Activist Investors: The Untold Story

Calvin Liou, Contributor

Ask many HBS students about the perception of activist investors as perpetuated by the RC curriculum, and you’ll hear the words “short-term,” “meddlers,” “aggressive,” and a number of other pejoratives that are neither politically correct nor publishable by the Harbus.  Indeed, many of the cases taught throughout the RC curriculum (across disciplines – FIN, FRC, LEAD, and LCA) characterize activists as just that.

In the Target case, Bill Ackman is portrayed as short-term and impulsive in his thinking and actions.  Then, there was the Ron Johnson (J.C. Penney) case that did the same thing.  In Kerr McGee, Carl Icahn and JANA are described as hell-bent on breaking up a company.  A recent LCA case on Sotheby’s characterized Dan Loeb as antagonistic and belligerent.

Upon closer review, there is a nuanced view of the activist landscape that is more balanced and intellectually honest, one left out of the RC curriculum entirely.  This curriculum has not only deliberately chosen cases casting activist investors in a negative light, but has also impressively managed to do so while neglecting to highlight the root causes of shareholder activism: underperforming and incompetent management teams, corporate boards that are asleep at the wheel, and passive shareholders who don’t have the time, resources, or economic incentives to hold their companies accountable for sub-optimal outcomes.

In every single activist-related case, an important part of the story was carefully omitted.  At Target and J.C. Penney, Ackman only got involved after the management teams and corporate boards of the respective companies supervised a sustained period of same-store sales declines, relative underperformance, and value destruction.  Separately, it is noteworthy that the curriculum cherry-picked two of Ackman’s high-profile failures rather than highlighting instances of positive long-term value creation resulting from his activism: General Growth, Air Products, Canadian Pacific, Zoetis, among others – all companies that are more valuable today than they were prior to his involvement.  Not to overly defend Ackman, but the holding period of a typical Pershing Square investment is in excess of four years (much longer than the average quarter-to-quarter hedge fund), a fact conveniently ignored when characterizing Ackman’s “short-termism” across cases.  In Kerr McGee, the casewriters do not adequately ascribe blame to a management team that intentionally destroyed shareholder value by keeping an underperforming business intact instead of considering strategic alternatives.  The Sotheby’s case fails to tell the story of how an executive team pillaged the company’s coffers for fancy meals and outsized compensation, all while egregiously under-managing the business.  The truth is that shareholder activism would cease to exist if executives did their jobs and corporate boards fulfilled their fiduciary responsibilities to shareholders by properly overseeing these executives.

Finally, there is the myth perpetuated by the curriculum that shareholder activists seek short-term value creation at the expense of long-term value.  In a paper authored by Lucian Bebchuk, Professor and Director of the Program on Corporate Governance at Harvard Law School, he asserts that there is “no evidence that activist interventions, including the investment-limiting and adversarial interventions that are most resisted and criticized, are followed by short-term gains in performance that come at the expense of long-term performance.”  In another study, McKinsey concluded that activist campaigns, on average, generate a sustained increase in shareholder returns.  This is further corroborated by a deep body of academic research, confirming this phenomenon in both the U.S. and abroad.  Indeed, while it may seem silly and obvious, it bears stating: short-term value creation that persists into the long term is long-term value creation.

Shareholder activists also play a critical role in our capital markets as a result of an agency problem that has been exacerbated by passive investors, who comprise a substantial (and growing) portion of public companies’ capital structures.  These passive investors, who arguably don’t really care about an individual company’s performance, have only recently started paying lip service to the importance of good governance and value creation, catalyzed by what appears to be public backlash and fear of regulation as opposed to a genuine desire to create shareholder value.  This apathy is best-understood when considering an index fund’s economic gain when a company in the index creates value and becomes more valuable: next to nothing.  Passive investors are not incentivized to care because they are selling an index fund product, charging fees to customers for index construction and access instead of for generating returns.  With hundreds or thousands of companies in a passive index, of course there is no time for a passive investor to properly assess and engage each one individually.  Alarmingly, index and mutual fund companies are also discouraged from holding index constituents accountable for poor performance, as these funds simultaneously peddle their products to companies’ retirement programs – a glaring conflict of interest.

Large, passive investors have already failed the test of holding corporations accountable.  And with this phenomenon, can executives and corporate boards then be trusted to maximize value for shareholders?  The evidence (and every single activist-related RC case) suggests that the answer is no.  Yet, somehow, many RCs walk away from the first semester accepting the curriculum’s editorial and academic bias against shareholder activism, hook, line, and sinker.

So why has the RC curriculum been constructed in a way that characterizes shareholder activists in such an unbalanced and disparaging light?  Maybe it’s because admitting an activist’s success also means acknowledging the failings of management teams and corporate boards, many of which are comprised of HBS alumni.  Perhaps HBS could be pandering to corporations, a key source of MBA recruitment and donations to the school.  Or maybe it’s fun to publicize the few public failures of hedge fund billionaires who have seized on an unconventional way of making money.  Whatever the reason, HBS has a responsibility to tell both sides of the story and educate future leaders on not only the phenomenon of shareholder activism, but also its merits and the root causes.  On the latter points, the school has been eerily and irresponsibly silent.

Calvin O. Liou (HBS ’19) is an RC at HBS.  He split his childhood between Phoenix, Arizona, and Hsinchu, Taiwan, before spending his career thus far in Indonesia, New York, and Chicago.  Prior to HBS, Calvin spent five years in finance – microfinance, investment banking, and private equity. In his spare time, he enjoys playing tennis and identifying areas of value creation.