Value Based Management – A Poison Pill against Activist Investors

Value Based Management – A Poison Pill against Activist Investors
Activist investors have been lauded and criticized by many. The Economist magazine recently published a special report on these investors, dubbing them the saviors of capitalism. Yet many CEOs dread the moment they will pick up the phone and an activist will be on the other end asking for more share -buybacks, spin-offs of subsidiaries, or disinvestments.

Activist attacks create necessary debate. Management can become complacent and an activist’s interest can shake off this complacency and spur action. Most of today’s activists are not the corporate raiders of the ‘80s. They are more Warren Buffett, less Gordon Gecko. As The Economist has written, their goal is not short-term profitability but rather sustainable improvements in governance and medium- to long-term value creation.

But intervention by activists is not always needed. Firms that have properly implemented a value-based management system would already have in place sound internal governance systems that are aligned with creating long-term value for shareholders. This would make activists’ intervention redundant.

Activists, however, are no chumps. They can differentiate between firms that pay lip-service to value and those that have value ingrained into their culture and operations. The latter will be safe from intervention, while the former may soon find a Carl Icahn on their board of directors.

A quick way of identifying firms that pay lip service to value is by looking at their proxy statements to see how they compensate their key executives. For example, a firm that pays managers annual bonuses to achieve EBITDA targets are not aligned with long-term value creation: EBITDA encourages managers to focus on short-term profitability, which does not account for working capital management or investments in fixed assets or intangibles like marketing and R&D (expenditure on capital is free to managers). None of the bonus earned is likely held at risk, subject to loss, if profits are not sustained.

A robust value-based management system has responsibility at its core. Unit managers are accountable for the capital allocated to them. Strategic planning is not a negotiation game. Targets are determined objectively and transparently. Bonuses are based on achieving medium- to long-term profitability, with part of annual bonuses earned held at risk, pending sustained management performance. Thus a value-based management system is the best poison pill against activist investors. If you adopt one, you are guaranteed that the only time you will hear activists will be in the media.

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