Activists Are Tough on Companies They Don't Own

That's fine for the activists: They own shares in this company, not in the competitors, and if this company wins a zero- or negative-sum game then the activists are happy. Other, normal, diversified shareholders, who also own the competitors, have less reason to want their companies to play negative-sum games. So you might expect passive diversified shareholders to vote against activist campaigns, and particularly against operational proposals focused on competition. And there is some suggestive evidence for that.

So maybe diversified institutional investing really is anti-competitive. Or, at least, its opposite — concentrated activist investing — seems to be pro-competitive. Should you care? I mean, in the long run, in theory, competition is good and monopolies are bad. And the law does disfavor anti-competitive conspiracies. On the other hand, diversification is also really good for investors, and it would be rather a shame to get rid of it. And fierce competition has its own obvious downsides. Competing by cost-cutting often means competing by job-cutting, and who knows, maybe those supracompetitive profits are being reinvested in human immortality or whatever.

Or maybe diversified passive investors and concentrated activist investors are two balancing elements of one ecosystem, and if diversified passive investors didn't exist you wouldn't need activists, and vice versa. 

Last week we talked about this Roosevelt Institute paper calling on regulators to limit stock buybacks, "affirm board power" and "clarify the fact that shareholders are not owners or residual claimants" of public companies. Today Senator Tammy Baldwin, a Wisconsin Democrat and perhaps the leading congressional critic of stock buybacks, criticized buybacks in a keynote speech at an event hosted by Americans for Financial Reform called "Hedge Funds & Private Equity: Transferring Wealth Up."³ It seems reasonable to say that stock buybacks, and the activist hedge funds that demand them, are not much loved by the American left.

This leads to some awkwardness. If you want to prevent stock buybacks, what you are doing is demanding that big corporations accumulate more capital, and more power over the economy.⁴ If you want to limit (activist) shareholder rights, what you want is for corporate managers to have more power. It is perfectly reasonable to want big companies to accumulate more capital and corporate managers to have more power!⁵ It is just not intuitively that much of a progressive platform, at least as progressivism used to be understood. There was a time when corporate capital and managerial power were the enemy. Now financial capitalism is the enemy, and corporate capital and managers are potential allies in the fight to restrain financial capitalism.⁶

Where does that leave antitrust, and competition? Antitrust law has historically been a progressive tool to prevent the concentration of corporate power; stereotypically Democrats like antitrust enforcement more than Republicans do.⁷ In a world where progressives are more tolerant of concentrated corporate power, and where activist financial capitalism turns out to promote competition, I wonder if that will change.

¹ Relevant findings include that "the typical rival suffers reductions in price-cost markups and market shares," and that:

In terms of operating performance, HFA on average pressures profitability, cash flows, and productivity of rival firms, but not their capital investment, presumably because competitors may be forced to increase investment in response to improvements in target firms.

There is also a small negative stock-price cumulative abnormal return for rival firms over the 10-day period surrounding an activist announcement. But the rivals' stock-price return depends on what the activist is proposing:

Among the specific proposals, demands for changes in firm governance, such as changing the composition of the board and trimming executive compensation, have insignificant announcement effects, consistent with the literature that finds insignificant stock return effects of governance proposals for target returns (Gillan and Starks, 2000). In contrast, demands for changes in business strategy and capital structure of target firms have statistically significant and economically sizeable negative effects on rivals' stock returns. The size and significance of the negative announcement effects on rivals when HFA focuses on changes in the business strategy of target firms is of substantial interest from the viewpoint of industrial organization and strategy literatures. Our findings indicate that financial markets expect HFA to raise target performance through improvements in production efficiency, product differentiation, and business strategy rather than through tacit collusion with rivals (Green and Porter, 1984). 

² In that the people who think index funds should be illegal:

• Are mostly academic types, with not much visible support from, say, corporate managers or regulators or politicians or lobbying groups or anyone else who might make that actually happen, and
• More or less deny that they think index funds should be illegal.

I know, though. I know.

Meanwhile, the people who argue that index funds should not be illegal are basically just me. And I kind of agree with the other side! It is quite a debate. It takes place mostly in footnotes. 

³ According to an e-mailed statement from her office, the AFR event "was sponsored by AFL-CIO, Americans for Financial Reform, American Federation of Teachers, and The Center for Economic and Policy Research." And yesterday shesent another letter to the Securities and Exchange Commission criticizing stock buybacks. 

⁴ What would Marx say? 

⁵ The Roosevelt Institute authors – Mike Konczal, J.W. Mason and Amanda Page-Hoongrajok — are quite sensitive to the weirdness here:

Some may hesitate to give managers more power and protection, but there are two reasons to consider this approach. First, this action should be carried out in tandem with the other policy proposals in the agenda. The most effective way to address short-termism is holistically, seeking to end short-termist trends but also empower good management. Second, the business judgment rule is powerful but not invincible. If management fails to demonstrate to a judge that it utilized all available information in its decision-making, it will be overruled in shareholders' favor. 

⁶ Some of this draws very loosely on Jürgen Kocka's forthcoming "Capitalism: A Short History." 

⁷ But:

For better or worse, the Administration's enforcement record does not bear out this impression. With only a few exceptions, current enforcement looks much like enforcement under the Bush Administration. Antitrust enforcement in the modern era is a technical and technocratic enterprise. Although there will be tweaks at the margin from administration to administration, the core of antitrust enforcement has been practiced in a relatively nonideological and nonpartisan way over the last several decades.