Futarchy For Fundraising
The Making of Modern Corporate Finance: A History of the Ideas and How They Help Build the Wealth of Nations (quotes below), by Donald Chew, persuaded me that for-profit-firm capitalism has varied quite a lot over space and time, and that the U.S. still has a big lead. Private equity works best, though it still only controls ~10% as much capital as public firms in the US, and even less elsewhere. Academics and other elites don’t report much on this story, as improvements usually defied their advice and pressures.
The fact that hostile takeovers are widely hindered also tells me that we still have lots of room for improvement. Which raises my hopes that futarchy might also be allowed to help. Most CEOs are not at all eager for futarchy to advise on the decisions they feel they “own”. But it should be easier to get CEO support for futarchy advising decisions that they often cannot make on their own, but must instead make together with boards and investors. For example, futarchy could advise whether to keep or dump the CEO.
Another promising application is decisions on when and how to raise more capital. The book says that when CEOs initiate a sale of more stock, stock prices fall by 2-3%, as investors fear secret CEO info on firm money problems, or that the stock price is currently too high. While board approval is usually required for such sales, that doesn’t prevent this problem. However when shareholder votes must also approve such stock sales, prices instead rise. The same pattern holds for mergers and acquisitions done with or without shareholder approval. Similarly, stocks rise 6-7% when activist investors buy blocks of stocks, intending to make governance proposals to be approved by shareholder votes.
Thus there are many identifiable types of firm governance decisions where investors are right to be skeptical about CEO proposals, even when they are supported by boards. Requiring shareholder votes to approve those proposals is one kind of check, but instead requiring futarchy approval, or at least the lack of a futarchy veto, seems to me a faster cheaper better-informed alternative process. Great firm value may be unleashed via creating futarchy systems for such decisions.
Those book quotes:
Corporate conglomerates had been “allowed to destroy 50% for more of the operating value of their franchises” before outside investors became willing and able to raise the funding to intervene.(p.xiv)
Stock prices do indeed fall - by 2-3% on average - upon seasoned equity offering announcements. … But why do they fall? Stew’s explanation … focuses on the infraction disadvantage of outside investors vis-a-vis managers or other insiders about matters like to affect the value of the firm. …
* The plan to raise any capital - debt or equity - increases the possibility, and investors’ suspicions, that the company is seeking new capital mainly just to make up for an unexpected shortfall in earnings for cash flows, and not to fund necessary or promising investment.
* Investors view managements and seeking to raise equality opportunistically - that is, when they think the company’s shares are overvalued - and to avoid issuing new shares when the company is undervalued, since this would effectively transfer value from the old shareholders to any new shareholders who take up the offering. (p.95)
Data … about the operating performance of U.S. companies with at least $50 million in sales that were bought by US. buyout firms during the period 1981-1986 … For the 76 “round trip” deals (management buyouts of public companies that went public again through IPOs) in his sample, the operating gains resulted init increases enterprise value (debt plus equity) of roughly 100%. … Little evidence of a decline in employment levels or averse wage rates of blue collar workers after LBOs. (p.129)
For the 29 public equity (PE) vintage years from 1986 through 2014, PE firms produced for their LPs an impressive average “direct alpha” or above market return of almost 500 basis points … reported an annual average value-weighted excess return of 3.5%. (p.134)
Recent estimates … private equity owned U.S. companies … have attained a total market cap roughly equivalent to 10% of the total market cap of U.S. public companies. (p.143)
Remarkable “meta study” of over 100 studies of the market reactions to announcements of the three main kinds of seasoned stock offerings - public offers, rights offers and private placements - by public companies in 23 different countries. What Holderness finds is an astonishingly simple, and consistent, empirical regularity. When shareholders are required to approve new stock issues, the average stock returns to announcements of seasoned stock offerings by public companies are positive - on the order of 2% (and highly statistically significant). But when managers issue stock without shareholder approvals, as we have already seen in the case of U.S. public offerings, the returns are significant negative - a percent to -3%, on average. …
Strikingly consistent positive market responses to announcements of large acquisitions by UK companies that require shareholder approval … in sharp contrast to the zero or negative average announcement returns for the transactions not subject to a shareholder vote. … U.S. M&A markets - where even the largest deals can easily be (and typically are) structured to avoid shareholder votes … the larger U.S. deals provide returns to shareholders that were significantly negative, on average. (p.148)
Longer-run effects of some 1,740 separate “engagements” of public companies by 330 different hedge funds operating in 23 countries during the period 2000-2010. Like many other studies of activists this one starts by confirming the market’s initial enthusiasm about activists block purchases and proposals. But the initial positive returns (of round 6-7% on almost all countries) are maintained only when the engagements lead to “events” with consequences - outcomes like increases in payouts, board replacements, or restructurings. In such cases the initial returns end up significantly higher than 6%. … the incidence and probability of activist engagements are greatest in in companies and countries with large proportions of institutional investors, particular when the investors happen to be based in the U.S. (p.149)
To me, private equity seems like the opposite direction as futarchy. The point of private equity is that all the transparency, crowd input, and rules around being a publicly listed company can be detrimental, and you can do better if you just take the whole thing private for a while. Whereas futarchy is this idea of applying even more transparency and rules for crowd input to the operation of a company.
Again you're conflating CEO ownership (where the CEO might be expected to have insider information about the company) with ownership by a separate private equity firm, which would be expected to have no more information about the company than any other activist investor.
I'm skeptical about some of these figures. What's actually being measured for the "excess return"? Most private equity firms are not buying out publicly traded companies, so you can't compare stock prices before and after. They're buying out small privately owned companies - probably taking advantage of the owners' ignorant undervaluation of their own company. They're competing with the prior owners, not the market at large.
If, when a private equity firm buys out a public company, it achieves a value-weighted annual excess return of 3.5%, why don't they already control most of the capital in the nation, instead of just 10%?
> But the initial positive returns (of round 6-7% on almost all countries) are maintained only when the engagements lead to “events” with consequences - outcomes like increases in payouts, board replacements, or restructurings.
To me this smells like subgroup analysis. There are positive returns... but only when we restrict the sample by some ill-defined post-hoc criteria.