The Purpose of a Corporation
September 2019 Letter
The Purpose of a Corporation
The news on the business front seems as busy as Grand Central Station on a weekday at 5pm lately, given trade wars, Brexit, impeachment inquiries, failed IPO’s, etc….One item swiftly passing by caught our attention within the past month. It possibly signifies a “changing of the guard”. The item we refer to is the announcement from the U.S. Business Roundtable that they were redefining the Purpose of a Corporation. The updated mission is for the benefit of all stakeholders, moving away from shareholder primacy. Shareholder primacy had been the first priority for this group since 1997. This is a fascinating item for many reasons, and it merits more discussion.
There are four reasons that this announcement deserves attention. First, it came from U.S. executives. This would be less noteworthy if it was from a global roundtable, or European or Japanese executives. We’ve never read an annual statement from a Japanese CEO that did not focus on a greater good for society. U.S. CEO’s reached their status within a framework that they clearly could successfully navigate. They did so with executive pay that is the envy of the income seeking world. For them to turn back and suggest that the same system needs to be flipped over is somewhat shocking. Second, politics may be playing a role here. Elizabeth Warren has become the leading Democratic contender for President in 2020. Senator Warren is not fond of the high earning corporate types. She has growing support for not every measure of corporate power she wishes to rein in, but certainly some of them. The Technology heavyweights, for example, are the source of growing bipartisan pressure. The Roundtable may have thought it was best to throw some meat at the angry mob at the doorstep. Third, it signifies that CEO’s require acceptance from the global investor base to steer away from “Short-termism”. It is almost a cry for help from the damage they could be required to do to their community, employees or customers. An example I often think of is the Pharmaceutical company CEO’s that are roundly criticized when a drug price is raised by an astronomical amount. What we don’t hear from these CEO’s is the brutally honest admission, “If I don’t do it, they’ll fire me”, with the “they” being the shareholders. Fourth, this could bring important changes to Executive compensation. If U.S. Boards follow this lead, the criteria for pay should change, and the incentives they create.
The Institutional Investor feedback mechanism seems to be functioning much better than the political feedback loop here in the United States. CEO’s have felt tremendous pressure on ESG issues such as climate change, female compensation and living wages. The updated mission of the Business Roundtable is feedback in the reverse direction back to the investment community. We at Ballina Capital would add one next step to the conversation. We believe that share buybacks have been overutilized in the United States in the last 20 years. In some cases, such as Bed Bath & Beyond (“BBBY”, we are currently shareholders), considerable sums have been wasted in the pursuit of the previous Purpose of a Corporation. BBBY repurchased $10.6bn in stock from 2003-2018 at an average share price of $50. Today the share price is 80% lower than the cost of the buyback, at roughly $10 (Ballina average cost is in the mid-teens). 80% of $10.6bn is enough to fund all the goods in BBBY stores for more than a full year! A strong incentive throughout the 15 year period were the Earnings Per Share and Total Shareholder Return metrics that feature so strongly in U.S. Executive compensation. Buybacks are perhaps the most direct path for executives to influence these metrics. If the reward metrics change, as they should, perhaps disastrous examples like that of BBBY can be avoided in U.S. markets?
Source: “Restore Bed Bath & Beyond”, Legion Capital, Macellum Capital Management, Ancora, April 26, 2019.
Many large U.S. Corporations are the envy of their global industries. It is unclear to what extent less of a focus on Shareholder Primacy could damage their positions. Perhaps a changing of the guard now is a safe way to build a stronger moat around their status for fear of regulatory overreach? Milton Friedman is credited with establishing the primacy of Shareholder Value nearly 50 years ago. As with many good ideas, a myopic pursuit can, over extended periods of time, erode it’s original purpose.
International All-Cap Value returned 4.81% (gross basis) in September 2019 versus 2.72% for the benchmark. Year to date performance was 11.89% (gross) versus 11.66% for the benchmark.
Global Small Cap Value returned 2.94% (gross) in September 2019 versus 2.09% for the benchmark. Year to date performance was 10.24% versus 11.72% for the benchmark.
Top Contributors and Detractors
International All-Cap Value’s top contributor was Surgutneftegas. The Russian Oil and Gas producer returned 31.4% in the month of September as some possible changes in capital allocation highlighted the extraordinary discount on the valuation. Surgutneftegas represented the strategy’s biggest position exiting the month. The top detractor in the strategy was Centerra Gold. The stock declined -11.3%, giving back some of the gains from the previous month.
Global Small Cap Value’s top contributor in September was Chico’s FAS. The U.S. women’s fashion retailer returned 31.3% in September as results calmed persistent fears that things were getting even worse. The top detractor in the strategy was EZCorp Inc. The stock declined -17.9% as there were some Board changes post weak results.
 Benchmark for Global Small Cap Value comprised of 50% weight iShares Russell 2000 Index (IWM) and 50% weight Vanguard FTSE All-World ex-US Small-Cap ETF (VSS)