Director duties come into stark relief when it comes to considering whether or not to recommend a takeover bid. Fundamentally, these duties are to act in the interests of “the company as a whole” and for a proper purpose. Taking the “shareholder primacy” view of the world, conventional wisdom suggests that acting in the best interests of the company means acting in the best interests of the current shareholders.
But how do directors reconcile the short-term interests of institutional shareholders with those of mum-and-dad investors who are typically long term supporters, often with no interest in selling out?
Most recently, Downer’s bid for Spotless prompted a furious defence by the Spotless Board who refused to be cowed into abandoning what they believed was the best pathway to maximising long-term value from the company. This was a stand against short-termism. Control did ultimately pass, and, as a result, highlights the thorny balancing act boards face.
The longstanding position of the Courts has been that directors should act fairly across the interests of different shareholders where those interests diverge, and in doing so, it may be appropriate to consider the interests of shareholders focused on the here-and-now, like event-driven hedge funds. While this makes sense, it isn’t specific enough to be helpful for directors wrestling with the bifurcated interests of event-driven shareholders and long-term investors.
In the recent Brickworks decision, the Federal Court endorsed the long-term approach of the boards of both Soul Patts and Brickworks, noting that directors are entitled to substantial latitude in weighing up the best interests of the company, including taking longer-term interests into consideration.
When it comes to takeover bids though, the nature of the two divergent classes of investors often writes the ending of this David and Goliath shareholder tale. Mum-and-dad investors are typically passive, unlikely to sell their shares en-masse, punish directors at AGMs or challenge board decision-making in the Courts.
On the other hand, institutional shareholders like event funds have the means to pressure directors and, frankly, are more likely to sue for perceived breaches of duty. And so “shareholder primacy” turns into “Goliath primacy”, with the noisiest and most powerful shareholders building irresistible pressure for short-term decision making. After a bid is announced, 30% of a register can end up in the hands of event-driven hedge funds within 48 hours.
So how do we give boards a fairer chance at pursuing long-term goals? Brickworks is a good start and gives directors some comfort, but it involved unique circumstances and says more about the grounds of oppressive conduct than the general application of directors’ duties. To finish the job we either need to change the “Goliath Primacy” model and provide a stronger, more explicit endorsement of long-term decision making or change the way fund managers are incentivised to behave.
In the US, prominent investors have started this process, forming the Investor Stewardship Group (ISG) to develop a governance framework to combat short-termism, which will come into effect1 January 2018. This will hold investors to a higher standard by forcing them to consider the long-term interests of the funds’ own beneficiaries, and discourage the fishing-with-dynamite strategies to which public companies are often subject.
An industry response like the ISG in Australia would serve the interests of the people whose superannuation drives our capital markets. Such a movement would also change the pressures faced by directors and encourage boards to look beyond short-term horizons. Another (left-field, old-school and equally unlikely) approach would be for companies to have stated objects around medium and long-term wealth creation. This would mean that directors would be bound to act in accordance with those objects, deterring opportunistic funds.
Bidders think long-term, knowing that some major shareholders don’t – that’s why hostile bids, like Downer’s for Spotless or CIMIC’s for MacMahon, often come straight after earnings downgrades and during turnaround cycles.
With time we will see whether the Federal Court’s decision in Brickworks will give confidence to boards looking to fight for the long-term interests of a company. Until then, an industry response will send a strong message that the tide is turning. The Spotless board was courageous and principled in its focus on long-term value, we should make it easier for other boards to follow their lead.