin-off, it clearly fulfilled the first of the activist hedge fund's recommendations. At the same time, the release said it is considering actions that comport with Third Point's other suggestions: "Murphy also reaffirmed the plan to divest the U.K. downstream operations and stated that it is continuing to review possible options with respect to selected assets."

Third Point also revealed in its investor letter that it was seeking Hart-Scott-Rodino clearance from the Federal Trade Commission in order to provide them with the flexibility to augment their 1.5 million share position.  On October 10 Third Point was granted "early termination" from the FTC, clearing the way for Third Point to add to its position.

Posted by Paul Springer

Activist Investors Are Cautioned on Passive vs. Active Filings (with the FTC and the SEC)

Biglari Holdings (Ticker: BH), which has been an investor in Cracker Barrel Old Country Store (Ticker: CBRL) since last year agreed to pay an $850,000 fine to resolve allegations that it continued to file as a “passive” investor under Hart-Scott-Rodino (HSR) when BH had in fact intended to become actively involved in the management of the Company. (Note: BH is currently seeking two seats on CBRL’s board for a second year in a row and now owns 17.5% of CBRL at an average cost of $48.59 per share.  Read our recent activist research report on CBRL.)

BH’s settlement made it clear investors need to stay on top of not only Securities and Exchange Commission filings but also Federal Trade Commission HSR filings as well.

BACKGROUND

BH changed its filing status from “passive” (13G) investor to “active” (13D) investor with the SEC on June 13 last year disclosing a 9.7% ownership in CBRL, but neglected to file with the FTC or observe the HSR waiting period, which is intended to provide the FTC enough time to examine the competitive (i.e. antitrust) dynamics of any large investment.

The sanction hinges on a complaint the FTC filed alleging BH’s abuse of the HSR's passive investor exemption.

According to a press release issued by the FTC on September 25:

“The Hart-Scott-Rodino Act contains an exemption for acquisitions of up to ten percent of voting securities if the acquisition is made solely for the purpose of investment.  The HSR Rules state that such transactions are exempt from premerger filings, if ‘the person holding or acquiring such voting securities has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer.’  However, if the buyer intends to be actively involved in the management of the acquired asset, the exemption does not apply and an HSR filing may be required.”

The Department of Justice confirmed that the issue was indeed related to the passive investor exemption:

According to the complaint, “…in May and June 2011, Biglari Holdings acquired approximately 8.7 percent of the outstanding voting securities of Cracker Barrel.  On June 8, 2011, Biglari Holdings exceeded the then-$66 million threshold for HSR filings, and continued to acquire additional voting securities through June 13, 2011.  The complaint alleges that, at the time of its acquisitions, Biglari Holdings intended to actively participate in the management of Cracker Barrel, including seeking a seat on the company’s board of directors.  As a result, Biglari Holdings was ineligible for the passive investor exemption and was required to submit an HSR notification before acquiring shares of Cracker Barrel in excess of $66 million.”

VARIOUS PERSPECTIVES

BH took a different view of the situation. According to a company press release BH argued its plans were never “active”, stating, "Biglari Holdings has made clear in all of its public filings that it has no intention of becoming actively involved in day-to-day management or in seeking control of the Board of Cracker Barrel."

Obviously, HSR's opinion of the passive investor exemption is very much at odds with BH’s interpretation.  BH’s effort to seek representation on the Cracker Barrel board alone appears to be enough to make the FTC see it as a move towards seizing control of the company, regardless of BH’s claims to the contrary.  In addition, since BH operates in the restaurant business, the FTC considers it a competitor - which will strip an investor of its passive status, as does (i) submitting a proposal for shareholder approval, (ii) soliciting proxies, or (iii) investing when a company creates a shareholder rights plan (which CBRL did after BH began acquiring shares last year).

Analysis from the law firm of Wachtell Lipton highlights the FTC's view: "The FTC’s complaint and press release allege that Biglari Holdings’ actions, including the request for two board seats, were inconsistent with investment-only intent . . . ."

Another assessment from Proskauer Rose notes a variety of actions likely to raise eyebrows at the FTC and focuses on one particular issue in the case of Biglari and Cracker Barrel: "According to the agency, seeking representation on the target company's board of directors, as Biglari did, creates an irrebuttable presumption of intent inconsistent with a passive investment."

In another view, Schulte Roth & Zabel advises investors to talk to their attorneys about anything that could signal a change from passive to active investing: "While the Agencies acknowledge that investors’ intent may change over time from passive to active, the allegations in this matter show the Agencies' willingness to question and challenge an investor's reliance on the passive investment exemption."

Posted by Paul Springer