Yahoo, Verizon, and the promise and perils of shareholder activism

The Verizon-Yahoo marriage might be over before it begins.

This summer, telecom giant Verizon inked a $4.8 billion agreement to buy struggling internet pioneer Yahoo. But then, last month, news broke that hackers had stolen data from 500 million Yahoo accounts back in 2014. That revelation could give Verizon the legal leverage to demand a lower buying price, or back out entirely. "We have a reasonable basis to believe right now that the impact is material, and we're looking to Yahoo to demonstrate to us the full impact," Verizon's general counsel Craig Silliman said. "If they believe that it's not, then they'll need to show us that."

The hacking revelation is a big deal, of course, and could legitimately effect Yahoo's value. Still, Verizon's sudden skittishness raises the question of just how valuable this deal was to Verizon to begin with. And answering that question requires that we shine a light on a curious creature of the financial world: the activist shareholder.

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Activist shareholders (or activist investors) buy enough stock in a company to gain serious leverage in the corporate decision-making process, and then try to force a course correction — maybe by replacing the CEO, replacing corporate board members, or at least altering compensation structures.

Occasionally, they get even more ambitious. In this instance, an activist shareholder firm called Starboard Value acquired a stake in Yahoo in 2014, by which point the internet company had slid into mediocre performance. Starboard used its leverage to force a full overhaul of Yahoo's corporate board, looking to reinvigorate Yahoo's returns to shareholders. That effort didn't work, but eventually Starboard got its people into the right positions to force Yahoo to start looking for a buyer. Starboard Value has forced a number of other companies — AOL, Macy's, Office Max — to sell off or retool, as deals like this are certainly one way for companies to inflate their finances, potentially (though certainly not always) scoring big paydays for investors.

Critics say activist shareholders are essentially raiding parties, plundering companies for big immediate payouts. Hillary Clinton has criticized this sort of thing as the work of "hit-and-run activists," and she's proposed changes to capital gains taxes to force shareholders to take the long view.

But others argue that activist shareholders provide a necessary pushback against sclerotic corporate boards and CEOs, who are themselves parasites on the companies they're supposed to be shepherding. In this view, Starboard is forcing an ailing company to cut its losses, slim down, and sell off its spare parts to people who can use them more productively.

In some sense, both views are correct. That is, activist shareholders tend to switch back and forth between these two roles on a case-by-case basis.

Remember, CEOs and members of corporate boards tend to be shareholders themselves, and CEOs in particular get much of their compensation through stock ownership. Activist shareholders and these more traditional corporate managers often have different agendas, values, and visions for their companies. Or they just have different timelines for when they want to get their payday. At the same time, they all share certain overarching interests as members of the shareholder class: They benefit when companies pay them bigger dividends, or funnel them money in other ways like stock buybacks.

Now, any shareholder payouts have to come out of profits. So any company that's increasing its profits is clearly doing something right, right? And by pursuing their self-interest, shareholders can't help but promote the company's interests as well.

The problem, though, is the many ways shareholders can game the system. These shareholders can still make out like bandits, but at the expense of undermining or dissolving an otherwise perfectly worthwhile company.

The dueling views of activist shareholders as white hats or black hats demonstrates the limits of Clinton's critique of "short-termism." The problem is probably less that shareholders have bad tax incentives, or that certain tribes of shareholders are irresponsible, as it is that shareholders as a group have too much say in the corporate decision-making process. A better solution? Scale back their power, and elevate workers as a countervailing group of stakeholders with their own leverage.

To Clinton's credit, she has proposals to do that too, such as profit sharing, rebuilding unions, and raising the minimum wage. Though she could afford to get a lot more ambitious: Use taxes to clamp down on all capital gains, not just short-term ones, for example. Or rewrite corporate governance law to require worker representatives on company boards.

It would interesting to hear what the average activist shareholder makes of those ideas.