The DuPont Proxy Contest Is a Battle for the Soul of American Capitalism

The sub-title in Saturday’s New York Times op-ed by Joe Nocera jumped off the page, “Why shareholder value has become a disaster for the country.” Nocera was writing about the seminal proxy fight that will be settled on Wednesday, May 13, at DuPont’s annual meeting.

On one side is the DuPont board of directors, one of the most distinguished of any U.S. corporation, which recommends the re-election of its 12 members. On the other is the activist investor Trian Fund that proposes a new slate of directors, led by Trian CEO Nelson Peltz, to replace four current DuPont directors.

The two strategies for the company could not be more different. The DuPont board proposes to complete the divestiture of its performance chemicals business into a new company, Chemours, and concentrate on its three high growth, high margin businesses: agriculture & nutrition, advanced materials and bio-based industrials, all anchored by DuPont’s famed central research laboratories. Trian and Peltz, on the other hand, have contemplated separating DuPont into three companies and eliminating central research, which spends just $220 million per year (0.7% of sales).

Outside activists play a useful role when they recommend transformation to poor management teams at under-performing companies. At DuPont, CEO Ellen Kullman is an outstanding executive running a high-performing company. Upon her election to CEO in 2009, she immediately began to streamline DuPont and transform it into a competitive chemicals company focusing on its high margin businesses. During her first six years, DuPont’s stock rose 266% compared with 165% for the S&P 500. Kullman has positioned the company for sustainable growth and profitability while the market has recognized the progress. Where is the need for an activist in this equation?

Trian’s proxy attack is perplexing, yet is one of a number that activist investors have launched targeting healthy companies. In his recent forays, Peltz has been successful in taking over H.J. Heinz and splitting apart Kraft. Both efforts led to mediocre results and wound up with both companies being sold to Brazilian private equity fund 3G. Meanwhile activists have also attacked many of America’s greatest companies, including Apple, Amgen, PepsiCo, Dow, Allergan, and Target. This can only make America’s business focus even more short-term – damaging the country’s long-term competitiveness.

Of great concern to me is that these activist pressures will result in significant reductions in long-term corporate performance. The playbook for many of these activists is to cut research, throttle back on new businesses, eliminate thousands of jobs, and leverage the balance sheet. These actions almost always improve the financial numbers in the next reporting period, but they weaken the long-term earning power of the company. Worse, they put the entire enterprise at risk when unpredicted events occur, such as the next economic downturn.

As a professor at Harvard, I have been an outspoken advocate of creating sustainable shareholder value by balancing near-term performance with long-term investments. The right long-term investments drive future growth and profitability. While leading Medtronic, we transformed the company into the leading medical device company and grew the company’s market capitalization from $1.1 billion to $110 billion today.

I have no problem with activist investors that challenge poorly managed companies without viable long-term strategies. Rather, I am a critic of corporate boards and executives and activists who only focus on the short-term stock price. Recently, Larry Fink, CEO of Blackrock (the world’s largest fund manager), wrote all 500 of the S&P 500 CEOs and urged them not to respond to these pressures for financial engineering and to continue to invest for their long-term futures.

Wednesday’s vote will be seminal in determining how aggressive activists will be in taking on major global corporations. Peltz and Trian have run a very effective proxy campaign for their nominees, using the media and working closely with many investors to persuade them to vote for their slate. This effort convinced both proxy advisory services, ISS and Glass-Lewis, to back all or part of its slate. DuPont, led by Kullman, has also worked extremely hard to tell its very positive story. CalPERS and the Canadian Proxy Fund recently endorsed management’s efforts. The vote appears to be extremely close, with half of the shareholder votes still not in.

Peltz has some investors asking, “What’s the harm in electing Peltz to the DuPont board?” A great deal. Peltz’s presence will not only disrupt DuPont’s long-term strategy for sustainable success, it will signal “open season” to activists launching proxy fights. If DuPont gets broken up and its central research labs shut down, it will mark the loss of a national treasure, just as it did the demise of the famed Bell Labs. Beyond that, it will give momentum to the short-term shareholder activists.

The DuPont proxy vote is a part of a battle for the soul of corporate America. The venerable Martin Lipton, quoted in Nocera’s column, has it right: this form of shareholder value is “a disaster for the country.”