Why Carl Icahn Is Bad for Investors
By LYNN A. STOUT
August 1, 2008; Page A11, WSJ
Yahoo's annual meeting today will be much less exciting than anticipated, now that Carl Icahn has made a deal with the company to call off his proxy challenge.
But if history is any guide, Mr. Icahn and his fellow activist hedge fund managers will be back at it again soon enough, either at Yahoo or elsewhere. In the process, they will be robbing average investors of better returns.
Shareholder activism can raise the stock price of a particular company, to benefit particular shareholders, in the short run. But it lowers the value of the stock market as a whole, for average investors, in the long run.
This is because the shareholder activists that corporate boards fear most today are hedge funds like Mr. Icahn's: unregulated pools of wealthy investors who take large positions in a few select companies, use their ownership position to pressure boards into strategies they claim unlock "shareholder value," and then dump their stock as soon as the price rises. (A recent study, "The Returns to Hedge Fund Activism," by Alan Brav et al., posted on ssrn.com, for example, found these funds had a median holding period of 12 months.) Mr. Icahn's fund alone has recently launched activist attacks against the directors at Time-Warner, Motorola, Blockbuster and Yahoo, among others.
Hedge funds want to make money, quick. They push for strategies that raise the stock price of the few companies they own but may lower the stocks of other companies, or that raise prices in the short term while harming companies' long-term prospects.
For example, one favorite hedge fund tactic is to urge the outright sale of the company they have a position in, as Mr. Icahn did in the case of Yahoo. Yet numerous studies show that while the shareholders of an acquired company typically receive a premium in a sale, the shareholders of the generally much-larger acquirer often lose when the acquirer's stock declines.
One 2005 study in the Journal of Finance calculated acquiring-company shareholders' losses at $240 billion over a four-year period. This might explain why Mr. Icahn demands sales when he owns the target -- but protests mightily in the rare case, as in Mylan Lab's proposed acquisition of King Pharmaceuticals, where he owned stock in the would-be acquirer.
A second favored hedge fund strategy is to demand massive dividend or share repurchase programs, temporarily raising share prices by draining "excess" cash out of a firm. This is exactly what Mr. Icahn got in recent years at Time-Warner and Motorola. The result is often an anemic, over-leveraged company that lacks the funds to invest in long-term projects and that cannot weather economic downturns. This is of no concern to an activist hedge fund, which has already sold its shares. It's a serious problem for long-term average investors trying to save for retirement.
Finally, shareholder activism hurts average investors by making entrepreneurs and managers more reluctant to operate as public companies. A common outcome of an activist campaign is to see the target company sold to a private equity firm. As a result, average public shareholders are finding fewer public companies -- at least fewer good ones -- to invest in.
This may explain why private equity funds able to snap up well-performing companies whose managers are tired of dealing with activists have enjoyed returns of 10% to 20% even while average investors' returns have been nearly flat.
All this is not to suggest that corporate officers and directors don't need oversight, or that some companies aren't so poorly run they'd be better off with new owners. But after a decade of disappointing overall investor returns, we should contemplate the possibility that increasing shareholder activism may be a cure that is worse than the disease, at least for the average investor.
Ms. Stout is a law professor at UCLA and the principal investigator for the UCLA-Sloan Foundation Research Program on Business Organizations. |
