I have long believed that our economy would greatly improve if corporate governance rules that insulate crony boards and underperforming CEOs from shareholder demands were changed.
Among the worst of these rules is the poison pill, which presents major obstacles to investors seeking to buy larger stakes and influence companies they own. Poison pills function as a drawbridge that protects CEOs and boards in a fortress, even though shareholders own the fortresses and should be able to exercise property rights, including making changes on who manages their property.
Poison pills, euphemistically called shareholder rights plans, allow boards to issue a flood of new securities when a potential acquirer buys a large stake and seeks changes. While rarely if ever exercised, the simple right of a company to adopt a pill is a potent threat to any entity deemed hostile by the incumbent board and CEO.
Martin Lipton, the lawyer who devised the poison pill, says the pill allows boards to resist pressure from hedge funds to abandon long-term value creating strategies in favor of short-term moves like giving money back to investors or breaking a company up. Shareholders should go through proper channels, like electing new board members that share their views, he argues.
The problem with this is that shareholders face formidable hurdles and massive expense to nominate board members and get them elected, while incumbent boards have unfettered access to the company’s treasury and levers of power to maintain their control.
I have seen the inner workings of many boards. Many are made up of cronies of the CEO and management teams whose aim is to perpetuate their lucrative positions no matter what investors may want or what the company needs. Boards and managements are essentially a club that gets to vote on who they accept as a member. This hurts shareholder value.
Yet studies have shown that increased shareholder power leads to higher value at companies. Harvard Prof. Lucian Bebchuk, for instance, found that “arrangements that insulate boards from shareholders and shareholder pressure have been consistently associated with lower firm value as well as with declining operating performance.”
“Public officials and institutional investors would do well to reject arguments that are based on the asserted long-term benefits of board insulation whenever such alleged benefits are invoked,” said Bebchuk in a recent study.
In Delaware, where a majority of U.S. public companies are domiciled, boards have the right to erect a poison pill at any time. Other jurisdictions like Canada give shareholders more power, particularly when a bidder makes a tender offer for the company. Canadian companies can’t “just say no” to a potential acquirer under the “business judgment rule” widely used in the U.S.
Just saying no, as lawyers often advise businesses to do, is almost insulting to shareholders. It’s like your gardener telling you it’s not your right to sell your house to someone who makes you a great offer!
In Canada, if a company facing an unsolicited offer adopts a pill, it has a limited period to find another buyer or securities regulators can kill the pill and allow the bid to go through with shareholders’ approval. Should it find a buyer willing to pay more, all shareholders benefit, including the original bidder for the expense of making the initial offer.
Who benefits when inefficient companies are protected by U.S. anti-takeover rules? Not the economy where those assets could be better managed to create more value. Not investors whose shares are depressed by a “bad management discount.” Not workers, who would have more opportunities at companies where assets are better managed for growth. Not the government, which benefits when better managed companies pay more taxes.
It is only the managements and crony boards that benefit from the current rules. They are the true corporate raiders in my view, soaking the company treasury for ever-larger compensation and perks. In my opinion, the outrageous management compensation at some companies is directly attributable to corporate governance laws that protect entrenched boards and managements and allow them to appropriate shareholder wealth for their own benefit.
I don’t believe poison pills should necessarily be abolished, but we need a less board-centric system of state laws with respect to pills and many other aspects of corporate governance. Some states, like North Dakota, give shareholders far more rights.
It is time for shareholders, including institutional investors, to stand up for ownership rights and insist on a more appropriate allocation of power between corporate boards and shareholders.
Why should investors be forced to simply sell their stock when managements fail to perform, or be limited in the amount of stock they wish to buy in an enterprise? Investors are the owners of companies and should have rights to demand changes.
Our country was founded on the concept of having checks and balances with the three branches of government. Why should this be any different in the corporate world with boards and shareholders? Everyone relies on the wealth-generating capacity of corporations. We should not allow a small cabal of executives at poorly run companies to destroy the engines of our economy for their own self-interest.
I am initiating a forum called the Shareholders Square Table to influence this debate. For more information, follow me on Twitter: @Carl_C_Icahn.