Nuns, Whores, DCFs

For some reason it is corporate governance day at Dealbreaker, so here is a grab-bag of inchoate nonsense (for a change!). First of all look at this: The third-largest U.S. proxy adviser recommended that El Paso Corp shareholders vote against a proposed $23 billion sale of the company to Kinder Morgan Inc, switching its position after comments made by a Delaware judge. Egan-Jones Proxy Services said in a report that it was withdrawing its endorsement of the deal because of "the conflicts of interest cited by (Delaware Chancery Court judge Leo Strine) and the attendant doubts cast on the deal." How should you take this? Well, one way to take it would be: if you paid me to tell you how to vote on things, you'd probably want me to look into those things and decide if they're good things for you, and if they are tell you to vote for them and if not etc. So Egan-Jones* went and looked at this merger and decided it was a good merger and that its clients should vote for it. Then they learned about the conflicts of interest cited by the Delaware court, most of which were publicly available long before the opinion came out,** and changed their minds. Suggesting that they didn't really do a bang-up job of examining the merger to begin with. But that's a stupid way of looking at Egan-Jones's role because, really, you're an EP shareholder and you're like "oh Egan-Jones ran a DCF and this price looks good to them"? You can go read the DCFs of actual investment banks if that's the sort of thing that gets you going. Nobody's actually paying proxy advisors (do people pay them? I don't know) for actual advice on how they should actually vote their shares. Instead they're paying (maybe?) for some vague patina of good "corporate governance," which means something like "good processes and independent boards and no conflicts of interest" and gets lots of chin-stroking academic articles written about it.
Author:
Publish date:
Updated on

For some reason it is corporate governance day at Dealbreaker, so here is a grab-bag of inchoate nonsense (for a change!). First of all look at this:

The third-largest U.S. proxy adviser recommended that El Paso Corp shareholders vote against a proposed $23 billion sale of the company to Kinder Morgan Inc, switching its position after comments made by a Delaware judge.

Egan-Jones Proxy Services said in a report that it was withdrawing its endorsement of the deal because of "the conflicts of interest cited by (Delaware Chancery Court judge Leo Strine) and the attendant doubts cast on the deal."

How should you take this? Well, one way to take it would be: if you paid me to tell you how to vote on things, you'd probably want me to look into those things and decide if they're good things for you, and if they are tell you to vote for them and if not etc. So Egan-Jones* went and looked at this merger and decided it was a good merger and that its clients should vote for it. Then they learned about the conflicts of interest cited by the Delaware court, most of which were publicly available long before the opinion came out,** and changed their minds. Suggesting that they didn't really do a bang-up job of examining the merger to begin with.

But that's a stupid way of looking at Egan-Jones's role because, really, you're an EP shareholder and you're like "oh Egan-Jones ran a DCF and this price looks good to them"? You can go read the DCFs of actual investment banks if that's the sort of thing that gets you going. Nobody's actually paying proxy advisors (do people pay them? I don't know) for actual advice on how they should actually vote their shares. Instead they're paying (maybe?) for some vague patina of good "corporate governance," which means something like "good processes and independent boards and no conflicts of interest" and gets lots of chin-stroking academic articles written about it.

For myself, I'm not all that jazzed on governance as a thing generally, which may be a result of the doleful influences of these people. I always suspect that the worst-governed companies are ones run by crazy brilliant jackasses whom everyone hates but who actually get things done, rather than checklist-following bureaucratic caretakers; Facebook's governanceblows but, y'know, blah blah blah you would've invented Facebook. (See, corporate governance day at Dealbreaker!)

By coincidence a reader called our attention today to this, an SEC no-action letter allowing Citi to exclude from its proxy some nuns' proposal that it disclose more detail about its repo positions. You could spin various theories on why the nuns are so up on repo markets, but one thing to note is that they hold 300 shares, or around $10,000 worth, of Citi stock. Now that's not necessarily a small amount - if I had $10k of Citi stock I'd care a lot about what happened to it too, because, while I haven't actually taken a vow of poverty, I did take a job at a blog - but it's worth noting that the holders of the other 99.99999% of Citi did not think to bug Uncle Vik about his repo-ing. This suggests they mostly think he's got a handle on it (I guess?).

The nuns, you might suspect, are not really in this to preserve their $10k nest egg but rather to achieve what they see as a social aim of bringing transparency and stability to the financial system: they have social goals rather than shareholder wealth maximization goals. This is why I am suspicious of "governance" as a thing; the people who make the most governance noise tend to be (1) Egan-Joneseses who are focused on academic views of good process and will tell you to vote against a merger that is in your economic best interests because an advisor got scolded by a court, (2) nuns, and (3) public pensions, union pensions, and other socially committed investors. I have nothing against these people but if you're just, like, a person who has an economic interest in having the price of the shares you own go up, they don't particularly represent you.***

Finally another reader wrote today:

What are your thoughts on the implications of the rise of ETFs on corporate governance. What I mean is this - a tracking ETF's (the majority of existing ETFs) goal is to track an index, so presumably the manager only incentive is to track that index as closely as possible. This, obviously, differs from a mutual fund in that a mutual fund attempts to beat its stated benchmark. Presumably a mutual fund investment manger (being a fiduciary) has a incentive/duty to vote proxies in the investors' favor, whereby this incentive is absent for ETFs.

You don't have to say "ETFs," you can say "index funds" if you like. Also you don't have to say "governance" necessarily; indexing seems to me to raise broader issues in this vein though it's possible that I'm just crazy. But it's governance day so, yeah, I agree. At least since Jack Bogle crawled out from the sea, corporate voting has moved from being the domain of humans who go to shareholder meetings and bitch at CEOs to being the domain of fund complexes who'd rather get a few bps of stock borrow fees than vote their shares.**** And so the voices of good governance tend to be more and more crank-ish/nunnish.

Enough nuns, let's talk whores. It's just possible that Anna Gristina's Morgan Stanley meeting was not an IPO pitch attended by John Mack, though I won't believe that until we get the details at trial. One thing to think about is where rise of indexing and ETFing and marginalization of governance leaves the gatekeepers of the capital markets, in this case represented by the MSSB broker who was going to take the UES madaming business online (and legit?). If shareholders are not going to focus on running of the businesses they fund, because they're index funds or tracking ETFs or otherwise, then that arguably puts greater responsibility in the hands of underwriters.

I've sometimes amused myself by thinking about a limit-case world where everyone invests through index funds and so no one chooses what businesses to fund - whatever's on offer is what gets funded, in direct proportion to how much is on offer.***** In that (totally imaginary) world, the people deciding what businesses got funding - and, also, having an outsize say in things like valuation and corporate governance requirements - would be underwriters, returning them to their historic role as gatekeepers of the capital markets. But whereas in the Olden Days they were gatekeepers who stood between businesses and the naïve individual investors they wanted to fleece, in the all-ETFs-all-the-time future world they will be gatekeepers between businesses and governance-insensitive, index-hugging algorithms. Who are less likely to thank them for it.

Proxy adviser opposes El Paso-Kinder Morgan deal [Reuters]

* Do we make fun of Egan-Jones more than we should? I don't really know anything about them but they seem to be the Slate of ratings agencies and, now, also of proxy advisory services.

** But not all - specifically everyone seems to have missed that the lead GS banker had like a $300k shareholding in Kinder Morgan. I think that that's actually kind of silly to get worked up about but then I would, whatever.

*** Also activist funds, who mostly do represent you, or want to, if you happen to own alongside them, but who pick their battles. Nuns submit proposals to, like, every company, and ISS goes around puffing about governance everywhere.

**** Though maybe not Vanguard.

***** I mean, really, isn't that sort of amusing to think about? It's impossible, of course, price discovery and all that, but I feel like it's a limit case that you should occasionally give a thought to. Like, big companies that do follow-on equity offerings are just guaranteed a certain amount of demand from index funds, even if they're raising capital to start a brothel or something. Isn't that weird?

Related

One More Thing For Governance Day

Felix Salmon put up a great note from a reader about investment banking conflicts; it's fantastic so go read it. But this is a tiny bit unfair: You and many other commentators seem to have some misconceptions about what exactly large, sophisticated clients such as El Paso’s board hire investment bankers to do. Its always funny how, in the minds of pundits everywhere, those conniving and all-powerful one-percenters who sit on corporate boards become impotent and completely incapable of independent decision-making once an investment banker walks into the room. The basic argument is that repeat-player investment bankers provide value not by telling brainless executives whether to accept or reject a merger, but by providing intelligent decisionmakers with access and relationships, and relationships come with conflicts. As he says: When sophisticated clients (management teams, company boards, PE funds, etc) hire M&A bankers, they typically hire them for two main reasons (in addition to the legally required shams referred to as “fairness opinions”): Execution and Connections. Of those things, connections are higher-value and inextricable from conflicts. If you're hiring someone to sell you to Company X, a bank who has done work for Company X - heck, who owns 20% of Company X - is the bank you want. And sure maybe their "conflict" will cause them to advise you to sell for a lowball price so that Company X appreciates them more but, hey, nobody's forcing you to take their advice. So, yes, this is all true. But he's maybe a little too harsh on the commentators and their misconceptions.

Quis Custodiet Ipsos Egan-Joneses?

Let's not stop there with the clichés.* Here's a great one: "never attribute to malice that which can be adequately explained by stupidity." In applied form: your model of all the AAA mortgage CDOs that were maybe not so AAA could be "ratings agencies were paid by banks so they were venal and corrupt and sold the banks good ratings on products they knew were bad." Or it could be "ratings agencies created medium-dumb criteria to make a thing be AAA, and bankers who were smarter than medium-dumb arbed those criteria to make more things be AAA than should have been AAA." The incentives model has good economic theory behind it, and some suggestive evidence; the stupidity model has that lovely cliché but also some evidence, about which more later. But first hilarious contrarian ratings agency Egan-Jones is in trouble:

Facebook Will Take Free Money From Banks But Don't Expect It To Show Any Gratitude

The Wall Street Journal today discovered that universal banks that lend money to companies for cheap tend to want investment banking business in return for that lending and I guess that's a scandal: As the market for technology IPOs revs up and the biggest banks seek to capitalize on the size of their balance sheets, the practice of selecting underwriters that also provided loans is coming under focus, spurred by Facebook's IPO process. Critics of the practice say the choices aren't accidental and reflect the "you-scratch-my-back-I-scratch-yours" way that Wall Street works. Bankers, for their part, say they aren't allowed to make loans on the condition that they receive other business, but borrowers can use the loans as a factor in choosing underwriters. Some bankers say that lending is just one of the many services they offer companies. At Facebook, the credit line played a role in the batting order for underwriters, said a banker who worked on an underwriting pitch to the company. When I was young and naive and pitching for underwriting business against banks that did lots of lending, I always thought that banks "aren't allowed to make loans on the condition that they receive other business, but borrowers can use the loans as a factor in choosing underwriters" thing was ripe for a scandal. I still sort of think that: I just do not believe that no client coverage banker has ever said "we'll be in your credit facility but only if you promise us underwriting or M&A business." (Some people agree with me!) And, as the Journal notes, that would be a criminal violation of the antitrust laws, which is unspeakably weird but there you go. But if you ask a banker who has been carefully and recently briefed on anti-tying regulations, he will probably tell you something like "we don't demand underwriting business to provide a loan. Companies demand loans to get underwriting business." And, as the Journal says, that's not illegal.