How the New ‘Activist Investors’ Can Interfere with Long Term Smart & Sustainable Growth

Here at TriplePundit, we have long supported activist investors, since they have a unique opportunity to influence a company's response to climate change and other pertinent 3bl issues. They serve as a fly in the ointment for company executives and board directors, bringing issues to light that would never otherwise be considered by the top brass.

But shareholder activism can have its dark side, too, as Steve Blank recently explained on Harvard Business Review. The “corporate raiders” notorious in the 1980s and 1990s have morphed, rebranded, and now are quick to label themselves as the new activist investors for the 21st century. And unlike their corporate raider ancestors of the 20th century, these investors do not have to acquire a huge portion of a company’s stock in order to exact control. They often see their mission as to “work collaboratively” with the management and boards of “underperforming” and “undervalued” companies in order boost stock prices and “increase shareholder value” which does not necessarily serve the company's long term interests.

One such episode occurred at General Electric (GE) earlier this summer, when the company’s board decided to retire Jeff Immelt and replace him with John Flannery.

As the board mentioned, Immelt “led the successful transformation of GE into a simpler, stronger and more focused digital industrial portfolio aligned to key markets.”

But Flannery was seen as a turnaround artist, one who could revive the company’s stock price. Critics of the company noted that GE’s stock price was trading at about the same level as it was 20 years earlier. During Immelt’s tenure, GE built up cash reserves while selling off stagnant businesses such as entertainment, plastics, appliances and financial services. Immelt also accelerated investments in research and development and hired a team that helped transform the company’s culture into one that embraced technology.

Shortly after Flannery replaced Immelt, that team was let go, a $2 billion cost savings program was launched and GE currently is shifting away from its long-term innovation strategy.

These changes, Blank insists, were largely because of chess moves made by Trian Partners, an investment firm that bought $2.5 billion in GE stock, or the equivalent of less than 2 percent of the company’s equity. Shortly after that transaction, Trian issued a white paper, Transformation Underway . . . But No One Cares. The paper, laden with persuasive graphs and tables, argued that the GE’s investors were dubious that GE’s management would take any steps needed to drive the company’s stock price higher and pay higher dividends to shareholders.

The solution, said Trian, was to incur $20 billion in debt, boost operating margins to 18 percent in a few years and buy back approximately $100 billion in the company’s stock – double the $50 billion to which GE had reportedly committed.

But Immelt pushed back on that plan. While agreeing that Trian’s strategy would increase GE’s stock price (and therefore pad the value of the investment firm’s share in GE), he felt the cuts in expenditures and spike in debt would undermine GE’s long-term innovation goals.

Nevertheless, Trian was far more successful in communicating the benefits of its plan to GE’s board of directors. Immelt and many of his allies are gone, while Edward Garden, one of Trian’s founders, now has a seat on the company’s board.

Since Garden ascended to GE’s board last month, the company’s stock price is down $3 a share. Supporters of the company’s new strategy would respond that the company’s stock has fallen by over 25 percent so far this year, and investors need time to buy into GE’s recalibrated approach.

Hence Trian’s victory in this power struggle is a win for short-termism and investors who still insist on quarterly returns.

But Blank notes that if this trend of a small activist investor being able to topple an accomplished CEO continues, we will hear of less long-term strategies with a focus on R&D and innovation – in addition to more pink slips as employees are let go in the name of downsizing and reorgs. And for those who are still yearning for a revitalization of U.S. manufacturing, Trian’s victory is not encouraging – for either factory employees or the expectation that new innovations can generate both new investments, sustainable development and down the road, even the possibility of an increase in well-paying jobs.

Finally, at time when Washington, D.C. is determined to reverse the financial reforms that were seen as necessary in the wake of the 2008-2009 financial crises, this surge in activist investors does not bode well for effective corporate governance. The quest for quick profits means increased risks of unethical and risky shortcuts in order to boost shareholder returns.

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