This article was originally published in the Wall Street Journal.
Soaring CEO compensation can make it hard to feel sorry for the boss, especially when eye-popping pay packets are not matched by performance. While Uber founder Travis Kalanick’s questionable conduct got him ousted, anxious corporate boards facing short-term investor pressures recently have sent unprecedented numbers of virtuous and transformational CEOs packing well before their times.
The Wall Street Journal reported last week that 13 companies with market capitalizations greater than $40 billion replaced their CEOs during the first five months of 2017. This list includes Ford, General Electric , U.S. Steel, Buffalo Wild Wings, CSX, AIG, Yahoo, and Arconic. Many fell victim to a short-term mindset fueled by activist hedge funds. Meantime, some top-performing CEOs—such as Michael Dell, Whole Foods founder John Mackey, and Panera Bread’s Ron Shaich—have led their companies away from short-term financial markets to focus on long-term business investments.
Today’s corporate bosses aren’t the robber barons or country-club networkers of yesteryear. Modern CEOs are generally smart, diligent, and committed to their jobs. They can easily travel hundreds of thousands of miles a year. Eighty-hour weeks are the norm. Many report that the professional demands are so intense that they have little time for family or personal friendships.
Mark Fields worked for the Ford Motor Co. for 28 years, rising to become its CEO in 2014. During his three-year tenure at the helm of America’s second-largest auto maker, the company was profitable. Ford’s recent success was due in part to the popularity of the redesigned F-150 truck, which became America’s best-selling vehicle on Mr. Fields’s watch, and to other major product relaunches, including the legendary Mustang. In 2015, the company enjoyed the best earnings year in its 113-year history.
But since Mr. Fields took the reins, Ford’s stock price had plummeted by 36%. He had warned investors that the pace of technological change meant Ford needed to sink some of its recent profits into long-term research and development. Ultimately the company’s family-controlled board decided it could no longer resist pressure from investors to reinflate the stock price. Mr. Fields was let go in May.
Board panic is a feature of the current corporate environment. The board of retail giant J.C. Penney fell victim to activist pressure and pushed out the highly successful CEO Myron Ullman in 2011. Two years later they sheepishly had to lure him back.
Ellen Kullman’s brilliant six-year reign at DuPont produced a 266% total shareholder return. In early 2015, she beat back a challenge from an activist hedge fund with a 2.7% stake in the chemical manufacturer. But while Ms. Kullman survived that battle, she couldn’t hang on for long. Later that year DuPont suffered two weak quarters due to the strength of the dollar against Brazil’s currency and a downturn in Chinese demand for agricultural chemicals. Before the company could recover from this modest setback, the board panicked and let Ms. Kullman go. A subsequent decision to merge with Dow Chemical has cost jobs, destroyed shareholder value, and ruined the reputation of this 215-year-old global icon.
Honeywell’s Dave Cote left a proud legacy when he retired this spring in a classic internal succession. In a decade at the helm, Mr. Cote grew the Morris Plains, New Jersey-based conglomerate’s global market share and spurred a stock-price gain of nearly 200%. During the same period, the Standard & Poor’s 500 index gained only 63%. Yet two months into the reign of successor Darius Adamczyk, activist investor Dan Loeb pushed for change. So much for a honeymoon at Honeywell.
Activist proxy campaigns are on the rise as hedge funds hunt for short-term stock returns. In the 1960s investors held stocks on average for eight years. Now the average is eight months. Fearing the cost of engaging in proxy battles, not to mention the bad press, directors often wrongly settle with activists, just as many settled with the leveraged-buyout artists of the 1980s. Corporate boards settled 45% of proxy battles in 2016, with many settlements involving invitations to activists to join the board. Fifteen years ago only 17.5% of proxy battles were settled in this way.
These settlements often lead to disproportionate activist representation on corporate boards. It’s not unusual for a 4% ownership stake to net an activist as much as a third of the seats on a board. The research and consulting firm FTI looked at 300 activist campaigns between 2012 and 2015 and found that CEOs were three times as likely to be replaced within 12 months after activists joined the board.
All of this activist agitation hasn’t translated into soaring performance. According to a 2015 Fortune magazine study, activist funds beat the S&P 500 index in only three of the previous eight years. Preqin’s Hedge Fund Spotlight found that 100% of the institutional investors it surveyed were disappointed with their activist hedge fund investments.
The hedge funds are not the only ones to blame for the short-termism stalking corporate America’s corner offices. Institutional investors such as public pension funds and university endowments fuel the activists’ war chests. Eager to make up for faltering performance and lacking the resources for in-depth research on targeted companies, hundreds of such funds delegate their judgment to proxy raters and activists solely focused on short-term share price.
Some institutional investors have begun to push back. Companies targeted by activists have seen high rates of management turnover and communities devastated by large-scale job losses. Behemoth funds such as Calpers, BlackRock, and Vanguard have begun to see how contrary these trends are to their own investors’ longer-term interests.
Corporate boards need backbone, something that is unfortunately in short supply. Without it, many more quality CEOs will fall victim to the terror of short-termism.