Friday, May 01, 2009

Short-Termist Managers and Short-Termist Investors

We're all geniuses, after the fact. We now know how badly the slow-motion train wreck of the economy played out over the past two years. But I find it interesting to go back before the conventional wisdom was so conventional and see what people thought before the fact. Hopefully, we learn from that moving forward.

I came across a gem of an interview in the New York Times blog Freakonomics done in August 2007 with hedge fund manger Neil Barsky of Alson Capital Partners in New York.

Neil, it turns out, did warn of the clouds ahead. Here's an excerpt, where Barsky responds to a reader's question about whether hedge fund managers have forced public companies to be too short-term focused:

This is a great question: does the presence of short-term-oriented investors such as hedge funds alter the behavior of the companies they invest in? Let me throw a few more questions out there: To what extent does widespread options issuance create an incentive for a CEO to focus on his or her stock price to the exclusion of building long-term business value? Does the ubiquity of earnings estimates cause companies -- unconsciously or, ahem, intentionally -- to distort their business practices in order to please investors? Does all the money sloshing around hedge fund coffers allow them to throw their weight around and often force managements to make bad business decisions?

My answers would be: Yes. A lot. Yes. Yes. Short-term thinking infected Wall Street some time ago, and I would suggest it was performance-obsessed mutual funds that got the ball rolling back in the 1980s bull market. Not all hedge funds are activist or short-term thinkers, of course, but the rise of "activist" hedge funds and private equity firms certainly have exacerbated the situation.

I believe the chickens are coming home to roost, however. Often, companies go private when activists chase management into the arms of LBO shops willing to put a level of debt on corporate balance sheets that public investors would find imprudent. As the economy slows or credit markets tighten, these companies will have trouble making their debt payments, and -- just as the LBO boom in the 1980s burst -- lenders and possibly private equity investors will be left holding the bag.

Nice job, Neil. Few really saw it as clearly, even in late 2007. There were plenty of "short-termist" activist investors who gave "activism" a bad name.

Position: None.

Originally published in on 4/28/2009 7:10 AM EDT

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