The notion of "survival of the fittest" is not only something attributable to the development of species, but, in a more contemporary sense, to world markets as well. The defragmentation process of regional markets that has been set in motion by the followers of those who advocate closer integration of global markets is a force to be reckoned with.
In the past regulation created barriers that protected regional and national firms from the more efficient and competitive adversaries that operate in more capital efficient and less regulated environments, where capital is allocated to the most productive parts of the economy. This is increasingly changing today, with hedge funds and private equity groups jumping at the new found opportunity to take advantage. Hedge funds and private equity are in fact the aquarium algae eating fish that take out the dirt and keep the water clean for the other fish. This is not to say that firms targeted by private equity directly equate to fish guano. No, these firms are simply more able to asses the true value of a firm, albeit like a skeleton being sold off bone by bone to piecemeal investors.
When firms perform less than optimal, the question amongst shareholders - which can include private equity groups or hedgefunds - is whether management resources have been utilized optimally to achieve maximum utility in comparison to capital market benchmarks. As hedge funds often operate with long-short positions, performance or under-performance is crucial. It is no surprise, therefore, that hedge funds are perhaps the most shortsighted investors in terms of their investment horizons. They often propagate and support the shedding of assets, business, or other holdings if it contributes to short term operational results.
With hedgefunds as shareholders, it becomes essential for the firm to not only "know thy self" but also "know thy shareholders." Shareholders are not a homogeneous group; a pension fund, for instance, may have a longer term perspective and subsequently influences firm management in that direction. Hedgefunds have a different investment and return horizon. By their very nature they are required to give high returns in a relatively short time period. This can create a conflict of interest with regards to the strategy and horizon between firm management and a disparate group of shareholders.
This makes the concept of value difficult to grasp for the management of firms, as they have to deal with a heterogeneous group of investors with different time horizons. This destroys any homogeneous expectations of value and allows for arbitrage based on different views on time, value and strategy. The key word, really, is arbitrage: a key pricing component in the pricing of assets. By means of shareholder activism, buyouts, long-short strategies and others, hedgefunds and private equity improve market efficiency through re-pricing. Hedgefunds reprice through long-short strategies and private equity reprice via financial engineering and other management strategies. Technically hedgefunds can do the same by pressuring management. Either way, the end result is the same.
The power of shareholders in efficient, unconstrained capital markets is a key component in the arsenal of hedgefunds and private equity groups alike. Without transparency and various takeover and management defense mechanisms, shareholders would not be entitled to the influence they deserve as owners of a firm. Yet for years many firms in the Netherlands enjoyed the benefit of various defense constructions against hostile takeovers. This in the end suppressed the value of firms so notably that the phenomenon became known as the Dutch discount.
What empowers private equity and hedgefunds even more is the world of cheap capital that we live in. Low interest rates and low spreads on many forms of debt (excluding subprime market) is stocking the weapons arsenal of hedge funds and private equity alike. The bitter reality of this low interest world in which we live in consequentially empowers the lashes of capital and market efficiency through the empowerment of hedge funds and private equity. In terms of the functioning of markets, I would argue that it is a good thing.
Unfortunately, hedge funds and private equity do not spend much time on press relations, and whenever there is talk of hedge fund activity or private equity, it is equated with some evil power bent on selling off assets and mass firings. The truth is that if management of firms under question such as ABN-Amro had performed more adequately, the scenario we are seeing today would have been less likely. In the end the question is often whether a company is worth more as a whole than the sum of its parts. If the sum of its parts is more valuable than the whole, then management must have failed its shareholders in creating significant value.
Furthermore, management could be accused of empire building and not shedding assets that would be to the benefit of its shareholders. Management has the same tools available as private equity; the difference is the perspective on value. The time window for performance delivery has also narrowed in recent decades, in part due to increased accounting transparency that enables more financial performance benchmarking. This, in tandem with increased integration with global markets, has helped to create enormous "peer" pressure to perform.
This should by no means induce us to feel sorry for management, as performance is more than handsomely rewarded. It is the common employee of the firm who stands to lose the most in this hyper-competitive world. Employees bear the burden of under-performance and often gain, relatively speaking, little when performance is good. Except perhaps for the continuation of job security and perhaps performance. This is not a picture that top management would adhere to. It is a bitter reality. I can imagine ABN-Amro employees being more than a little disgruntled if the management leaves with a nice big bonus due to a hostile take over and all they are left with is uncertainty. ABN is in that regard comparable to the titanic: the only rescue vessels available are for the captain, the shareholders and a select group of officers. The bulk of the crew are left behind in an ocean of uncertainty. This is not entirely fair, as a good captain should go down with his ship, instead of being rewarded for steering the ship into an ocean of icebergs.
In the past regulation created barriers that protected regional and national firms from the more efficient and competitive adversaries that operate in more capital efficient and less regulated environments, where capital is allocated to the most productive parts of the economy. This is increasingly changing today, with hedge funds and private equity groups jumping at the new found opportunity to take advantage. Hedge funds and private equity are in fact the aquarium algae eating fish that take out the dirt and keep the water clean for the other fish. This is not to say that firms targeted by private equity directly equate to fish guano. No, these firms are simply more able to asses the true value of a firm, albeit like a skeleton being sold off bone by bone to piecemeal investors.
When firms perform less than optimal, the question amongst shareholders - which can include private equity groups or hedgefunds - is whether management resources have been utilized optimally to achieve maximum utility in comparison to capital market benchmarks. As hedge funds often operate with long-short positions, performance or under-performance is crucial. It is no surprise, therefore, that hedge funds are perhaps the most shortsighted investors in terms of their investment horizons. They often propagate and support the shedding of assets, business, or other holdings if it contributes to short term operational results.
With hedgefunds as shareholders, it becomes essential for the firm to not only "know thy self" but also "know thy shareholders." Shareholders are not a homogeneous group; a pension fund, for instance, may have a longer term perspective and subsequently influences firm management in that direction. Hedgefunds have a different investment and return horizon. By their very nature they are required to give high returns in a relatively short time period. This can create a conflict of interest with regards to the strategy and horizon between firm management and a disparate group of shareholders.
This makes the concept of value difficult to grasp for the management of firms, as they have to deal with a heterogeneous group of investors with different time horizons. This destroys any homogeneous expectations of value and allows for arbitrage based on different views on time, value and strategy. The key word, really, is arbitrage: a key pricing component in the pricing of assets. By means of shareholder activism, buyouts, long-short strategies and others, hedgefunds and private equity improve market efficiency through re-pricing. Hedgefunds reprice through long-short strategies and private equity reprice via financial engineering and other management strategies. Technically hedgefunds can do the same by pressuring management. Either way, the end result is the same.
The power of shareholders in efficient, unconstrained capital markets is a key component in the arsenal of hedgefunds and private equity groups alike. Without transparency and various takeover and management defense mechanisms, shareholders would not be entitled to the influence they deserve as owners of a firm. Yet for years many firms in the Netherlands enjoyed the benefit of various defense constructions against hostile takeovers. This in the end suppressed the value of firms so notably that the phenomenon became known as the Dutch discount.
What empowers private equity and hedgefunds even more is the world of cheap capital that we live in. Low interest rates and low spreads on many forms of debt (excluding subprime market) is stocking the weapons arsenal of hedge funds and private equity alike. The bitter reality of this low interest world in which we live in consequentially empowers the lashes of capital and market efficiency through the empowerment of hedge funds and private equity. In terms of the functioning of markets, I would argue that it is a good thing.
Unfortunately, hedge funds and private equity do not spend much time on press relations, and whenever there is talk of hedge fund activity or private equity, it is equated with some evil power bent on selling off assets and mass firings. The truth is that if management of firms under question such as ABN-Amro had performed more adequately, the scenario we are seeing today would have been less likely. In the end the question is often whether a company is worth more as a whole than the sum of its parts. If the sum of its parts is more valuable than the whole, then management must have failed its shareholders in creating significant value.
Furthermore, management could be accused of empire building and not shedding assets that would be to the benefit of its shareholders. Management has the same tools available as private equity; the difference is the perspective on value. The time window for performance delivery has also narrowed in recent decades, in part due to increased accounting transparency that enables more financial performance benchmarking. This, in tandem with increased integration with global markets, has helped to create enormous "peer" pressure to perform.
This should by no means induce us to feel sorry for management, as performance is more than handsomely rewarded. It is the common employee of the firm who stands to lose the most in this hyper-competitive world. Employees bear the burden of under-performance and often gain, relatively speaking, little when performance is good. Except perhaps for the continuation of job security and perhaps performance. This is not a picture that top management would adhere to. It is a bitter reality. I can imagine ABN-Amro employees being more than a little disgruntled if the management leaves with a nice big bonus due to a hostile take over and all they are left with is uncertainty. ABN is in that regard comparable to the titanic: the only rescue vessels available are for the captain, the shareholders and a select group of officers. The bulk of the crew are left behind in an ocean of uncertainty. This is not entirely fair, as a good captain should go down with his ship, instead of being rewarded for steering the ship into an ocean of icebergs.
1 comment:
thank you for this interesting article on the influence of share holders. You have discussed the impact on employees, both top and bottom and clearly those at the bottom always feel the pain.
But it has also an important impact on society and its development. A company has also a social function, it is there where new (technical) development happens that will impact our lives. Large amounts of collective knowledge are concentrated in companies and get lost every time that it is dissected. A company is in a way an organic being (I liked your methaphores) that has better and worse states during its lifetime. Dissecting it at a time of weakness can do much more harm then letting it continue into a new strong period.
The short term view of shareholders will kill any long term thinking in a company and thus impact society in a very negative manner.
Please note that my remakr does not necessarily hold for companies that in fact do not produce any real products, like banks...
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