[No. 191] Where Long-Termism Meets Short-Termism

Andrew Ross Sorkin of the New York Times just published an interesting article on Kraft's multibillion dollar bid on Cadbury. Remarkably, at least from a US perspective, the board of Cadbury is limited in its ability to fend off the bid, due to restrictive UK takeover rules. Ross Sorkin suggests the deal illustrates that the notion of shareholder democracy isn’t all it’s cracked up to be:

So what’s not to like? Professor Sonnenfeld [of the Yale School of Management, MS] noted an important asterisk — that this push for shareholder democracy may create a perverse incentive system so that short-term shareholders can end up determining the long-term fate of the company. So the balance of interests becomes skewed.

“It raises a question about short-termism,” Professor Sonnenfeld said.

Indeed, one parlor game in London has been to guess how much of Cadbury’s long-term shareholder base has already sold out to arbitrageurs, whose goal is to see the company sold as quickly as possible and then move on to another deal. (That’s not to say the right strategic decision isn’t for Cadbury to be sold to Kraft, though that’s the position of Cadbury’s board.)

People involved in the deal estimate that about a third of the shares have already changed hands, moving from long-term shareholders to hedge funds. Those funds, said Joseph Grundfest, a professor at Stanford Law School, “have a long-term time horizon of about 12 minutes.

But wait a minute - if the company's value on a stand alone basis exceeds the value of the bid, why would long-term shareholders sell their shares to begin with? Thankfully, there's Steve Kaplan of the University of Chicago, who is quoted later in the article and makes precisely this point:  

Professor Kaplan argues that both boards and shareholders will always make mistakes, but that when shareholders are in charge, “Net-net, the shareholder wins.”

And he may have a point: While Cadbury’s fate may now be in the hands of fast-money arbitrageurs, “some long-term investor had to make the decision to sell.” And selling is in itself a vote on the long-term future of the company.

The case nicely illustrates the peculiar divergence between US takeover rules, which allow the board to just say no, and UK takeover rules, which require board neutrality. For a classic explanation of this divergence, see this paper by John Armour and David Skeel.  

Comments

[Matthijs de Jongh]

Hi Michael,
Nice blog and an intriguing point you make. Some questions came up to my mind after I read it.

- Are pension funds, which have to report to DNB on a monthly basis, still long term shareholders? Or other institutional investors, whose principals want to see results every quarter, especially after the crash last year? Aren’t these ‘long term investors’ obliged to take short term gains as well in case of a knock out bid?
- Even if ‘net-net, the shareholder wins,’ how about the interests of other stakeholders, at least in a stakeholder oriented country?
- There is evidence that, while target shareholders gain from acquisitions, acquirer shareholders almost always lose, especially in the long run , a phenomenon which seems to contradict the efficient market theory and which has not yet been fully understood. It could be because of agency problems with the bidder (empire building; information asymmetries) or rational herding. Maybe behavorial economics are able to give an answer (remember the enthousiast Fortis shareholders, when they voted on the ABN AMRO-takeover). See Schenk 2008; www2.econ.uu.nl/users/schenk/Downloads_Articles/21st%20Century%20Mgmt_2008_Schenk_Merger%20Paradox.pdf)

By the way, just today, Roderick Munsters (Robeco, former chairman of www.Eumedion.nl) argued in the FD (http://www.fd.nl/artikel/13632876/munsters-gelijk-stemrecht-niet-meer-heilig):

'Beurzen en beurskoersen worden in toenemende mate overheerst door kortetermijnbeleggers, hun invloed is groeiende', motiveert Munsters zijn standpunt. 'Dit jaagt de ondernemingen op, wat zowel aan hen als aan hun lange termijn beleggers schade kan brengen. Op macroniveau gezien levert dit een maatschappelijke kostenpost op, waarvoor oplossingen moeten worden bedacht.'
'Binnen het toenemende beursgeweld zoekt Munsters naar middelen die meer rust in de relatie tussen een onderneming en zijn eigenaren brengen. 'Daarbij moet over alles nagedacht kunnen worden, zoals ook het niet langer gelijk behandelen van aandeelhouders als het gaat om stemrecht.' (…) Hij haast zich te zeggen dat het belonen van langetermijnbeleggers met meer dividend zijn voorkeur heeft.'