Activism for profit

L.E. Kesselman
10 min readDec 25, 2014
Bill Ackman hugs Carl Icahn at a hedge fund conference
The big embrace: Carl Icahn and Bill Ackman

Activist hedge funds have been playing an increasingly central role in corporate governance. Financial markets rarely capture the long-term effects of short-term pillaging. As a result, activist investors can pursue transactions that increase prices at the expense of long-term performance, such as cutting project investments or reserve funds.


Pressure to boost short-term performance metrics was one of many behaviors identified by Congress, regulators and corporate governance experts as they investigated the reasons for the financial crisis of 2007–2008.

In her last speech as FDIC chairman, Sheila Bair said:

“the overarching lesson of the crisis is the pervasive short-term thinking that helped to bring it about”.

Martin Lipton, partner at mergers and acquisitions law firm Wachtell, Lipton, Rosen & Katz and Rich Ferlauto, former director of Pension Programs for the American Federation of State, County and Municipal Employees, had similar concerns as Bair. Lipton and Ferlauto drafted a recommendation to overcome short-termism with a more responsible approach to investment and business management. It was signed by 28 business, investment, academic, and labor leaders in September 2009. The call to action offered numerous proposals, (e.g. regulatory rules, laws for employee pension fund management) to government for consideration.

The impact was nil.

Identifying the activists

Activist hedge funds exploit loopholes in 13(d) beneficial ownership disclosure requirements to accumulate control-influencing stakes in public companies. Without disclosure, they can accomplish this surreptitiously, escaping notice by market participants. Derivatives and various electronic trading technologies support such activities.

Activist attacks can also involve a network of investors, referred to as a “wolf pack”. The network supports the lead activist hedge fund, while trying to avoid detection. Shareholder activists are not limited to a cadre of Wall Street hedge funds or Silicon Valley financiers. Partnerships between activists and institutional investors provide additional capital, enabling increasingly aggressive attacks.

Disclosed activist campaigns are at an all-time high. There were 250 in 2014 compared to 27 in 2000. During a single week in May 2014, SunEdison and Conn were both targeted by a single hedge fund (David Einhorn’s Greenlight Capital). The day before, Bill Ackman (Pershing Square) began a run-up of share purchases as part of his effort to acquire Botox manufacturer Allergan. The following week, a single tweet by Carl Icahn sent Apple shares up 5% in one day.

TWA vs Carl Icahn

Carl Icahn is bad for a target company, its employees, and its long-term stakeholders, but very good for Carl Icahn. He’s been doing this for years.

Icahn’s shareholder activism was described less euphemistically as “corporate raiding” in 1985, when he gained control of Trans World Airlines (TWA) after acquiring 20% of its stock. Icahn completed his hostile takeover by taking TWA private. Next, he made himself CEO and chairman of the board. Going private made $469 million in profit for Icahn, while the airline took on $540 million of debt. TWA declared bankruptcy the very next year.

By 1993, TWA’s unionized employees AND management were desperate to get rid of Icahn. They agreed to pay him $100 million per year for eight years in exchange for his resignation from the company’s board immediately. Icahn agreed to the deal and resigned.

TWA went bankrupt again in 1995. After having paid Icahn for six years, TWA declared bankruptcy for a third and final time shortly before 9/11. In 2014, while Icahn was making a play for eBay, Marc Andreessen summarized it well:

Carl Icahn Killed An Entire Airline

In the early 1980s, prior to Icahn, TWA employed 30,000 people. Only 500 remained by the time Icahn collected his final $100 million payment in 2001.

Timken Steel

Incongruously, some institutional investor activists include public employee pension funds. For example, the California State Teachers Retirement System (CalSTRS) and Relational (a hedge fund) used their combined shareholder power to carve up Timken Steel of Canton, Ohio.

Why is it incongruous? Timken was a profitable and innovative specialty steel mill. It had been in business for over 100 years and was locally-owned. It was profitable. Once the activist hedge fund and teachers retirement system took majority control, they broke up Timken into several small companies, severing the metallurgy research and high-end steel from the less specialized products. Facilities that had been geographically concentrated in Canton were relocated in seemingly less expensive locations.

This was short-sighted and harmful, as the synergies between research and manufacturing had been significant drivers of innovation and even long-term customer relationships. Over the next 5 years, the restructuring imposed by CalSTRS and Relational directly resulted in the closure of several Timken plants and the loss of thousands of highly-skilled manufacturing jobs.

Also incongruous: CalSTRS is a union retirement fund, yet it was directly responsible for the job losses of many unionized manufacturing workers in Ohio.

Timken Steel is not alone. The Ontario Teachers’ Pension Fund similarly teamed up with hedge fund activist Bill Ackman of Pershing Square to force a takeover of the Canadian Pacific Railroad. Many unionized workers were let go as a result of that hostile acquisition.

Pas de Deux: Bebchuk vs Wachtell Lipton

Lucian Bebchuk, Director of the Harvard Law School Program on Corporate Governance, believes that shareholders should have the right to control all the material decisions of the companies in which they invest. Bebchuk established the Harvard Law Shareholder Rights Project.

The project’s stated intent is to facilitate activist investor attacks on companies.

Bebchuk asserts that adversarial interventions by hedge funds employing hostile tactics improve long-term business performance. He bases his claim on an empirical study, The Long-Term Effects of Hedge Fund Activism in which he analyzed 2,000 interventions by activist hedge funds from 1994–2007, with a five year follow-up interval for each.

We test the empirical validity of… the claim that interventions by activist shareholders, and in particular activist hedge funds, have an adverse effect on the long-term interests of companies and their shareholders. While this “myopic activist” claim has been regularly invoked and has had considerable influence, its supporters have thus far failed to back it up with evidence.

Bebchuk uses Tobin’s Q as his primary metric to gauge the five-year performance of companies that were the targets of activist attacks.

              Tobin’s Q = $market value / $book value          where book value is a proxy for replacement value

Higher Q indicates a more favorable outlook for a company, and vice-versa. If Q is higher in the years following the activist attack, that suggests the attack was beneficial.

There are two flaws in Bebchuk’s work. One is in the statistical analysis of calculated Tobin’s Q (due to design and to survivorship bias). The other flaw is methodological, in using Tobin’s Q as a proxy for company performance to begin with!

Mean is less meaningful

Bebchuk used average Q over the five-year interval following each activist investor attack, and found that Q increased over time. The average (i.e. mean) is not representative of a data series, if extreme values skew the distribution in one direction, though. This was the case for the calculated Q values. Median is better for capturing central tendency.

Re-running the analysis reveals that the median Q for each of the four years after the attack is less than the median Q during Year 1, the year of the attack. Only in Year 5 does the median Q recover sufficiently such that it is equal to or greater than the median Q in Year 1.

Survivorship bias

These results, even using median Q values, are further weakened because only 47% of the 2,000 companies survived the activist attack, five years later! Bebchuk did not account for this in his study.


It is unclear whether Tobin’s Q is an appropriate measure of company performance. Recall that higher Q indicates a more favorable outlook. According to Tobin’s Q Does Not Measure Firm Performance: Theory, Empirics, and Alternative Measures, emphasis mine:

Tobin’s Q is often used to proxy for firm performance when studying the relationship between corporate governance and firm performance. However, our theoretical and empirical analysis demonstrate that Tobin’s Q does not measure firm performance since under-investment increases rather than decreases Tobin’s Q.

Operational measures such as scale efficiency and cost discipline, essential to the ideal of maximizing firm value (net of invested capital), lead to a different conclusion than Tobin’s Q when run on the same firms, using the same data.

Bebchuk responded with Don’t Run Away from the Evidence: A Reply to Wachtell Lipton. His supporters chimed in, claiming that Martin Lipton was a threat to the Ontario Stock Exchange, because Lipton had suggested that raiders like Carl Icahn be curtailed, thus harming small investors, see Speaking with the enemy.

Wachtell reiterated, in April 2014, that the short-termism of hedge fund activists is detrimental to businesses AND the U.S. economy:

The individuals who are directly responsible for the stewardship and management of our major public companies… are nearly uniform in their desire to get out from under the short-term constraints imposed by hedge-fund activists and agree, as do many of their long-term shareholders, that doing so would improve the long-term performance of their companies and, ultimately, the country’s economy.


Investor preferences

Investment by individuals is stratifying by affluence. In 2015, asset allocation preferences by those earning more than $75,000 were for real-estate and stocks, whereas employed poor people invested in gold or time deposit savings accounts with zero or even negative real returns. Investors scared to death of stocks:

The disparity highlights the difference in attitude toward the future. Where the wealthier who have benefited far more proportionately from stock and real estate gains have a more positive outlook on those assets and the future, the poor have languished in a recovery that has seen income disparity surge to historic highs. It is also related to a general view of the world as being very threatening.

Market inefficiency

Front-running effects and transaction opacity impair financial market efficiency. This is concerning to both regulators and investors. In combination with shifting investor preferences described above, liquidity and trading volume will suffer. Liquidity and volume are important attributes of a competitive, fair marketplace.

If Bebchuk were correct, and activism improved market efficiency, then targeted companies would tend to be mismanaged, financially weak, or fallen stars. Timken Steel was none of those, and it was not an anomaly. No company is too large, too popular or too successful, to be preyed upon:

Even companies that are respected industry leaders and have outperformed peers can come under fire. Among the major companies that have been targeted are Amgen, Apple, Microsoft, Sony, Proctor & Gamble, eBay, DuPont, and PepsiCo. There are more than 100 hedge funds that have engaged in activism. Activist hedge funds have approximately $200 billion of assets under management.

Another expert who does not see things the same way as Bebchuk is Delaware Supreme Court Chief Justice Leo Strine:

The direct stockholders of private companies are typically not end-user investors, but instead money managers, such as mutual funds or hedge funds, whose interests as agents are not necessarily aligned with the interests of long-term investors… Bebchuk’s crusade for ever more stockholder power… and his contention — that further empowering stockholders with short-term investment horizons will not compromise long-term corporate value — is far from proven.

Greed may be good but hostile takeovers? Not so much

For many years, Carl Icahn and Martin Lipton have been fierce rivals. Icahn is the raider, attacking corporate boards. Lipton has spent his career being paid to defend companies from Icahn. (In 1980, Lipton conceived of the “poison pill” shareholder defense in one of their first encounters, when Phillips Petroleum retained Lipton to help defend itself from a takeover attempt by T. Boone Pickens and Icahn.)

In a single interview, broadcast on CBS in 2014, Icahn defended hedge fund activists Ackman and Einhorn, praised Bebchuk, and criticized Lipton. Why? Because Icahn lauded himself and his wolf pack for the net benefit to society that he claimed was realized through the plundering of activist investors. This comes as no surprise, even though he is wrong.

The creation of durable wealth through fundamentally sound economic activity is what really matters for investors, the economy, and our society as a whole.

End notes

For background reading about issues related to hedge fund activism, see UCLA School of Law’s recent Micro-Symposium on Competing Theories of Corporate Governance (62 UCLA L. Rev. Disc. 66, full text), which includes essays by Lucian Bebchuk and Stephen Bainbridge.

Wachtell and Lipton are not social justice crusaders. They are acting in their clients’ best interests. Also, Wachtell was instrumental in aiding Sandy Weill and others to roll back the Glass-Steagall Act. Doing so enabled the formation of Citigroup, the result of merging FDIC-insured Citibank with Weill’s various investment banking and trading firms. Only three short years later, Wachtell & Lipton attorneys were unsuccessful in defending Weill, as chairman of Citigroup, from regulatory conflict-of-interest charges that resulted in Weill never to be allowed to speak to Citigroup investment analysts unless a lawyer were present.

The increasing concentration of control (among asset managers) of business drivers of the US economy was identified by the U.S. Department of Justice in the first year of the Trump administration. Regulatory authorities such as the U.S. Securities and Exchange Commission stated that they were still considering further scrutiny in April 2021. Yet after four years of the Trump administration, and two years of the Biden administration, nothing has changed.