Who Knows Best When It Comes to Protecting Shareholders?

Wharton’s Andrew Metrick has some surprising answers.

By Nancy Moffitt

It was a time of near-constant proxy fights, leveraged buyouts, and corporate raiders, of once indomitable firms like Texaco, TWA, and Revlon, mired in costly, historic battles with men like T. Boone Pickens and Ivan Boesky, men who told business students that greed was a good and healthy thing.

The 1980s forever changed corporate America. Mergers, historically a gentlemanly process, become a battlefield that ultimately affected every industry: by 1985, 3,000 transactions took place, worth a record-breaking $200 billion. Firms were broken into pieces that were spun off, layoffs were rampant. “The 1980s looked like a game of Monopoly come to life,” wrote one business writer. A lot has changed since those Wild West days. Throughout the 1990s, the takeover frenzy receded. And today’s takeover attempts are typically more strategically motivated, often involving an interloper hoping to dash a proposed takeover, or simply trying to acquire a competitor. Nonetheless, a key remnant of the 1980s remains: the arsenals of anti-takeover tools, from poison pills and golden parachutes to staggered boards that many companies put into place during the late 1980s, are quietly intact – and often given nary a strategic thought.

But a study co-authored by Wharton finance professor Andrew Metrick could change that. Metrick’s study of 1,500 companies and their performance throughout the 1990s, published this February in The Quarterly Journal of Economics, found that firms that protected management rights with anti-takeover provisions significantly under-performed those that gave more power to shareholders. Shareholders, not management, Metrick’s study finds, best protect shareholders. “If I were a large institutional shareholder of a company, I would insist they dismantle their takeover defenses,” says Metrick, an associate professor of finance. “They don’t seem to be doing much good, and they might be doing a lot of harm. Our research suggests that there’s some chance that this would unlock a tremendous amount of value in an organization.”

The study found a striking relationship between corporate governance and equity prices but also found that firms with weaker shareholder rights were less profitable, had lower sales growth, and higher capital expenditures and made more acquisitions than other firms in their industry. Co-authored with Harvard Professor Paul Gompers and Harvard graduate student Joy L. Ishii, the study garnered international media attention, including writeups in The New York Times, Financial Times and The Economist.

“When venture capitalists are forming young companies, they work very hard to write contracts with entrepreneurs that make the entrepreneurs really beholden to the shareholders and make them have to listen to the shareholders,” Metrick says. “There’s a reason for this – they want effective governance. I think that in public companies we’ve gotten a little away from that – from management and directors being beholden to shareholders, having to report back to them; and if they don’t do a good job, the company will get taken over, and they will get fired. It’s not that we want people walking around every day worrying about their jobs, but I think the pendulum has swung too far toward entrenching them.”

Working with a massive database of companies, Metrick used 24 different provisions, including takeover defenses such as poison pills, golden parachutes, and staggered boards, to build a “governance index” for about 1,500 firms per year. He then studied the relationship between the index and several performance measures during the decade of the 1990s. Each year from 1990 to 1999, the shareholder-friendly or “democratic” firms outperformed the S&P’s 500 by 3.5 percentage points, while the pro-management or “dictatorship” group lagged by about 5 points. Hewlett-Packard, IBM, Wal-Mart, and DuPont were among the most shareholder-friendly firms found, while pro-management firms included Kmart, GTE, Waste Management, Woolworth, and Time Warner.

Given such striking differences, should investors seek out these “democratic” firms? Metrick says no. “When people ask me, ‘When should we start the mutual fund,’ I tell them, ‘1990,’” he says. “If you had started in 1990, you’d have done really well. But today, people pay a lot more attention to corporate governance, and the things that we look at are most likely priced in the market.”

Instead, the study’s long-term value, Metrick argues, is in helping firms organize to increase value, profits, and sales. “Nothing is supposed to predict the stock market, but we find that these things did predict the stock market, suggesting that the market underestimated or underappreciated the importance of these organizational differences,” Metrick says. “This is where the work has to be going forward – to understand better what the things are that companies can do – how can they change the way they organize themselves to lead to better performance. We think that there are a lot of things that go into creating a pervasive corporate culture. Corporate culture matters,” Metrick says.

He points to Enron and Tyco as recent examples of what happens when corporate culture collapses. “You can’t have this going on if people are all on the same page and thinking they need to serve shareholders,” he says. Going forward, Metrick applied for and received a grant from the National Science Foundation to expand his corporate governance research and answer the many questions the study’s conclusions raise.

Interestingly, Metrick and his co-authors happened across their findings somewhat by accident. After completing a separate study on institutional investors, Metrick and Gompers became interested in the growing impact of institutional shareholder activism on corporate governance. In searching for data to investigate this relationship, they discovered a rich and untapped source – The Investor Responsibility Research Center – with detailed information on shareholder rights. They saw that most variation in shareholder rights came about in the 1980s, thanks to the anti-takeover strategies many firms adopted and the laws passed by many states giving firms further takeover protection.

The end result was a wide range of governance structures among U.S. firms, making it possible to study the differences between firms that operated as democracies and those that operated as dictatorships. The team ran a long-term experiment similar to a medical experiment, “just to see what happened,” says Metrick. “Now you can say, ‘OK, what happened in the 1990s?’ It’s very similar to saying ‘OK, some people started eating a lot of vegetables, and some didn’t. Was there any difference in their life expectancy?’ There was no reason to know at the beginning which one of these strategies was going to be right.”

“But we found this monstrous relationship. And nothing we could do would make it go away,” he says. “We didn’t really think it was real when we first saw it. But no matter what we did, it was there, and then it was there in a lot of other contexts like stock performance and stock valuation, and capital expenditures. It was pretty exciting.” But just like most long-run medical studies, Metrick says, “It is difficult to prove causality. What we have instead is a very strong and economically important correlation. If this were the medical study, the results would still be enough to get me to eat my vegetables.”

Metrick’s other research has examined a broad range of issues, from a study on the Internet’s effect on stock trading to another that used the television game show “Jeopardy!” to investigate the choices people make during times of uncertainty. He’s most excited, though, about a book he’s begun on venture capital valuations – work that came about during classroom discussions with Wharton students. In trying to teach corporate finance, he learned that standard valuation tools are often lacking, designed largely for manufacturing companies trying to decide, for instance, when to build a factory or replace a large piece of equipment. “There are some big differences between corporate finance for manufacturing companies and corporate finance for innovative technological companies,” Metrick says. “And when you are considering making a venture capital investment, standard valuation tools that have been developed for traditional industries are only marginally useful.” Metrick hopes his book, based almost entirely on his lecture notes, will fill some of these gaps.

Obsessed with Numbers

Andrew Metrick’s fantasy vacation has nothing to do with beaches, mountains, or French food. The self-described “data nut” finds Nirvana in thick books of statistics – on any subject. “When I was a kid, my favorite books were the baseball encyclopedia and the World Almanac,” says Metrick, 36. “I would open up the almanac and begin to organize the numbers by category – I’d look at the biggest buildings in the world, for example, then categorize them based on the year they were built, what city they were in – things like that.” “I was not a great mathematician; it’s not that kind of thing,” he says, commenting on his life-long love for numbers. “They are deeply logical, analytical people. I just liked rows and rows of numbers. I liked to look at them, I liked to hold them, and I liked to know things about them.”

As a teen, Metrick spent an entire summer building models to predict how well baseball players would perform, typing most of the baseball encyclopedia into the family computer. In graduate school, instead of writing his dissertation, he worked thousands of hours categorizing and scrutinizing basketball statistics – and graduated a year later as a result. “Yeah, I’m a little bit of a crazy person, “ he says, laughing. “I wanted to work with big data sets and try to make sense of them.”

His work has bounced to and from a variety of disciplines, from economics to a range of finance issues, but it is all linked by interesting, unexamined sets of data. “That’s where the passion for research is for me. A lot of my work has been driven by the fact that suddenly I’ll become obsessed with a certain kind of data.” In recent years, Metrick has learned to channel this tendency, focusing his energies on projects that will lead to useful conclusions “instead of typing baseball statistics. It’s only as I’ve gotten older that I’ve realized that this is what I need to do,” he says.

Metrick grew up in a community on Long Island, a land of doctors, lawyers, and executives, with only a vague sense of what a professor was. It wasn’t until he went to college that he found himself drawn to academia. As an undergraduate at Yale, he worked as a research assistant for James Tobin, a Nobel Prize-winning economist who died in 2002. “He was an extraordinary man. You see someone like that, and you say ‘I want to be like that.’ It’s kind of an impossible standard, but you’re always striving,” Metrick says. His summers on Wall Street reinforced his academic leanings. “It seemed like hard work,” he says, laughing. “I thought, ‘Gee, being a professor seems like a lot of fun. You don’t have to work all night, and you don’t have to wear a suit.”

He was inspired, he says, by different elements of his parents. His father, who recently retired as an investment banker at Bear Stearns, also worked as a CFO for a Fortune 500 company. “He’s a great, natural economist, largely self-taught,” says Metrick. “His background was in engineering and law, and he kind of taught himself economics and finance and has fantastic intuition. Growing up talking to him was a great way to learn.” His mother, meanwhile, had “an amazing capacity for work and self-sacrifice for her family.” His parents divorced when he was young, and while his father lived nearby, Metrick’s mother “took care of three kids, then earned a degree, then took care of three kids and worked” – a fact he finds all the more astonishing today as he and wife Susie struggle to juggle day-to-day life, work, and 18-month-old David. “My parents were both late bloomers in a way,” Metrick says. “In my family, we seem to be that way. So I’m looking forward to finally getting my act together.”

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