Money Stuff

Activist Fights and College Recruiting

Also: private equity fees, Uber, law firms, Charging Bull and unicorns.


A standard move in the activist investor playbook is to buy stock in a struggling company, suggest changes to the company's management and board of directors, and then call up a friendly journalist to try to get her to write articles about how your ideas are good and the company is resisting them for bad reasons of managerial entrenchment and featherbedding. This can be more or less efficient for the activist, and for the rest of the shareholders, but it is never all that efficient for the journalist. If she succeeds in convincing people that the activist is right, the activist gets rich, and if the activist is right, the other shareholders get rich, but there is no likely scenario in which the journalist gets rich.

So I was pleased to see Frank Partnoy and Steven Davidoff Solomon, two law professors who often write about activism, try to make the process more efficient: They mounted an activist campaign at Tejon Ranch Company, and then just wrote their own article about it in The Atlantic, explaining that their ideas for the company were good and that the company resisted them for bad reasons of managerial entrenchment and featherbedding. Sadly, they waited until after they had given up their campaign and sold their shares to publish the article, which is sensible as a matter of journalistic ethics, but sort of misses the point as a matter of activism. You want to persuade people, then sell.

Anyway the article is great fun and makes me want to be an activist. Also it makes me want to be a public-company director; here's Tejon Ranch's board:

All were men, and their average age was 65. One told us he was serving on the board as a public service. Another said he couldn’t believe Tejon Ranch was still a public company, and should find a buyer. When we asked a third director about the idea of selling the company, he said, “Sure, we’d be open to that, but we haven’t received any offers.” 

My favorite part may be this counterintuitive account of one of their conversations with Gregory Bielli, Tejon Ranch's chief executive officer:

He said that the benefits of being public outweighed the costs. He had been at a private company and had worked under pressure from private-equity investors. Public markets, he said, enabled Tejon Ranch to operate under much less short-term pressure, and to take a longer-term perspective. We were flabbergasted: Many companies go private or stay private to avoid the short-term pressure that public markets can create. But the fact is, for companies the size of Tejon Ranch—and there are thousands of them, filling the portfolios of mutual funds and pension funds, even though most investors have never heard their name—Bielli is probably right. Because so many investors are passive today, most CEOs can relax, even if their performance is mediocre.

Your model could be something like:

  1. Public investors have short time horizons but also short attention spans. If you miss your quarterly earnings expectations, you'll get some irate phone calls, but if you let them go to voicemail there's a good chance, they'll probably forget to call again. If you succeed in distracting from disappointing short-term results by explaining that you have a long-term plan, they'll never remember to hold you to that plan.
  2. Private investors have longer time horizons but also pay attention. They don't necessarily care about quarterly earnings, but if you fail to execute on the long-term plan, they'll eventually fire you.

This suggests that if you actually have a good long-term plan you should probably be private, ceteris paribus, while if your plan is to entrench yourself and hope no one notices, that probably works best in public markets.

Is college recruiting illegal?

If you are a big financial-services firm with a formal program to hire a big class of junior employees every year by doing on-campus recruiting at a group of target colleges, those new junior employees are mostly going to be 22. There is a lot to be said for that -- they will be young, hungry, and probably childless; they will work with each other late into the night because it reminds them of college; they will defer without question to their slightly older and more experienced bosses; and you can bring in consultants to help you understand them as an undifferentiated mass of "millennials" -- but you can't say any of it too loudly, because it might sound like you're endorsing age discrimination. You are not going to find a lot of 50-year-olds at on-campus recruiting! Though that would make a decent Will Ferrell movie?

Anyway here are two guys who are suing PricewaterhouseCoopers for recruiting at colleges:

The named plaintiffs in the PwC case are two men—one 53 years old and the other 47—whose applications for entry-level associate positions at the firm were rejected.

The litigants have years of accounting and bookkeeping experience under their belts, but both failed to make the cut. They allege they were turned down because they lacked the youthful profile possessed by so many PwC recruits.

As someone who has been a junior associate at a law firm, and who has supervised junior analysts at an investment bank, my first reaction was of course: Why would those guys want that job? And my second reaction was: Boy, it would be rough to be the 26-year-old senior associate supervising the 53-year-old associate with "years of accounting and bookkeeping experience" and, you know, a lawsuit under his belt. But perhaps that is just a product of my indoctrination into those cultures. Lots of companies hire people because they will do a good job, let all employees have a decent work/life balance, and promote based on ability and contribution rather than seniority. If that's your plan, you don't have to limit your junior hires to college kids.

Anyway, "the idea that company recruitment efforts aimed at students and recent graduates can be unlawful is a controversial premise that no federal appeals court has ever endorsed," but I do kind of want to see what would happen to the financial industry, and the college industry for that matter, if on-campus recruiting became illegal. I suspect it's about as likely as index funds becoming illegal.

Private equity fees.

I mean:

Even though private equity has outperformed other Calpers assets over a recent two-decade period, no other investment has been so expensive. Private-equity returns were 12.3% in the 20 years ended June 30, 2015, but they would have been 19.3% without fees and costs.

Sure, and my lunch would also be more delicious if it were free. The California Public Employees' Retirement System got a gross annual return of 8.24 percent from its public equity investments over the past 20 years and paid basically zero of it -- 0.04 percentage points -- to the managers in fees. It got a gross annual return of 19.3 percent from its private equity investments and paid 7.0 percentage points to the managers, leaving it a full 4.1 percentage points better off -- that is, with 50 percent higher annual returns -- with the private equity than the public equity. Of course the private equity managers were 175 times better off than the public equity managers, but they earned it! There is a meta-efficient-markets argument that investment managers should charge fees at least equal to the amount of alpha they provide; on that math, Calpers's private equity managers were too generous.

The usual reaction among public pension funds to statistics like this seems to be to get rid of private equity: Better to make less money for retirees, but virtuously, than to make more money for retirees, and also pay higher fees to Wall Street. Calpers isn't going quite that far:

The options under consideration could give the $315 billion retirement system a greater hand in selecting and managing its investments in private companies, according to these people. Calpers hopes a new approach will reduce costs.

Among the options being considered are: buying a private-equity firm or creating a separate company outside Calpers that would make private-equity wagers. Calpers could also choose to act as the sole investor in more customized accounts with outside managers, these people said.

We talk sometimes around here about "the hollowing out of the investing middle class": As money is increasingly concentrated in massive institutions, it can make sense for those institutions to just track indexes, and it can make sense for them to develop in-house specialized expertise to make direct private investments, but it makes less and less sense for those institutions to just give allocations to dozens of outside managers and pay them big fees.

Elsewhere, here is a story about subscription line financing:

The practice isn’t illegal, and is largely cosmetic, but it allows private equity firms to goose what’s known as their internal rate of return, or IRR. That’s the most important annual performance yardstick they trumpet to woo prospective investors. The strategy essentially uses short-term bank loans to shrink the time that investors’ money is deployed, thereby boosting annual results. It can make returns look better by 25 percent or more, a recent study shows.

Private equity firms, generally, make a lot of use of leverage: Instead of using their limited partners' capital to pay for a whole company, they borrow money to increase the return on the equity capital. Subscription line financing is sort of the same thing, but it applies the leverage over time: Instead of using the LP's capital to pay for the whole equity portion of the deal, the firms use a bank loan to pay for it for the first few months (or "as many as two years"), and then call capital, making the annualized return on that capital higher. Should I be bothered by this? Meh. It does not strike me as obviously worse than other forms of leverage. But as I said when we talked about subscription line financing last October:

There is a general lesson here, which is: Be careful how you measure performance, because whatever you measure might be gamed. If you really want to maximize IRR, go ahead and pay your agents for maximizing IRR. If you get annoyed at "tricks" that maximize IRR without increasing absolute economic returns, then maybe you should measure something else.


It feels like only a month ago that Uber Technologies Inc. was in the news for its "culture of sexism and sexual harassment," its chief executive officer's self-confessed need to "fundamentally change as a leader and grow up," its string of executive departures, its alleged theft of self-driving car technology from Alphabet Inc., the program it built to help drivers evade law enforcement, and probably a bunch of other terrible stuff that I'm forgetting. Not a great month for Uber, public-relations-wise. But in modern capitalism, all those sins are forgiven if you are making money. Uber isn't, but it is losing a lot of money, which is basically just as good:

Uber’s business is massive and getting bigger. In the last three months of 2016, gross bookings increased 28 percent from the previous quarter to $6.9 billion. The company generated $2.9 billion in revenue, a 74 percent increase from the third quarter. Losses rose 6.1 percent over the same period to $991 million.

"This is a cash-burning machine," says Aswath Damodaran, the New York University finance professor and valuation expert, and I feel like that's going to be the cover blurb on Uber's initial public offering prospectus.

What do law firms do?

Here is a blog post (and related article) by Elisabeth de Fontenay about what big corporate law firms do, which is basically remember the last deal and recreate it in the next deal. This is a valuable contribution because the last deal was probably fine, and if you just started the next deal over from scratch you'd probably forget something important:

This joint investment in market information ensures that the parties will get the benefit of all value-increasing transaction terms, while avoiding costly signals to an uninformed counterparty.

The implication is that aggregating and selling market information can be important roles for law firms with leading transactional practices, as distinguished from their traditional roles as reputational intermediaries, regulatory experts, and draftsmen. Such law firms should therefore have a self-perpetuating volume advantage for transactions in which a material share of the information about transaction terms is private.

Insider trading. 

You remember the Second Law of Insider Trading, right? The Securities and Exchange Commission sure does:

According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, highly suspicious transactions have been detected surrounding last week’s announcement that Liberty Interactive Corp. had agreed to acquire General Communication Inc. The traders, who are currently unknown, allegedly used foreign brokerage accounts in the United Kingdom and Lebanon to purchase call option contracts through U.S.-based brokerages and on U.S.-based exchanges in the days leading up to the April 4 public announcement of the acquisition. The court’s order freezes the foreign accounts’ assets contained in the U.S. brokerages.

I like to mention cases like that here, because: 

  1. I never tire of reminding you of the Second Law: If you have inside information about an upcoming merger, don't buy short-dated out-of-the-money call options on the target. The SEC knows that trick.
  2. As you read more and more of these cases, the odds increase that one of them has to be innocent. Surely someone in history picked a day to trade options for the first time, went out and bought some short-dated out-of-the-money call options on XYZ Co. because he liked the name, and woke up the following day to find that XYZ Co. had been taken over at a big premium. Sure most of these cases are probably insider trading, but if the SEC is just relying on circumstantial evidence, eventually it is going to freeze the assets of an innocent but extremely lucky trader.

Charging Bull.

Last Thursday I expressed some sympathy for Arturo Di Modica, the sculptor of downtown Manhattan's "Charging Bull" statue, who is going around complaining that State Street Corp.'s "Fearless Girl" statue distorts the message of his art. "The problem," I said, "is not what 'Fearless Girl' means; it's that she has changed what the 'Charging Bull' means." My Bloomberg Gadfly colleague Tara Lachapelle disagreed over email, arguing that "Fearless Girl" didn't change what "Charging Bull" means, "she just made more people think about what the bull means": a representation of a Wall Street "culture that is not welcoming and has an air of superiority and machismo." This is ... not wrong? The main use of the bull these days really may be for people to take pictures of each other giving thumbs up to his testicles. I sympathize with Di Modica's disappointment that "Fearless Girl" interprets his bull differently than he does, but of course his interpretation is not binding: Art means what it means, not what its creator wants it to mean. "The progress of an artist," says Eliot, "is a continual self-sacrifice, a continual extinction of personality."

People are worried about unicorns.

A Willy Staley profile of Mike Judge is doubly self-recommending, but there's also a Silicon Valley/"Silicon Valley" hook, and for that matter a Wall Street one:

Judge entertained me with anecdotes, including one about meeting Andrew Mason, who founded Groupon. Mason had played in punk bands, and the company he started, originally called the Point, was intended to help people organize around social causes. Early on, though, its users realized they could band together to save money, so Mason reoriented the company around that purpose. Eventually he realized he could just go directly to other companies to ask for discount deals, then sell those to groups of users. “Before I knew it,” Judge recalled him saying, “I was selling coupons.” Judge sympathizes with members of the tech world, he explained, because they’re not like Wall Street guys — they actually build things people use. “They don’t seem to get into it for the purpose of pure greed and trying to make money,” he said. “They end up there.”

Elsewhere in tech companies! Here's Tanium Inc.:

One of the most unnerving aspects of life at Tanium is what’s known internally as Orion’s List. The CEO allegedly kept a close eye on which employees would soon be eligible to take sizable chunks of stock. For those he could stand to do without, Hindawi ordered the workers to be fired before they were able to acquire the shares, according to current and former employees. The alleged process, which would help Hindawi defend his ownership by limiting the number of stakeholders, is notorious inside Tanium. Employees refer to it by various names. Some of Hindawi’s deputies tastelessly called it Schindler’s List.

People are worried about bond market liquidity.

Here's a story about how index-tracking exchange-traded funds don't work as well for emerging-market debt as they do for equities, partly because of liquidity:

Because of liquidity constraints, ETF providers tend to own the more liquid bonds as a proxy for the entire market. That has led prices of certain bonds that are ETF constituents to become more costly as flows of cash increase—a circumstance that has emerged with some Russian and Indonesian bonds this year.

Meanwhile: "Exchange traded funds attract record inflows in first quarter."

Work Stuff.

Would you like to read an employment lawyer describing hugs? I think you might:

During training on workplace harassment, Mr. Goldstein takes managers through his taxonomy of hugging. He’s dubbed one the HR hug, “the go-to-hug for HR professionals looking not to offend anyone,” a one-armed sideways embrace; another the FFBB, “full-frontal but brief.” “If it lasts for more than a second it’s weird,” he adds.

Elsewhere: You should work six hours a day.

Things happen.

Wells Fargo Board Faces High-Stakes Vote. Fed Puts Together Plan to Unwind Securities Portfolio. U.S. Treasury Has Switzerland in Its Sights. IMF warnings of US protectionism ‘rubbish’, says Ross. Emmanuel Roman fixes his sights on Pimco’s rivals. Fired KPMG Audit Head: How Did Scott Marcello Fall From Grace? Down-on-Its-Luck Caesars Pays Online Chief Garber $210 Million. Airbus sued by dismissed middlemen following fraud inquiry. WhatsApp’s Jan Koum sold or gifted more than $5 billion worth of Facebook stock last year. A new bargaining perspective on sovereign debt restructuring. The Case for Hedge Fund Marxism. "We haven’t actually seen anybody who’s laying down their glass of wine to pick up a bong." Cumins of New York. Arizona police chief swears-in drug-sniffing bearded dragon. 

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