Drew Johnson: How Companies Can Ward Off Vulture Investors and Save American Capitalism

It’s an all-too-common story in corporate America: A deep-pocketed hedge fund purchases a minority stake in a company. Hoping to turn a speedy profit, the investor then launches a campaign to radically remake the business from the inside by appointing new board members, shaking up management, and charting a new strategic direction aimed at maximizing short-term earnings — even at the expense of the company’s long-term health.

Such “activist investing,” as it’s known, has grown increasingly popular in recent years. According to FTI Consulting, the first half of 2022 saw 321 campaigns of this sort — an increase of 23% from the year before.

The proxy battles that result from these activist campaigns can have dire consequences for a company’s future prospects — and often fail to achieve even short-term results. Too often, the activist’s new strategy is at odds with a company’s core values and competencies, to say nothing of its obligations to workers and consumers. In an age of vulture capitalism, resisting this toxic trend is absolutely critical.

Activist investors often lack the knowledge and experience to succeed in unfamiliar industries. After all, a hedge fund manager might be great at picking stocks, but it doesn’t mean he can successfully manage a hospital chain or restaurant network.  

A recent analysis by Yvan Allaire of the Institute for Governance of Private and Public Organizations looked at activist hedge fund interventions in companies between 2005 and 2013. It estimates that the compounded annual shareholder returns between 2009 and 2013 were 12.4% — noticeably lower than the 13.5% annual return of S&P 500 over the same period.

Another recent study from researchers at Pennsylvania State University and HEC Paris examined 1,324 companies targeted by activist hedge funds. The study’s authors find that, following an intervention, a targeted firm’s value does tend to rise. But after just a few years, value declines quickly, often wiping out any earlier gains the activist might have secured.

Consider the recent experience of chemical giant DuPont. In 2013, investor Nelson Peltz and his hedge fund Trian Fund Management purchased a stake and began lobbying for major changes. By 2015, tensions had escalated, with Trian proposing four new directors for DuPont’s board and pressuring the CEO to resign. Initially, Trian lost the proxy battle after most other shareholders stood by the existing management team and rejected Trian’s proposed directors.

But eventually, Trian’s pressure campaign succeeded, with CEO Ellen Kullman — a seasoned executive with a nearly three-decade track record of success at DuPont — stepping down and the company embarking on an aggressive cost-cutting campaign at Trian’s urging. The company laid off 5,000 employees around the world — 10% of its workforce at the time — and rolled back its research and development efforts dramatically.

Those cutbacks managed to juice the stock price in the short term. DuPont’s total market capitalization rose from roughly $60 billion in late October 2015, the month that Kullman departed, to over $176 billion by January 2018.

But it wasn’t sustainable. By August 2019, the sugar high had completely worn off, with the market cap falling to $50 billion. Today, it’s about $35 billion.

In 2016, another famous activist investor, Carl Icahn, used his less than 10% stake in Xerox to gain 3 board seats, force the company to split into two firms, and cut costs by $700 million. The move resulted in the layoff of 5,000 workers in just six months. The storied printing firm’s market cap has plummeted since then, dropping from roughly $10 billion in January 2016 — when the split into two firms was announced — to roughly $2.4 billion today.

Of course, there’s no law against hubris. Activist investing is perfectly legal, even if it’s often disastrous for workers, consumers, and the long-term stockholders of a company.

So if long-sighted corporate boards want to ward off predatory activists, they should proactively and preemptively adjust their company’s bylaws to disincentivize activist investors from acquiring too much power.

Earlier this year, activist investor Quentin Koffey’s firm, Politan Capital Management, purchased an 8.8% stake in medical equipment manufacturer Masimo and demanded 40% of the board seats.

Masimo’s existing board, suspecting that Politan might be funded by foreign actors eager to access an American company’s sensitive technology, adopted a relatively innocuous bylaw change, merely requiring any nominating director — such as Koffey — disclose the source of his funding. So far, Koffey has refused, even suing in court to overturn the “poison pill.”

Activist investors have a not-so-distinguished track record of gutting companies that took decades — even centuries — to build. This approach to capitalism is deeply destructive to our country, our economy, and our way of life. And “poison pills,” as detractors like to call them, are among the most effective ways to prevent such takeovers before they begin.

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