Book Summary - Dear Chairman
Jan 22, 2018


Dear Chairman: Boardroom Battles and the Rise of Shareholder Activism by Jeff Gramm

By studying shareholder activism through history, we’ll see the tremendous influence investors now have over public companies, and what issues this raises for the future. We’ll also learn about how boards of directors work, what drives management teams (location 104)

One of my goals is to help readers assess the wisdom of particular campaigns, and differentiate between good and bad interventions. Each chapter provides a sufficiently deep dive to let us look past slogans and grandstanding so we can rationally evaluate the key players, their intentions, and their incentives. (location 137)

Chapter Summaries

1: Benjamin Graham versus Northern Pipeline: The Birth of Modern Shareholder Activism

In 1926, Benjamin Graham, the father of value investing, researched Northern Pipeline Company and noticed that they owned millions of dollars of investment securities worth much more than Northern Pipeline’s current stock price. He waged a proxy fight to gain board seats and eventually persuaded management to give excess capital back to shareholders.

Northern Pipeline featured a classic breakdown in the checks and balances of corporate power: a disinterested shareholder base combined with a board of directors dominated by key members of the management team. (page 12)

“The determination of whether capital not needed in the business is to remain there or be withdrawn, should be made in the first instance by the owners of the capital rather than by those administering [it].” (10)

Managers will be biased toward self-preservation, while shareholders are easily persuaded by short-term profits. In an ideal world, the board of directors is able to negate these biases, but, in reality, it often just defers to one side. The results can be ugly. (13)

2: Robert Young versus New York Central: The Proxyteers Storm the Vanderbilt Line

In 1954, Robert Young waged a public campaign to convince shareholders of New York Central (a railroad company) to vote him in as CEO. He was the first person to use marketing style tactics to persuade shareholders, a group that became known as proxyteers. Young and New York Central traded barbs back and forth in the form of open letters and advertisements.

3: Warren Buffett and American Express: The Great Salad Oil Swindle

The Great Salad Oil Swindle was an audacious fraud that nearly toppled American Express in the 1960s. Warren Buffet became one of American Express’s largest shareholders after buying into the stock following a severe drop in stock price following the Salad Oil Swindle. Buffet wanted American Express to use its capital to pay parties who were defrauded. This investment represented a change in Buffet’s investment philosophy to date - investing in an asset-light company with a valuable brand and on-going business, instead of cheaply valued asset-rich companies.

4: Carl Icahn versus Phillips Petroleum: The Rise and Fall of the Corporate Raiders

Carl Icahn launched a hostile tender offer for Phillips in 1985. He used loosely committed capital from Drexel Burnham Lambert, which would be raised by issuing junk bonds and preferred stock. Ichahn was one of several corporate raiders funded by the junk bond debt explosion of the 1980s. Phillips used a “poison pill” provision to attempt to thwart Ichan’s efforts.

5: Ross Perot versus General Motors: The Unmaking of the Modern Corporation

General Motors bought Ross Perot’s company, Electronic Data Systems, in 1984, making Perot GM’s largest shareholder and giving him a seat on the board. Perot did not think GM executives were doing a good job running the company, so he started making noise about changes that needed to be made. GM’s board eventually paid more than $700 million to Perot to make him go away. This absurd move finally caused institutional investors to wake up to the mis-management at GM.

While Sloan was not an accountant, he developed a system to track the performance of his companies. His primary focus was not the profit of each business, but its return on investment. By learning where the highest returns on invested capital could be obtained, Sloan knew which businesses warranted additional funding and which ones needed improvement. As he later wrote, “no other financial principle with which I am acquainted serves better than rate of return as an objective aid to business judgment.” (100)

By the 1960s, General Motors was a modern public company, run by professional managers and governed by a board of directors with little share ownership. From that point forward, institutions would dominate the company’s shareholder base. (117)

6: Karla Scherer versus R. P. Scherer: A Kingdom in a Capsule

R.P. Scherer was a patent-protected, low-cost producer of softgels. After the founder died, the subsequent CEOs, his son and son-in-law, started to “de-worsify” into other business lines. The founder’s daughter, Karla, got herself a board seat and eventually succeeded in convincing the board to sell the company. This was made difficult by the composition of the board, which was full of members with conflicts of interest.

Most large American public companies feature a wide separation between share owners and managers. The board of directors bridges this gap. In some ways, the board is a middleman, making sure the managers’ interests remain aligned with those of the shareholders.52 But the board is also bestowed with tremendous powers to run the business. It chooses the CEO and provides counsel on major strategic decisions. More than any other party, the board of directors governs the company. (138)

The board of directors is supposed to select managers and help them guide the company, but it must also evaluate them and hold them accountable on behalf of shareholders. In other words, the board helps define a company’s strategy but is then responsible for deciding if the strategy is working. How objective are directors likely to be in evaluating a company’s performance if they played a major role in choosing the CEO and advising him or her? (138)

Even if director independence were tremendously effective in improving boards, there’s only so long a director can serve before developing a closer relationship with management. We humans are social beings, and the corporate directors and CEOs among us are probably more social than average. Even when boards are not built around social connections, these still develop over time. (141)

7: Daniel Loeb and Hedge Fund Activism: The Shame Game

Daniel Loeb is archetypal of hedge fund activists who write snarky letters to companies and seek to effect change to improve the company’s stock price.

Part of the education requires discussing your ideas and investment process with others rather than just sprinting onto the battlefield alone. Today, investors swap thoughts on Twitter. Maybe tomorrow they’ll strap on a virtual reality headset and chat with AI bots programmed to look and think like Warren Buffett. In the early days of Daniel Loeb’s Third Point, they posted stock recommendations on anonymous Internet message boards. (153)

8: BKF Capital: The Corrosion of Conformity

A shareholder activist sought to fix what it believed was poor expense management by BKF Capital (an investment vehicle). For example, they believed BKF was paying their employees too much. The activist succeeded in “fixing” these issues, but the changes caused key BFK employees to leave and led to the collapse of BFK Capital. Failed shareholder activism.

But the rise of the shareholder also promotes a bias to conformity among industry peers. Icahn’s quote about getting your stock price up before someone does it for you could be rewritten for today’s market as “Get your operating margin up to the industry norm or someone will try to do it for you.” Many of today’s shareholder activists focus their efforts on maximizing operating margins.

Key Takeaways

The truth is, a board of directors on its own is rarely capable of successfully managing a company for the long term. This is why our fixation on making corporate boards infallible misses the point. Good governance doesn’t only require an able board of directors; it also demands the right shareholders and managers. For a public company to run well despite the inherent schism between managers and investors, it needs a fanatical CEO, a long-term-oriented, but attentive, shareholder base, and a vigilant board of directors. (145)

The publicly owned corporation has been a remarkable engine for progress and economic growth because it can place large amounts of capital in the hands of the right people with the right ideas. Without proper oversight, however, public companies can squander unimaginable amounts of money and inflict great harm on everything around them. (200)