Who is in control of a public company’s destiny these days?

Posted by on April 29th, 2016

Most people would say the management and board of directors are in control of a company’s destiny; however, the SEC intentionally tipped the scales towards investors a few years ago by introducing proxy rule 14a-8.  For better or worse, the Rule 14a-8 has empowered shareholders by making it easier to force changes through proposals in a company’s proxy. Under this rule, any shareholder that has continuously held at least $2,000 in market value or 1% of the company’s securities for at least one year is able to submit a proposal for inclusion in the annual proxy. These proposals may cover a variety of topics, including matters of corporate governance, social and environmental issues.

The SEC’s intention for Rule 14a-8 is to combat entrenched boards and management teams. An unintended consequence is that it has left management teams and boards exposed to the whims of “predatory” shareholders. Increasingly, we are seeing companies inclined to make short sighted decisions as they look to please these now empowered, vocal investors.  My fear is that we will increasingly see companies become rudderless over a prolonged period of time, well after the original antagonists have moved on to their next targets; and primed for the next activist investor to take his turn.

There are a lot of examples of public companies that have been impacted by the small percentage investors taking advantage of Rule 14a-8 to stir up public fights with board members and management teams over competing strategies. One recent example that has played out very publicly is Yahoo and Starboard Value LP, which reportedly only holds 1.7% of Yahoo’s shares as of March (Starboard’s 12/31/16 13F filing is for even less than that).

For years we had seen the board of directors at Yahoo play CEO musical chairs, as shareholders played musical chairs with board members.  It finally seemed as though Marissa Mayer was the master of Yahoo’s destiny, however, that shiny new crown didn’t last, as her decisions and direction for the company have been publicly called into question by investors repeatedly throughout her four year reign.  During the 1Q 2016 earnings call Mayer acknowledged the board is working to sell off the core company. This is in line with their decision to bow down to dissident shareholder Starboard Value LP in December when the company pulled the spinoff of its $32 billion stake in Alibaba, due to Starboard’s fear of a tax hit to shareholders and request to sell the core business instead (keep in mind that Starboard publicly called for Yahoo to sell off the Alibaba stake just a year earlier).  This was a sad admission of defeat for Mayer and the Board, as not long ago Mayer’s strategy was to build Yahoo’s business.  Even with the recent concession to sell the core business, it was announced this week that Yahoo’s board has agreed to give Starboard four seats on the board.  Starboard has been able to wield a surprising amount of influence over Yahoo even though it only reportedly owns 1.7% thanks to Rule 14a-8.

In the end, Yahoo’s long-term shareholders are the losers in this game. Billions (with a “B”) of dollars in valuation have disappeared from the core business as management, the Board and various institutional shareholders including Starboard have fought over what to do next.  Consider, if you subtract the estimated $32B Alibaba stake from Yahoo’s $34.6B mkt cap, there is little left of what was once one of the leaders in the tech sector.

While Yahoo’s demise wasn’t caused by a management team distracted by dissident shareholders, the ability for Mayer to build the new company she envisioned certainly was.

I believe the SEC has gone too far in opening up the proxy rules for small percentage shareholders that may have only been holders for a year to impact companies with short sighted goals.  One of the original versions of the SEC’s Rule 14a-8 limited proposals to investors that had held at least 3% of the company’s shares for three years or more. While 3% is still low considering a 13D doesn’t need to be filed until a shareholder has 5% of a company’s stock, the three year period makes a lot of sense in terms of proving any actions are driven by long-term investors.