private equity

Shipping, Private Equity and the Theory of Agency

Basil Karatzas
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March 14, 2015

The involvement of the private equity in the shipping industry has consumed plenty of ink and has rekindled not too little of a hope for an industry in distress; since the collapse of shipping market in 2008, private equity investors (and by extension, institutional investors wholesale-ly) have been accorded a portrait ranging from guardian angels and saviors of the industry to the “locusts” purveying industries in distress. A lot second-guessing can be excused when markets are dislocated and survival takes precedence over form or order. However, seven years after the instigation of the crisis and more than $30 billion in investments in shipping, people have been trying to take stock of what they had, what happened and what they should had. The fact that seven years after the instigation of the shipping market’s collapse still major shipping industry indices are flirting with all time lows does not make attempted assessments about the industry any easier.

As a matter of fact, the precipitous drop of the market and the establishment of thirty-year lows for indices like the Dry Baltic Index (BDI) have brought the concern of industry stock-taking to the pages of the mainstream business press. Most prominently, recently the Financial Times run an opinion article on shipping and the involvement of the private equity in shipping, and what it may have gone so awry; after all, the best and the brightest of the industry have poured their greyest of their gray power into alleviating the troubles of the industry. So far, the foray of institutional investors into shipping has not gone as modeled (at least up until now), and the aftershocks of such involvement are widely expected to make waves in an industry used to be dealing with physical waves.

Blame has been laid on the shortcomings of the agency theory as managers may try to put their own interests ahead of those of their principals and investors. The agency theory has been offered as a management or administration class in business schools, but actually applies nicely in the shipping industry, and actually twice. Corporate officers and corporate managers are running the shipping company on behalf of the investors – who are not involved with day-to-day operations, and in their absence, corporate managers may make decisions that have the managers’ best interests at heart instead of the shareholders. The potential conflict is clear.

In a model often adopted in shipping, the vessel management of the company’s fleet is often outsourced to a vessel management company often affiliated with the corporate officers or at least the ‘sponsor’ of the company when the shipping company was IPO-ed. Many shipowners – both operating and financial shipowners – outsource their vessel management to third parties, for many reasons – including benefitting from economies of scale, etc, and there is nothing inherent wrong with outsourcing; however, when the vessel management company is affiliated with the company’s management, and the earnings of the steady, market-neutral cash flows of the vessel management are unilaterally benefiting private the corporate management, then there may be a concern. It’s apparent that the potential for conflict arises twice when the agency theory is applied to shipping.

Now that several publicly listed shipping companies have become ‘penny stocks’, not mentioning several restructurings and bankruptcies and many investments by institutional investors gone sour, the conflicts of interest get front and center attention. It took a shipping cycle of a lifetime to burst in 2008 and a dip to 30-year low for the Baltic Dry Index (BDI) for concerns to be raised, as such in the article in the Financial Times.

The truth of the matter is that it’s unfortunate that conflicts of interest let the managers on occasion get the better end of the deal; it’s part of the human nature that such things happen, and the managerial science has been at work on how best to optimize corporate governance, motivate sufficiently the managers but not at the undue expense of the shareholders. However, this is not the first time that managerial abuse may have taken place, and shipping is not the only industry having such ‘privilege’. Just recently in the news, former CEO of Tyco International Dennis Kozlowski was looking for absolution for the managerial excesses of ice sculptures decorating corporate events in Sardinia of an era past (hopefully).

The truth of the matter also is that in reference to managerial excesses in shipping – and mostly when it comes to vessel management – the news about the abuses are often pre-announced and occasionally never exaggerated at all. One only has to peruse the filings and the prospectuses of shipping companies – mandatory information for publicly listed companies – to see that in many cases, there have been a garden variety of excesses and conflicts, including exorbitant vessel management fees.

There is no digging, begging, suing, etc to get access to such information; it’s in black and white, publicly filed, and available on any computer with internet access. It only takes a few phone calls to market experts and other vessel management companies to get a sense of the going market rate for vessel management fees, which coincidentally is less than $500 per diem; however, on average for most publicly listed shipping companies, the shareholders are paying more than twice as much to affiliated companies to have their vessels managed; There are actually publicly listed companies that they have proposed as high as $1,800 per diem vessel management fees. Why? Why anyone would accept such without qualifying the service or attempt to negotiate better pricing or shop the market?

And of course, vessel management fees is only one form of conflicts and managerial abuse; there are commissions for the sale & purchase of vessels managed, for the chartering and the commercial management of the vessels, for ordering the vessels at the shipbuilders, for supervising the construction, for … for… Back-of-the-envelope calculations for last year’s darling of shipping companies on Wall Street is that the management of the company has earned close to $100 million in fees alone, risk free and captive proceeds effectively for doing their job; and this is before executive compensation and other benefits. And a few years ago, executive compensation for another certain shipping company amounted to $75 million out of $125 million operating profit in the course of a few years. Again, such information has been filed publicly and it is not news, or it should not be news.

We can talk about the excesses of the shipping markets, but as in many things in life, there is the overarching principle of caveat emptor, buyer be aware; pertinent information is made publicly available, and let the investors make their own decision, and let them be prepared to take certain risks, let them benefit or suffer from the consequences. And, shipping is a very volatile industry with lots of inherent risk and meaningful chance of one losing their investment. Heightened management fees and other conflicts have exacerbated the results of the crisis but cannot be blamed for the crisis. And, placing the blame solely on the management teams doesn’t advance the debate about better corporate governance. After all, these prospectuses are primarily filed and intended for institutional investors who are well educated and experienced and compensated to invest money professionally; they should have done their due diligence, they should have checked the market, they should have ‘kicked the tires’ as they say, or in shipping, possibly they should have boarded a vessel or two. The truth of the matter is that sometimes investors are blinded, motivated by deal pressure and the need to deploy their money under management and start earning their own fees, they sometimes think monolithically and chase the same story, and unfortunately, very often, minimizing their due diligence to a box to be checked, and not a real in-depth search of the real events, causes and relationships. Unfortunately, we have seen it too many times in our business life, including most memorably once getting a call from Sydney, Australia from a firm where a US-institutional investor had outsourced their due diligence ‘box’ – the heavily Aussie-accented gent was calling to ask about a Greek shipowner; when the reply was ‘Well, they are not exactly Angelicoussis’, the follow-up question was ‘What’s Angelicoussis?’

Putting the blame solely on managerial abuses and conflicts of interest on the management and sponsors of shipping companies reminds of the joke where a prostitute, failing to collect the earnings after rendering certain services, yells ‘Rape!’ When professional fund and asset managers depend solely on screens and models to make their decisions and fail or turn a blind eye to conflicts in pursue of a quick return to be booked in this quarter, and follow a trend because everybody else is doing it (‘eco design’ newbuildings come to mind), it’s a disingenuous service to the shipping industry and a disingenuous service to the shareholders on behalf of whom institutional investors are acting. When short-termism and herd mentality guides investment decision-making, when due diligence is a box to be ticked, one has to wonder whether shipping will get to see better days soon… or more respectable days…


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