In a statement with the Business Roundtable (BRT), 181 major American CEOs recently proclaimed their desire to serve a variety of stakeholder interests beyond merely those of shareholders. ((Statement on the Purpose of a Corporation, Bus. Roundtable (Aug. 19, 2019), https://opportunity.businessroundtable.org/ourcommitment/ [hereinafter BRT Statement].)) However, stakeholder maximization is nearly impossible today for public corporations due to the rise of activist hedge funds; such funds, which exercise unprecedented control over public company behavior by weaponizing disclosures required under securities fraud regulations, are less concerned with corporate values beyond shareholder maximization. ((Jeff Schwartz, De Facto Shareholder Primacy,79 Md. L. Rev. (forthcoming 2020) (manuscript at 1) (on file with author).)) While at least one author has proposed a series of legislative reforms to reduce the control of activist investors, ((Id. at 46-48.)) there has been little discussion of what immediate action public companies should take to act consistently with their expressed values.
This post fills that gap by briefly explaining the legal background that those required disclosures and identifying non-legislative options available for CEOs that want to escape the paradigm of shareholder primacy without having to wait for legislation.
The “New” Purpose of a Corporation
On August 19th, the BRT released an updated Statement of Purpose for Corporations that “redefine[d]” the objectives of a corporation to include serving all shareholders, rejecting the notion of shareholder primacy. ((BRT Statement, supra note 1.)) In doing so, the signing CEOs expressed their view that the economy needs to work “for all Americans,” rather than just for shareholders. ((Id.)) Explicitly, the proclamation announced that managers need to advance the interests of a broad set of stakeholders including customers, employees, suppliers, local communities, the environment, and, conspicuously last among apparent equals, shareholders. ((Id.))
The BRT announcement burst to the forefront of media attention, especially the business press. Reviews were mixed. Some optimistic respondents proclaimed the note was “a big deal,” and that it could lead to a huge structural change in the way major corporations behave. ((Nell Derick Debevoise, 3 Steps to Activate the Business Roundtable Statement, Forbes (Aug. 23, 2019, 8:45 AM) https://www.forbes.com/sites/nelldebevoise/2019/08/23/3-steps-to-activate-the-business-roundtable-statement/#4517f8fb5462.)) Others, who agree with the message, but “have been in [the] field too long to get starry-eyed about the latest announcement” ((Kevin Moss & Eliot Metzger, With New Business Roundtable Statement, are 200 CEOs Stuck in Yesterday’s Corporate Sustainability? World Res. Inst.: Insights (Aug. 22, 2019), https://www.wri.org/blog/2019/08/new-business-roundtable-statement-are-200-ceos-stuck-yesterdays-corporate.)) responded with cynical skepticism. ((See e.g. Andrew Winston, Is the Business Roundtable Statement Just Empty Rhetoric? Harv. Bus. Rev. (Aug. 30, 2019), https://hbr.org/2019/08/is-the-business-roundtable-statement-just-empty-rhetoric. See also Luca Enriques, The Business Roundtable CEOs’ Statement: Same Old, Same Old, Stigler Ctr.: ProMarket (Sept. 9, 2019),
In the virtual firestorm that followed the BRT announcement, many LinkedIn feeds were updated and hundreds of tweets were rapidly fired discussing whether the statement is a good idea, how seriously (or not) it was meant to be taken, or how it should best be implemented. Yet while the media response paid attention to the views of most of the boardroom, CEOs, CFOs, and investors, almost no attention was paid to the legal background against which these public corporations operate.
Activist Hedge-Funds and “De Facto Shareholder Primacy”
In a forthcoming article in the Maryland Law Review, Jeff Schwartz, Professor of Law at the University of Utah, warns that by rejecting shareholder primacy, CEOs would open their companies up to liability through activist shareholder suits under modern securities regulation. ((Schwartz, supra note 2.)) In fact, even more strongly, he argues that because such a result is possible, managers of public corporations tailor their behavior to preemptively avoid such suits by prioritizing short-term increases in share price. He declares this legal landscape a regime of “De Facto Shareholder Primacy.” ((Id.))
Schwartz convincingly explains that along with coercing CEOs to give up on business plans they would rather pursue, activist hedge-funds also ultimately cause worse long-term financial performance by enforcing strict adherence to investments which can only return near-term, quantifiable, value. ((Id. (manuscript at 14-15). See also Lynn Stout, The Shareholder Value Myth: How Putting Shareholders First Harms Investors, Corporations, and the Public, 50-51 (2012).)) As a solution to this, Schwartz proposes a series of reforms to securities regulation which he believes would result in corporations being able to respond to a “broader range of interests” a la the espoused mission of the BRT. ((Schwartz, supra note 2, (manuscript at 46-48).))
While the CEO signers of the BRT announcement openly rejected the notion of shareholder primacy, those at the helm of public corporations may be nonetheless bound (or rather, strongly encouraged by activist shareholders) to behave the opposite. As Schwartz puts it: “[o]nce corporations go public, [securities laws] effectively require that they maximize share price at the expense of all other goals.” ((Id. (manuscript at 1).))
Securities Law, Weaponized
The main legal challenge is that when CEOs deviate from focusing on short-term increases in share price, they expose the company to attack from activist hedge funds. This is accomplished largely through the weaponization of information required to be disclosed by public corporations under existing securities fraud regulations. ((See 17 C.F.R. § 240.14a (2008).)) While the goal of these regulations is to create financial transparency for investors to guard their investments, the reality is that today hedge funds are able to use those disclosures to monitor and control management into focusing on delivering the short term increases in share price that activist investors seek. ((Schwartz, supra note 2, (manuscript at 24, 28). See also Alon et al., Hedge Fund Activism, Corporate Governance, and Firm Performance, 63 J. Fin. 1729, 1745 (2008).))
The result of this is that “[a]ctivist interventions, and the larger shadow they cast, are forcing firms to adopt the myopic view of shareholder primacy, where shareholder welfare is judged by share price regardless of its link to fundamental value.” ((Schwartz, supra note 2, (manuscript at 30).))
Why is this even a problem?
The goals of activist hedge funds do not align with the goals of all (or even most) company stakeholders. Because hedge funds are incentivized to measure against quarterly returns on a short-term basis, it is in their interest to pull future earnings into the nearer term future, rather than focusing on long-term investment and growth or even other areas of value.
As author Lynn Stout notes in The Shareholder Value Myth, one reason a focus on returning value to shareholders exclusively in the form of increases in stock price is misguided is that there is no such thing as a shareholder who is completely disconnected from everything except share price. ((Stout, supra note 13, at 88-89.)) At the end of the day, Stout reminds us, every shareholder has a life, home, and job that can be (and often is) affected by corporate actions. Consider the BP shareholder who also happens to live on the Florida Gulf Coast. While from a shareholder perspective it may make sense for BP to externalize its costs, risking environmental destruction that it may ultimately never have to fully pay for, Stout notes that from the perspective of the real person who holds those shares, it would make no sense! ((Id.))
In contrast, that hedge-funds do not face consequences in the same way. Because they are structured as large unregulated pools of investments managed for continuing short term gains leveraged on a relatively small number of positions, hedge funds actually are incentivized to act like the fictional shareholder who has no stake in anything beyond the share price of a few companies. This disconnect between the incentives of hedge funds and between actual persons who invest is yet another reason for alarm: the laws which were created to ultimately help people are instead used to empower funds.
Non-legislative Options for CEOs
While other commentators have suggested legislative changes to address these issues, there has not been much discussion of what options exist for public CEOs today to escape the undue influence of activist hedge funds.
The likely explanation for this is that there are no easy solutions. However, at least one option seems viable for corporate leaders who are confident in their vision and ability to execute: Going private.
Benefits of going private
The simplest solution to the problem of activist hedge funds is privatization. The disclosure requirements under securities regulations ultimately pose the greatest threat to public companies, and by privatizing, companies will be empowered to act consistently with their mission and values. Indeed, for many corporations and investors there are significant benefits to privatizing. The regulatory hurdles are fewer, the company is able to focus on purely its own vision, and, for the investors who privatize a company whose fundamental value is poorly captured in its stock price, there can be a huge payout. Finally, the company is insulated from the wild swings in stock price that result from speculation of the market. ((See Caleb Silver, How Does Privatization Affect a Company’s Shareholders?, Investopedia (updated Oct. 5, 2019), https://www.investopedia.com/ask/answers/05/publictoprivate.asp. See also Elon Musk (@elonmusk), Twitter (Aug. 7, 2018, 9:48 AM) https://twitter.com/elonmusk/status/1026872652290379776 (publicly suggesting he was considering taking Tesla private and had secured the funding to do so); Elon Musk, Taking Tesla Private, Tesla (Aug. 7, 2018) https://www.tesla.com/blog/taking-tesla-private (explaining later that day among the reasons he was considering doing so was that as a public company Tesla was “subject to wild swings in our stock price that can be a major distraction for everyone working at Tesla” and that “being public means that there are large numbers of people who have the incentive to attack the company.”).))
This is easier said than done of course. There are many challenges and other factors to be weighed when considering taking a company private. Not least of all, a company needs to be able to muster enough capital to buy itself out, and from that point on, access to capital is relatively more limited.
However, many corporations in the recent past have done it or publicly entertained the idea of doing so: Dell, Tesla, Burger King, and Panera to name a few. ((Silver, supra note 20.)) While the path may be difficult, it will likely prove rewarding for the corporate managers who yearn to be free from the yoke of hedge fund myopia. Though this post does not suggest that going private is an optimal, or even wise, idea for most public companies, privatization is an option that should be given due consideration in the current legal environment.
Public company CEOs are not able to execute on their visions to serve stakeholders beyond shareholders because activist hedge funds have weaponized information disclosures required under securities law to ensure that their target companies stay focused on short term increases in share price. While this should ultimately be addressed by legislative reform, legislation takes time. The CEOs who want to lead their company and all their stakeholders to a better future without waiting for Congress should seriously consider the benefits of going private to escape the modern paradigm of de facto shareholder primacy.
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