Monday, 26 May 2014

Intermediation, diversification, transparency and takeovers

The Pfizer bid for Astrazeneca now looks dead. But it's worth picking over some of the details. In particular, I'm fascinated by the behaviour of some asset managers after the Astrazeneca board rejected the bid. Unusually, some managers backed the board, but it is also clear that others - AXA, BlackRock, Jupiter, L&G and Schroders for instance - did not.

Let's be clear what happened here. The board considered the Pfizer bid, assessed what it thought were the prospects for the business continuing on its own, and rejected it. In doing so, the board could have drawn on the tweaked guidance in the Takeover Code, which says:

In particular, when giving its opinion, the board of the offeree company is not required by the Code to consider the offer price as the determining factor and is not precluded by the Code from taking into account any other factors which it considers relevant. 

So the board is able to take a slightly broader view than simply "is this a good price?"

Now a quick diversion, into diversification. The asset management lobby has often argued in the past that it shouldn't be expected to second guess company decision making. Which is why we shouldn't blame asset managers for failing to spot the risks the banks were running pre-crisis. And this is why they diversify, because they can't really know what is going on inside companies. Here, for example, is what the IMA told the Treasury select committee in 2009.
Although shareholder approval is required for major corporate actions they do not set strategy nor are they insiders, in that they only have access to information that is available to the market as a whole. Managers compensate for such information asymmetries by diversifying portfolio construction.
For what it's worth, I think this is pretty accurate. The whole point if diversification is to reduce risk. But I also think the inevitable result is that it reduces focus on individual companies. And of course one group of asset managers - the big passive houses - are massively diversified. For the bulk of their assets they don't make active investment decisions. They hold a large position in company X because company X is a constituent of index Y, not because of an assessment of its future prospects.

We now know that both BlackRock and Legal & General have been urging Astrazeneca to talk to Pfizer (though, to be clear, in the former case they apparently back the board's rejection of £55 a share). Given their greatly diversified holdings, and the fact that their large positions in Astrazeneca are not an active investment decision, I personally don't think we can ascribe any great insight into the prospects of the company if taken over or not. So I think we can probably conclude that they are simply focusing on the immediate gain.

So, in practical terms, whatever the Takeover Code says major asset managers will encourage boards facing a bid to focus on short-term price, rather than long-term prospects. This is not very surprising, but it is important. And it should also put some of the recent blah about short-termism into context.

Another aspect of asset manager pressure on Astrazeneca that seems to have gone without comment is the fact they are intermediaries. There will be pension funds whose capital is being used to try and push Astrazeneca back to the negotiating table. But I would put money on it that those clients are completely unaware that this is occurring. It just struck me, too, that the Stewardship Code is silent on the issue of takeovers, despite this surely being a pretty fundamental aspect of shareholders' interaction with companies.

In this particular case, I think the Astrazeneca board should publish all the correspondence it has received from shareholders. But perhaps in future asset managers should be required to disclose to their clients if they are lobbying a board - either way - on the outcome of a bid. We don't see that many cases like Astrazeneca to make this an onerous requirement. And it would encourage accountability within the investment chain.

Finally, some of the commentary around the bid is noteworthy, Martin Wolf's piece in the FT was particularly interesting. There is a loss of faith in the idea that markets alone should determine the ownership of major businesses. When you think about it, this is pretty significant. Whatever you might think about the rights of "owners", their ability to decide on a transfer in ownership ought to be considered pretty fundamental. But the implication in much commentary around this bid is that they may not be best placed to makes that decision. This is surely rather a big deal. On the one hand this looks like a further shift away from shareholder primacy. But on the other it also underlines that share ownership does matter (and therefore so does the behaviour of shareholders). If shareholders only own shares, not companies, why does it matter who they sell them too?

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