Dear Chairman

Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism by Jeff Gramm

Dear Chairman is a history of shareholder activism that takes the reader through a series of famous case studies. For us, the most valuable takeaway is just how much market behavior has changed over the past century. It's hard to comprehend, but there was a time when "value investing" was not a thing, debt was generally avoided, and public statements were carefully crafted to avoid upsetting anyone. The book does not overtly draw out these themes, but we feel the book shows how markets have generally become more efficient, the growing use and types of debt, and general decline in the civility of discourse by at least some market participants. We relate these three themes to our three favorite chapters:

Chapter 1: Benjamin Graham versus Northern Pipeline: The Birth of Modern Shareholder Activism

Equity investing in the 1920s was viewed by most as little more than gambling. True investing was reserved for “respectable” assets like bonds. Few had an appreciation for concepts like “diversification” and “intrinsic value”. This provided an opportunity for Benjamin Graham who, in 1926, Northern Pipeline Company and found that they owned $90 in liquid bonds per share with shares trading at only $60. He eventually persuaded management to give excess capital back to shareholders (including himself).

Value investors, like Warren Buffett, were able to profit from similar strategies, but as “value investing” became more popular, markets also became more efficient. Markets evolve and those seeking value can’t all look in the same place…a truth that in central to Peter Theil’s “Zero to One”.

Graham also noted that managers will be biased toward self-preservation, while shareholders are often too focused on short-term profits. The board of directors is supposed to negate these biases, but, in reality, it often defers to one side. While equity markets are clearly more efficient today, biases of managers and shareholders are timeless.

Chapter 4: Carl Icahn versus Phillips Petroleum: The Rise and Fall of the Corporate Raiders

Fast forward to 1985 to Carl Icahn’s hostile tender offer for Phillips using a leverage buyout (LBO); which is the practice of funding a buyout with debt. The 1980s are now infamous for LBOs after several prominent buyouts led to bankruptcy. Prior to this period, purchasing a company generally required the buyer to have cash on hand. Instead, Carl planned to pay for the buyout using a combination of cash and debt backed by, “the company's own cash flow”. To avoid the hostile takeover, Phillips essentially bought him off with corporate funds, a practice that would become harder for future corporate boards to get away with because of the obvious disadvantage to shareholders.

This particular case is just one example of expanding uses of debt. Junk bonds also became popular during the 1980s. Debt levels for sovereign governments, corporations, and households have generally been rising since this period. This is partly because of cheaper and easier methods for diversifying exposures, improved transparency via disclosure requirements, and technology for connecting global demand with supply. However, leverage is leverage and it is not always clear that rise in leverage can be tied back to meaningful investments to enhance innovation or improve quality of life.

7: Daniel Loeb and Hedge Fund Activism: The Shame Game

Daniel Loeb is a hedge fund activist whose letters to companies are described by one anonymous colleague as “the most obnoxious letters on the planet”. Here is just one example below to Star Gas Partners in 2005:

“We have also tried to reach you on innumerable occasions only to be told that your legal counsel advised you against speaking to bondholders and shareholders due to the torrent of shareholder litigation currently being brought against senior management and the Company . . . . Sadly, your ineptitude is not limited to your failure to communicate with bond and unit holders. A review of your record reveals years of value destruction and strategic blunders which have led us to dub you one of the most dangerous and incompetent executives in America. (I was amused to learn, in the course of our investigation, that at Cornell University there is an “[Star Gas C.E.O.] Irik Sevin Scholarship.” One can only pity the poor student who suffers the indignity of attaching your name to his academic record.)”Source

Daniel’s letters stand in stark contrast to Benjamin Graham’s letters from 1926 to Northern Pipeline which carried a highly civil tone. Of course, Daniel stands out as extreme even today, but the fact that his approach is welcomed in the marketplace is revealing. There was a time when some topics were simply out-of-bounds. Times have changed.

Investing implications

Shareholder activism is good for capitalism. It generally improves the behavior of corporate managers by incentivizing more efficient allocation of capital. It should therefore not be surprising that stock valuations are generally higher today than they were back in the 1920s.

Perhaps the most popular multiple that investors use to measure stock prices is the price to earning ratio (PE). PE ratios have generally risen since the 1990s. There are many potential reasons for this such as falling interest rates and cheaper methods for diversification. We would add shareholder activism to this list. The reason is that the earnings of the company are probably being used more wisely today than much of the past century.

Dear Chairman didn't get into this, but the rise in popularity of ETFs has some concerned about the future of shareholder activism. Vanguard is already the largest shareholder of several S&P 500 companies. Diversification has helped to reduce volatility, but also removed much incentive for most individual investors to examine particular companies. Online brokerages like Vanguard are supposed to vote on behalf of shareholders in proxies, but it isn't clear that their incentives are in line with clients. This could undermine the value of shareholder activism in improving corporate allocation of capital.


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