(Reuters) - Warren Buffett and Charlie Munger might be the greatest investing team of all time but they are dead wrong about the merits of activist investing.
“I don’t think it’s good for America,” Munger said when asked about activist investing, the practice of building stakes in companies in order to try to pressure management to change course.
The irony is that Berkshire’s annual jamboree is sometimes called the ‘Woodstock of capitalism’. Nothing could be more capitalist than the owners of companies influencing how they are run, and yet in the form of shareholder capitalism now practiced in the U.S., with its self-protecting circles of top management, boards and consultants, this sometimes feels like a principle more honored in the breach than in the observance.
Buffett was a bit more nuanced than Munger, noting that activism “won’t go away and scares the hell out of all our managers.”
Both statements are true, and here’s hoping they stay that way.
Buffett has attracted criticism from no less an activist than Carl Icahn, who penned a piece in Barron’s taking exception to Buffett’s decision to abstain from a vote on a widely panned executive compensation plan at Coca-Cola, of which he owns about 9 percent. Buffett instead is reported to have elected to work behind the scenes towards a revision.
That unwillingness to publicly call out managers, often the result of a chummy familiarity, is typical of those who own large stakes in companies, many of whom, like Buffett, aren’t just investors but agents acting on behalf of other investors.
Buffett and Munger, of course, are much to be preferred to the usual run of mutual fund or pension manager, who often neglect corporate governance, thereby abetting the growth and growth of executive compensation. This ‘beat the stock market’ culture of investing has led many to see corporate governance as a sideshow, believing instead that their role is to pick market winners and avoid losers.
That’s a lot easier than getting your hands dirty with corporate governance, which is usually less immediately gratifying than watching prices go up and down on a trading screen.
Unfortunately it has, along with inadequate shareholder protections in law, led to a situation in which top insiders are able to extract more than their fair share of the value companies create.
That’s opened up the way for investors like Icahn, who swoop in and publicly pressure companies to change policies, often by returning more cash to shareholders via dividends or share buybacks.
None of this is to say that Icahn and other activists are always, or even usually, right. Arguably their voices are louder than they ought to be because of the deafening silence from so many other share owners.
But activists do play a generally useful role despite sometimes arbitraging a broken system to their own advantage. As it stands, company governance is a system of opposing forces which can’t come into balance because insiders are too difficult to dislodge. That’s why activists are so irritating to management, and also why they are so needed.
Critics often says that activists act myopically, bringing on short-term spikes but hurting longer-term performance. The data tells a different story.
A 2013 study of more than 2,000 hedge fund interventions by activists found improved operating performance in the five years after the fracas. That held true also for interventions using hostile techniques, according to the study by Lucian Bebchuk of Harvard Law School, Alon Brav of the Fuqua School of Business at Duke and Wei Jiang of Columbia Business School.
The study found "no evidence that the initial positive stock price spike accompanying activist interventions fails to appreciate their long-term costs and therefore tends to be followed by negative long-term consequences; the data is consistent with the initial spike reflecting correctly the intervention's long-term consequences." (here)
There is a real possibility that the next 20 years of investing will be a lot less juicy for shareholders than the last 50. While the reasons why this may prove true are complex, demographics alone argue that far more investors will be in the stage of life in which they are selling their stakes to live on rather than building them up. It is also easy to observe that the equity risk premium, a simple measurement of what the stock market offers, has been in long-term decline.
If a long period of low returns does come, one of the easiest ways for investors, otherwise known as owners, to make good will come through better corporate governance.
That would be a Woodstock, in other words, with many more good seats.
(James Saft is a Reuters columnist. The opinions expressed are his own)
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft)
Editing by James Dalgleish