Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Pay out cash to shareholders and that will stop bosses wasting it on empire-building deals. This is activism-101 and it's a big component in the dual-fronted assault on Anglo-Australian miner BHP Billiton Ltd. The snag is that, in this industry at least, siphoning out cash to the max is a counterproductive way of keeping managers in check.

Hedge fund Elliott Advisors thinks BHP will generate $31 billion of excess cash flow in the next five years. It wants $33 billion returned to shareholders in a five-year buyback program to thwart management doing bad M&A.

Sydney-based Tribeca Investment Partners is just as concerned about misguided capital spending coming after bad M&A -- throwing good money after bad. It cites BHP's foray into the U.S. onshore energy business, calculating that this has delivered a cumulative cash outflow of $26 billion and substantial impairment charges, which may not be over. It wants the operation sold and part of the proceeds returned to investors.

At least BHP was saved by politicians and regulators from two deals that would have torched billions of shareholders' funds. Potash Corporation and Rio Tinto Plc are worth less today than BHP was willing to pay for them in 2010 and 2007.

Going Underground
Potash Corp shares have fallen since BHP was interested.
Source: Bloomberg

Mining bosses need to learn restraint in both M&A and capital expenditure. When the cycle is on the up, they splash out on new projects with abandon, creating a capacity glut that makes the next downturn worse.

But taking on debt to fund investor buyouts -- the approach favored by Elliott -- would cause bigger problems than it solves, even if it ties the hands of deal-hungry CEOs. If a miner ends up too highly indebted, it risks a near-death experience if there's an external shock. Just look at Glencore Plc and Anglo American Plc in 2015.

Moreover, the oil and mining industries are capital intensive and need to keep investing. That should take priority over shareholder payouts.

All this means investors have to tolerate miners having strong balance sheets. The onus has to be on governance to keep executives from misspending. One mechanism is tying CEO pay much more explicitly to ensuring capital investment delivers returns in a reasonable time frame, project by project. In M&A, shareholders would ideally always have a vote on big transactions, as the U.K. demands. Finally, shareholders can and should make their voice heard when companies are squandering capital. They have let management get away with a lot.

This is more in the style of Tribeca than Elliott. The Australian fund wants BHP's new chair to lead a cultural revolution around capital efficiency, starting with an overhaul of the board. The conclusion for managers is clear: earn the confidence of shareholders and you will escape the financial straightjacket.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Hughes in London at chughes89@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net