THE BLOG

Short Termism and the Danger to the Canadian Economy and Companies

03/27/2013 11:05 EDT | Updated 05/27/2013 05:12 EDT

There is a concept, called short-termism, which could devastate finances in the future, and has in the past devastated the millions who rely on their paycheques or pensions in the corporate world. The implosion of some of the largest companies in the world such as Enron and WorldCom in 2002 together with the world wide meltdown in the global financial crisis of 2008 could be blamed on the relentless drive for short-term profits.

The recovery from the devastation to both the lives of billions of people around the world and the global capital markets is still taking place today with warning signs from the Cyprus debacle which is also a victim of its over-sized banks seeking short-term profits and could still push Europe towards the financial abyss.

Today, there are new players that are engaging in short-termism that could also wreck havoc on global and national economies and companies, namely some activist hedge funds that live or die on short-term profits. Some of these funds are attempting to force management of successful companies to make decisions that create profits for the hedge funds in the short term but endanger the company in the long term. In the U.S., some of the largest companies such as Apple have been the recent targets of activist hedge funds where the motives were alleged to include short-term profits. In Canada, we have had Telus win one battle with an activist hedge fund Mason Capital where again it was alleged there was a conflict between the long-term interests of the company and the shorter term interests of the hedge fund.

Some of the most reputable experts, like attorney Ira Millstein in the New York Times Deal Book section on March 8, 2013, warn that companies need a new lens to view and reconcile the diverse interests and motivations of shareholders. In particular he questions the rise of shareholder activism that focuses on short-term profits, its impact on long-term growth and stability of companies and more broadly the economy. Another leading expert Martin Lipton in the Harvard Law School Forum on Corporate Governance and Financial Regulation also raises fundamental questions on whether hedge funds that "extort" short term profits from target companies are undermining the fundamentals of corporate governance.

There are no doubt, examples of some activist hedge funds that seek to increase returns from stockholdings by pressuring management to increase long-term share value and better governance practices. The recent successful proxy battle by William Ackman with Canadian Pacific Railway is perhaps a good example of such a good result from an activist hedge fund. It would be naive to believe that others are not focusing on short-term profits. In pursuit of this goal, some attempt to focus on the divesting of assets, proxy battles to replace management and other forms of war against corporate management to get short term profits through asset sales, cash dividends and share buybacks all at the cost of long-term value creation.

This threat often gains access to corporate board rooms under the guise of better governance. However, it can actually lead to a step backwards to the need for independent board members to help steward the resources of the company in the best interests of the company rather than for the interests of any one shareholder or creditor as laid down in the Supreme Court of Canada ruling in the BCE decision.

The dangers of short termism is no doubt being argued in the ongoing proxy battle between Jana Partners LLC (Jana) and Agrium Inc. (Agrium). Jana has proposed a slate of 5 directors in its attempt to drive its vision to breakup the company into its business units. Agrium is warning that this is in pursuit of a short term agenda. Agrium by all reasonable accounts has been and will continue to be a high performing company. It views its integrated strategy as a competitive advantage in building a sustainable company.

What is of particular concern to Agrium is Jana's chosen means of attracting director nominees. According to news reports, it has resorted to a special compensation scheme never seen in Canada before. The scheme involves its nominee directors receiving separate upfront compensation from Jana as well as a contract with Jana to receive additional payments based on the rise in value of Jana's share holdings in Agrium over a 3 year time horizon (the so called "golden leash" payments -- see article by Janet McFarland in the Globe & Mail dated March 4, 2013). Jana claims despite the golden leash compensation arrangements that these directors will be independent voices on the board as they only benefit if all shareholders benefit and therefore is not promoting short-termism. It will be up to the shareholders of Agrium ultimately to choose who is right.

However, the so called golden leash arrangement may also not meet the the accepted Canadian legal and fiduciary standards to act in the best interests of the corporation as it creates a Board where directors may have divergent self interests. The proxy battle between Jana and Agrium could be the first real test of who is best-suited to determine the long term best interests of the corporation when there is a battle between the management of a successful company and a hostile activist hedge fund that seeks to upset the decisions of management. Perhaps the debate and study advocated by Millstein and Lipton is upon us in real time. As these experts would argue, long term health of our leading corporations and our economy is dependent on all involved in the capital markets prying themselves away from the destructive grip of short termism. The fate of our economy and most successful companies are at stake.

Professor Mendes teaches, advises and consults in the area of corporate law and governance at the University of Ottawa. He has been an advisor to corporations in Canada and internationally in the area as well as to governments and the United Nations. He assisted in the development of the UN Global Compact which is the largest global coalition of private companies, universities and civil society promoting best practices in the area of environment, human rights, labour standards and anti-corruption.