Oxydarko governance I generally appreciate Carl Icahn's style, and one thing that I particularly appreciate is that he manages to hire lawyers who somehow share his sense of style. So Icahn is a big shareholder in Occidental Petroleum Corp., which recently agreed to buy Anadarko Petroleum Corp. It is funding the deal in part by selling $10 billion of preferred stock and warrants to Warren Buffett's Berkshire Hathaway Inc. on terms that are, I think it is safe to say (and I have said), quite lucrative for Buffett and expensive for Occidental. Another effect of the Buffett deal, besides costing a lot of money, is that it allowed Occidental to avoid holding a shareholder vote on the proposed merger: Without Buffett's money, Occidental would need to issue a lot of stock to buy Anadarko, triggering a shareholder vote under New York Stock Exchange rules; Buffett's money, though, replaces some of the stock and allows Occidental to sneak in under the voting threshold. "This is ... awkward," I once wrote; structuring the deal to avoid a shareholder vote seemed to me like "a confession that (1) your shareholders don't like the deal and (2) you don't care." Icahn, as an Occidental shareholder, has had similar thoughts; as an activist shareholder, he is doing something about them. Specifically he sued Oxy yesterday. The actual thing he is suing about is pretty boring—he's asking to inspect corporate books and records to prepare to mount a proxy fight—but Icahn's complaint nonetheless rehearses all of his grievances about the deal with a surprising amount of voice and energy for what is, after all, a books-and-records demand. Icahn, for instance, hates the Buffett financing, arguing, accurately, that it is expensive, not tax-deductible, and gives Buffett valuable warrants to sweeten an already sweet deal. His complaint suggests that Occidental Chief Executive Officer Vicki Hollub got hoodwinked by Buffett: To give Ms. Hollub credit, according to a May 11 Bloomberg story she admitted to her own inexperience in such matters: "What you should know is I'm an engineer. My experience with M&A is very limited." That candid admission brings to mind a Warren Buffett quote: "When you combine ignorance and leverage, you get some pretty interesting results." Mr. Buffett's insight into human nature is undoubtedly true, but unfortunately for Occidental's stockholders, as shown by the terms of the Berkshire preferred, a ninety-minute deal "negotiation" with one of history's canniest investors, is no place to gain M&A experience—at least if you care about protecting your stockholders. Zing! We talked yesterday about how people will pay millions of dollars to spend an hour or two with Buffett, but ninety minutes with a CEO looking for cash is obviously much more lucrative for him. Icahn also hates that the Buffett deal gives Occidental a way around a shareholder vote: Management appears to find the idea of a stockholder vote objectionable. Yet, the Anadarko deal is a classic "transformative" (a word that should send shudders through stockholders everywhere) bet-the-company deal, which is exactly the type of deal that management should present to the stockholders for approval. But it doesn't entirely avoid a shareholder vote. I mean, Occidental will get to buy Anadarko without giving shareholders a vote on it, but after that Icahn will, if he follows through, run a proxy contest and give shareholders a chance to express their displeasure by voting out the directors who did the deal and replacing them with Icahn's directors. (Obviously shareholders who aren't displeased, or who find Icahn even more unpleasant, won't have to vote for him; this is all, for him, a gamble.) Activist investors like Icahn sometimes get stereotyped as rapacious short-term investors who don't really understand the companies they invest in, and who just want a quick profit from stock buybacks and shotgun mergers. Icahn has sometimes played into that stereotype by, for instance, repeatedly telling Apple Inc. to buy back more stock with what seems like a superficial understanding of Apple's business and opportunities. But I think that with a lot of Icahn's engagements it is more helpful to think of him as—well, as what he says he is, a sort of abstract champion of shareholder democracy and good governance. You don't have to know much about Occidental's business, or about the logic and prospects of its Anadarko takeover, to see that (1) that Buffett financing sure is expensive and (2) it's kind of fishy to structure the deal specifically to avoid a shareholder vote. Similarly, last year, you didn't need to have any sort of informed view on the underlying value of Dell Technologies Inc. to know that its proposal to go public through a weird share exchange shortchanged its shareholders. And so Icahn swoops in not with detailed business analysis but with straightforward governance complaints delivered in vigorous and amusing language. And he actually runs, or at least credibly threatens to run, proxy fights, giving shareholders a meaningful vote on corporate actions that they would otherwise mostly grumble ineffectually about. It's a good service! It makes markets better. Maybe you can technically find a way to jam a deal past shareholders without giving them a vote, but if you do, you know there's a threat that Carl Icahn will show up, run a proxy fight, and take over your company from you. There are limits to what corporate managers and directors can put past shareholders, and one of those limits is Carl Icahn. Facebook governance Facebook Inc. has a dual-class stock structure in which Mark Zuckerberg owns about 13% of Facebook's stock but controls 53% of the voting power of the company. Anything that shareholders have to vote on—director elections, executive compensation, etc.—Mark Zuckerberg can, and does, just decide by himself. Every year, Facebook has an annual shareholder meeting anyway, and shareholders fill out proxy cards and show up to debate and vote on a bunch of stuff. This is all pretty pointless, but it is traditional and more or less required by law, so it happens. Also I suppose there is always the slim chance that Zuckerberg will forget to fill out his proxy and the other shareholders' votes will matter.[1] This year's meeting was held yesterday, and he did not forget. Every year, for the annual meeting, shareholders submit a proposal asking Facebook to get rid of its dual-class stock and, thus, Mark Zuckerberg's control of the company. This is also pretty pointless, because, again, Zuckerberg currently controls 53% of the vote, so the only way he will lose his voting power is if he votes to give it away.[2] So even if everyone else votes for this proposal, it will lose. I suppose there is an outside chance that the shareholder proposal will be so compelling, and the arguments for it will be so eloquent, that Zuckerberg will be persuaded to vote himself out of power? I do not think that the world works that way, but you never know. Here's this year's proposal. "Fake news, election interference, and threats to our democracy -- shareholders need more than deny, deflect, and delay," it says, that sort of thing. It doesn't feel like something that Zuckerberg would vote for. In the event, he didn't, and the proposal was voted down for the sixth year in a row.[3] Every year, Facebook's board of directors writes a little response to the proposal telling shareholders to vote against it. This, again, is pretty pointless, because of the stuff above: Even if all the shareholders except Zuckerberg vote for it, it won't pass, so it doesn't matter what the board says. The board could quite reasonably say "look, do what you want with this proposal, it doesn't matter, Zuck will just decide." But I suppose that would look bad. Even though Zuckerberg controls the company, the directors are nonetheless supposed to be independent fiduciaries who look out for the interests of all shareholders. They are impressive prestigious people who might want other fancy board jobs, and/or not to get sued, so they have to look like they're taking their jobs seriously. So they respond on the substance. Here is part of this year's response: The vision and leadership of our founder and CEO, Mark Zuckerberg, has guided us from our inception. Mr. Zuckerberg is invested in our long-term success, and under his guidance we have established a track record of creating value for our stockholders and navigating important opportunities and challenges. For example, our recent efforts to improve the safety and security of our community have required significant investment, which has impacted our profitability. This level of investment may not have been possible if our board of directors and CEO were focused on short-term success over the long-term interests of our community and our company. This is bland but interesting. The first part—"Zuck has made you all rich, stop complaining"—is quite true, though it's old news. But the second part is kind of wild. "If we replaced Zuckerberg's dictatorial power with a democracy of public shareholders," it basically says, "we would be even more rapacious and irresponsible in our unchecked pursuit of profit and growth." And that's true, right? The message here is that the Facebook shareholder who has even the vague theoretical desire to tame Facebook is Zuckerberg, and that if you take power away from him and give it to the market, Facebook will get even worse. I bet that's right. I don't know how to feel about it. Should index funds be illegal? We talk a lot about the theory that common ownership of multiple companies in the same industry by big institutional shareholders might reduce product-market competition and raise prices in that industry. The modern form of this theory was popularized by a paper about common ownership of airlines, finding that airlines competed less aggressively, and had higher prices, on routes where their competitors had high levels of overlapping ownership. There are of course a lot of objections to this theory, of which a very important one is: Come on, big institutional investors don't go around meeting with companies and telling them to raise prices to help their competitors. Here is a story about Letko Brosseau & Associates, which is the biggest shareholder of Transat AT Inc., a Canadian airline and travel firm. Letko Brosseau is also the biggest shareholder of Air Canada, which is in talks to acquire Transat, and it opposes the proposal because the price is too low. One thing that I tend to think is that increased common ownership should reduce this sort of thing: If the big shareholders of the merger target are also big shareholders of the acquirer, then it matters less to them how the benefits of an acquisition are shared. If the acquisition creates value, it doesn't matter if that value goes mostly to the target's shareholders (in the form of a high merger premium) or to the acquirer's (with a low premium), because the same shareholders are on both sides; they'll support mergers with good business logic even at a low premium. Not always, though; here, Letko Brosseau owns more of Transat than it does of Air Canada, so it makes sense to push for a higher premium. But Letko Brosseau also calls on Transat to raise prices, based in part on its experience talking to Air Canada about raising prices[4]: "It does not take a big increase in revenue to significantly change the level of profitability of the company. We are talking about a 3% increase in ticket prices, the equivalent of about $30 per ticket. It's really very little. But that makes all the difference in the world," says Daniel Brosseau, co-president of Letko Brosseau. … Both partners say it was a problem Air Canada had 10 years ago when Letko Brosseau became a shareholder. "Price management is complex, and that's the problem." Air Canada and WestJet are managing the situation better, according to Peter Letko. "We noticed significant differences in comparing Transat's prices with those of Air Canada and WestJet, of which we are also shareholders. At times," he said, "when their prices could increase by 4%, they could fall at Transat. The others reacted to what was happening in the market with the price of fuel and currencies." Peter Letko says he has discussed the issue with Transat executives. "We went to visit them again in the fall to better understand how they work. We did the same thing at Air Canada 10 years ago. More efficient tools, such as software, have been added at Air Canada to improve this aspect of the operations." Uh. So. There's that! Audits If you are an accountant auditing a company, you have to do it every year. This can feel repetitive and inefficient, since the company doesn't change all that much from year to year. If you start from a blank piece of paper every year, you will duplicate a lot of work; you'll ask a bunch of questions to which you already know the answer, and write down a lot of stuff that you already wrote down last year. So why start from a blank piece of paper? Why not start with last year's filled-out paper, and then just change what has changed? Here is a delightful paper by Sarah Bonner, Tracie Majors and Stacey Ritter of the University of Southern California that appeared in the Journal of Accounting Research last year: Risk assessment is a critical audit task, as auditors' accuracy therein affects audit effectiveness and financial reporting quality, as well as audit efficiency. We propose that risk assessment accuracy for client risks that have changed from the prior year is affected by the manner in which auditors access prior year risk assessments, specifically whether they face a default option created by the prepopulation of current year workpapers with those assessments. We find that auditors with prepopulated (vs. blank) workpapers are less accurate for risks that have changed because they are more likely to stick with last year's assessments, and also to work fast. Starting from scratch is a huge waste of time, but it forces you to think about everything from scratch; if things have changed, then your assessment changes. Starting from last year's papers is efficient, but it pushes you to assume that everything is the same as last year; if things have changed, then you might miss them.[5] This is about risk assessments in audits, but of course it is also about everything. Pretty much every document in finance is copied from the previous document. The system really couldn't work otherwise; imagine sitting down to write a bond indenture from scratch. If you're writing a pitchbook or drafting an IPO prospectus or building a merger valuation model, you're probably starting from a precedent and just changing the parts that need changing. But just starting from the precedent creates the risk that you'll just skip over what needs changing; seeing it written down there in black and white will give you the subconscious impression that it's already done. Bribes Here are some alleged euphemisms for bribes from an indictment of a Chicago alderman: In one conversation included in the indictment, Burke allegedly told Solis he wasn't going to help the chief developer on the post office project, New York-based Harry Skydell's 601W Cos., until Skydell agreed to hire Burke's firm for tax work. "The cash register has not rung yet," Burke allegedly told Solis in the January 2017 conversation. Four months later, Burke was again recorded asking Solis about the developers. "So did we land the, uh, the tuna?" he said to Solis in May 2017, according to the indictment. "Don't call bribes 'chickens,'" I once advised, when I was writing about some people who allegedly paid bribes to get lucrative contracts to build Mozambique a tuna fishing fleet. If you write an email like "please send me 50 million chickens" as part of a tuna deal, that is going to look suspicious. It is not a good euphemism, even if tuna is the chicken of the sea. Better to use a term like "success fee," which sounds almost as though it could be a legitimate thing. I don't know if saying "50 million tunas" would have been better in the tuna context; probably not really—still sounds like a kickback!—but maybe a little better. But it is all very situation-dependent, and "tuna," while it might be okay in Mozambique, is a terrible euphemism for "bribe" in the context of Chicago construction. You can't land a tuna in Lake Michigan, I hope. Really the goal in all of these things is to sound boring. Ask yourself "if I get caught and go to trial, will this email make me sound like a legitimate bureaucrat insisting on boring procedural requirements, or like a colorful wiseguy criminal?" Like if you say "expediting payment," which just straight-up means "bribe," I think that actually sounds better than "tuna." You say "tuna" and everyone knows it's a euphemism, and everyone knows you're using a euphemism because you know it's a crime. You say "expediting payment" and the prosecutor asks you about it on the stand and you're like "well that's just the payment for expediting" and she is like "isn't that a bribe" and you are like "no no no it's the expediting payment, that's in every deal." And the jury will be confused, maybe, a little. Be boring in your bribery! The funny euphemisms will give you a little entertainment now, and me a little entertainment when you get caught, but they will not work out well for you in the end! This is not legal advice. Things happen China Threatens Sweeping Blacklist of Firms After Huawei Ban. Uber Cites Tight Competition After Posting $1 Billion Loss. 'Socially responsible' investors may have unwittingly backed police-state surveillance in China. WeWork's CEO raised $4.4 billion from a Saudi-backed fund, but said going forward he'd consider declining investments on moral grounds. Mark Zuckerberg's personal security chief accused of sexual harassment and making racist remarks about Priscilla Chan by 2 former staffers. A Victory for Fathers in JPMorgan Parental Leave Case. A 600-Page Textbook About Modern Monetary Theory Has Sold Out. "The Scripps National Spelling Bee ended in an unprecedented eight-way tie Friday morning when the competition's moderators ran out of words for the contestants after 20 rounds." If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! [1] I kid; if that happened, there would not be a quorum and the meeting couldn't happen anyway. [2] Or sells down his stock, which actually is supposedly slowly happening. Even when he gets below 50% there'll be some period where he effectively controls the vote, though; it's hard to get *every* shareholder of a company to vote at all, never mind to vote the same way. [3] These are nonbinding proposals, by the way, so even if they had gotten a majority vote the board wouldn't have to implement them. You could just about imagine Zuckerberg voting for the proposal, and then in the next board meeting—where he is chairman—saying "you know what, let's not do this thing, I just voted for it to mess with people." Again, though, that doesn't feel like Zuckerberg's idea of a good time, though it is, a little bit, mine. [4] This is all in French in the original; the translation is mostly Google Translate with a few tweaks from me. [5] It's based on a training exercise given to auditors, rather than on real-world audits, but in fact auditors are pretty evenly split between starting from blank papers and starting from last year's. ("In our sample, 22% of auditors have experienced only prepopulated workpapers, 28% have experienced only non-prepopulated workpapers, and the remaining 50% have experienced a mix.") |
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