Yahoo chairman Roy Bostock and billionaire activist investor Carl Icahn were proxy war pen pals, but not in the traditional sense. Instead of friendly notes, they were exchanging jabs in letters to shareholders before ultimately reaching a truce earlier this week. Other companies — including CXS, Motorola, Time Warner, H.J. Heinz and The New York Times — have also waged proxy battles with activist shareholders in recent years.

While such spats make for good headlines, it’s unclear whether these public battles are productive, say experts at Wharton. A proxy war occurs when shareholders join forces to get enough votes to oust a company’s board of directors — ultimately changing management or corporate behavior. Proxy battles can go on for months leading up to a shareholder meeting.

In Yahoo’s case, Icahn blasted management for not selling the company to Microsoft when the software giant offered $31 a share in January 2008. Yahoo’s response was that the offer was too low and therefore not in shareholders’ best interest.

Icahn, who owns about 70 million shares of Yahoo, had made it clear in various statements and letters to shareholders that he wanted to take over the board, find a more experienced executive to replace CEO Jerry Yang, and do a deal with Microsoft. Yahoo, arguing that Microsoft had flip-flopped on its offers for the company, provided its own side of the story on its highly-trafficked home page. With its August 1 shareholder meeting looming, Yahoo announced July 21 that it had cut a deal with Icahn to give him a total of three seats on an expanded board of 11 members — one for him and two chosen from a list he provides. In return, Icahn will vote for Yahoo’s board nominees. In a statement, he said he still advocates the sale of Yahoo.

Lawrence Hrebriniak, a management professor at Wharton, says that the Icahn-Yahoo settlement removes a distraction, but it’s unclear whether shareholders will see any benefit. “This proxy fight was disruptive to Yahoo management,” he says. “Part of [it] was game playing between billionaires.”

One thing is certain: Proxy wars and other forms of shareholder activism are becoming more prevalent. According to FactSet Sharkwatch, a Stamford, Conn., research firm, shareholder activist campaigns rose to 501 in 2007, up from 429 in 2006. These activist campaigns can turn into full blown proxy wars, which are “the most powerful tool an investor [has] and are typically used as a weapon of last resort,” says Wharton finance professor Pavel Savor. “In general, activist investors really view proxy wars as something to avoid. It’s not something you just do. The costs are high — tens of millions of dollars.”

According to Wharton finance professor Franklin Allen, proxy wars generally aren’t very successful, in part because shareholders tend to side with current management. Why? If a shareholder doesn’t send in a proxy card, his or her vote automatically counts as a vote for the board’s recommendations. “Typically, proxy wars don’t have much effect. Sometimes they do, but it’s difficult with shareholder inertia. Most shareholders vote with management,” notes Allen, adding that many academic studies show proxy battles have minimal impact, although that could change in the future.

In many respects, proxy wars really represent management failure, argues Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. While proxy wars are a useful tool to initiate corporate change, the board of directors and shareholders “shouldn’t get to the point of proxy war. Frankly, no one wins in a proxy fight. A proxy fight represents the failure of management to respond to shareholder concerns. Boards should have been responsive to shareholders earlier,” says Elson.

Hrebiniak agrees and adds that proxy wars are just one item in a series of measures shareholders can take to force a change in direction at a company. “If there’s any benefit to the Icahn-Yahoo proxy fight, it’s that Yahoo management was put on notice that it can’t slide by,” he says. “Proxy fights are disruptive, but they do signal that things can’t go on as before.”

Proxy Campaigns and Politics

When shareholders and a company can’t resolve their differences, a proxy war can ensue. Once engaged, proxy wars resemble political campaigns, complete with advertising, media coverage and various parties spinning their side of the story. “Everything is fair in a proxy fight,” says Elson. “It’s really like a political campaign.”

A prime example of the communications tug of war is the Icahn-Yahoo battle. Both Icahn and Yahoo made their communications public either through Securities and Exchange Commission filings or press releases.

On July 12, Bostock issued a statement indicating that Yahoo had turned down an offer from Microsoft to buy the company’s search business. Microsoft’s offer, negotiated with Icahn, represents an “odd opportunistic alliance” that “has anything but the interests of Yahoo stockholders in mind,” the statement said. Yahoo argued that its search partnership with Google offers more value to shareholders. “Clearly, Microsoft, having failed to advance in search, is aligning with the short-term objectives of Mr. Icahn to coerce Yahoo into selling its core strategic search assets on terms that are highly advantageous to Microsoft, but disadvantageous to Yahoo stockholders.”

On July 14, Icahn fired back in a letter to Yahoo shareholders: “Over the years, I have attempted to make changes at many companies but I have yet to see a company distort, omit and twist events and facts in the manner that Yahoo has done in their press release issued Saturday night, July 12th.”

Yahoo’s Bostock sent out another shareholder letter on July 17 — just a few days before the July 21 compromise was reached — arguing that Icahn’s “short-term approach” gave him “a strong incentive to strike any deal with Microsoft that enables him to recover his investment and get back his money quickly.” On its home page and proxy statements, Yahoo also questioned Icahn’s shareholder reform record at companies like Motorola and Time Warner.

In January 2007, Icahn had bought a stake in Motorola, criticizing the performance of then CEO Ed Zander and arguing that the company needed to be broken up. Icahn later followed up with a proxy war designed to get a board seat, but lost that fight in May 2007. In 2008, Icahn again nominated new board members. This time, Motorola cut a deal with him, agreeing in April to expand its board of directors to include two Icahn picks — William R. Hambrecht and Keith A Meister. Motorola also has a new CEO, Gregory Brown, and plans to spin off its mobile handset division — moves that Icahn had advocated. As of May 7, 2008, Icahn owned 1.5% of Motorola, or more than 34 million shares. However, his investment hasn’t paid off. Back in January 2007, when Icahn acquired a 1.39% take in the company, Motorola’s shares traded between $17 and $20. The company’s shares closed July 18, 2008, at $7.46.

As for Time Warner, Icahn announced a proxy war against the company in September 2005. Icahn — along with a group of hedge funds — proposed a slate of directors and argued that the company needed to launch a $20 billion stock repurchase program. In February 2006, Time Warner agreed to the repurchase program and added two independent directors to its board, thereby averting a protracted proxy war with Icahn.

Icahn also bought a 8.53% stake in software company BEA Systems in September 2007 to become its largest shareholder. One month later, Oracle offered $17 a share for BEA, which rejected the offer as too low. Icahn agreed with BEA that Oracle’s offer undervalued the company, but continued to push for a sale. In January, BEA agreed to be bought by Oracle for $19.375 a share, or $8.5 billion.

Yesterday, a front-page story in the Wall Street Journal outlined Icahn’s proxy battle with Blockbuster three years ago. Icahn gained control of three board seats and has played a significant role in the company’s management since then, the article notes, adding that Blockbuster’s stock has dropped sharply since Icahn’s involvement. 

What’s notable about these proxy fights as opposed to earlier ones is that “it’s easier to communicate today. The technology and the ability [to start a proxy war] have become easier,” says Allen, adding that like any campaign, the outcome depends on proper messaging, hitting the right audiences — such as big institutional shareholders — and making a case for a position. Savor agrees. The big change with proxy wars, he notes, is that the communication is much more public. Before the Internet, activists would send letters to shareholders and take out ads in The Wall Street Journal to make their points. Today, messages are widely disseminated on the web and spread to multiple parties.

According to Indiana University’s Utpal Bhattacharya, a visiting finance professor at MIT, the current techniques used in proxy wars represent a sea change from previous practices. It’s less expensive to disseminate information, more shareholders are involved and there’s more communication overall about investor rights. Bhattacharya, who has researched the communications costs of proxy wars, says that the barriers to launching a proxy war were lowered in the early 1990s. Previously, companies could keep their lists of shareholders secret and had the option of holding shareholder meetings on weekends (a time when no one would come). Disgruntled investors had to ask for permission from the target company to start a proxy war.

There is a downside, however. According to Savor, these tit-for-tat proxy war responses can be a distraction for all involved — especially for the management of targeted companies. “No one is happy when things turn acrimonious.”

The Influence of Hedge Funds

Experts agree that one of the big reasons proxy wars and other activist actions have increased is the prevalence of hedge funds. “Activism is picking up because of the way hedge funds operate,” says Allen. “They are better at organizing people. They have tremendous resources, and proxy fights are one of their tools. Proxy fights are one way they can make money.” Nor do hedge funds object to operating companies if that’s what is required, adds Savor. “Mutual funds don’t want to run the business. If they don’t like something, they will just sell shares. Hedge funds will try and run the business to improve the value of firm. All shareholders can benefit.”

While hedge funds would prefer not to actually manage the companies they invest in, Elson notes that sometimes there is an incentive to do so. “These [people] have large stakes and their investment in the company is concentrated. They want to recoup the investment.” In addition, hedge funds are not reluctant to force changes if their returns are lower than expected.

The Children’s Investment Fund Management (TCI) is another example of bringing about change. In May 2005, the British hedge fund, then only two years old, was credited with forcing the resignation of Werner Seifert, CEO of Deutsche Börse, the company that runs the Frankfurt Stock Exchange. TCI had protested Deutsche Borse’s plans to acquire the London Stock Exchange, and forced Seifert’s resignation. Most recently, the fund secured a victory over CSX and won board seats pending a court case. TCI had argued that CSX CEO Michael Ward’s compensation was too hefty given his performance and noted that the company’s operational metrics lagged behind its rivals, such as Burlington Northern.

This penchant for activism also is catching on with other shareholders, who, “across the globe are trying, to control management more. It’s a long-running trend,” says Savor. “And if the economy is in downturn, shareholders are generally unhappy.”

Overall, corporate governance experts agree that proxy wars are a useful way to hold corporate management accountable to shareholders even if it’s unclear whether these battles actually result in better returns. “It’s a good thing for shareholders that these activists rattle the cage,” says Allen. “Whether they ultimately create value for shareholders is another issue.”