KKR and the Art of the Steal Shareholder Theory and Buyback Programs
Introduction

Kohlberg Kravis Roberts (KKR) is an investment firm that acquires influence in a company by purchasing a controlling amount of shares or else a significant amount of shares that enable it to put pressure on the company’s board. KKR has made a number of large-scale investments and leveraged buyouts (LBOs) over the years, including the LBO of RJR Nabisco by KKR in the 1990s. In that instance, the firm anticipated a higher return on investment (ROI) than it ended up receiving, and KKR went back on its promise to keep RJR Nabisco’s assets intact, liquidating them so as to be able to move on to other investment projects (Leveraged Buyouts, n.d.). By using its capital to influence the way a company is managed, KKR has been able to influence outcomes for various firms in which it heavily invests. Like any other activist investor, from Nelson Peltz, who famously battled the board of P&G for control after taking a significant stake in the company through purchases of public shares, to Bill Ackman and Carl Icahn, KKR looks to influence the companies in which it invests so that it can reap a large ROI (Brunsman, 2019; Huddleston, 2014). The problem is that in some cases there can arise a conflict of interest with respect to governance. The conflict of shareholder vs. stakeholder theory becomes evident and one must answer whether it is within reasonable ethical guidelines for a company to manage another firm for the purpose of increasing shareholder value at the expense of stakeholder value. Additionally, the issue of auditing comes into play, as external auditors are awarded large contracts to audit a firm but those firms often want a glowing review rather than one in which numerous red flags are found: in fact, that was the problem Andersen eventually ran into and that in the end led to the fall of the most famous and respected auditing firm in America (Neuman). This paper will analyze the problem of conflict of interests with respect to KKR and discuss how influencers deal with this issue and how they manage to make the right call.

How KKR Influences a Firm’s Board

KKR is able to influence a firm’s board by buying a controlling stake in the company or by having enough of the stake in the company that it can demand a seat on the board, much the way Peltz did with P&G. Peltz went on to advocate for certain changes in the company’s direction, which led to the company’s stock price rising substantially. KKR typically seeks to do the same thing. If it does not have a controlling stake it becomes like BlackRock, which has a massive stake in many of the top companies all over the world. Whenever an investment firm like KKR or BlackRock has such a large stake, it is able to influence the board by making demands that must be met lest the investment firm decide to punish the company by dumping its stock into a weak market and causing the share price to crash. As many board members and executives count on shares for compensation, they want the share price to remain high—thus they tend to give in to the influence of firms like KKR.

KKR is then able to change the corporate culture of the firm by focusing its governance on increasing shareholder value. Shareholder theory is the idea that a company’s duty is to increase the value of shares so that investors see a good ROI. One of the ways that companies today implement shareholder theory is by authorizing share buybacks on the open market. Companies will often take on cheap debt (i.e., debt at low interest rates) and buyback shares—and by creating demand for shares the price of the shares goes up, benefiting shareholders (Light, 2019).

This creates a problem because as Zhao (2010) puts it, “the essence of corporate governance in U.S. public corporations lies in the separation of ownership and control” (p. 495). When the owners of shares end up in control of the firm, the idea of corporate governance becomes conflicted. However, it is actually much more complicated than just one investor buying up stock, as KKR does, because in the US corporate governance is the result of the integration of various entities and parties: from executives to shareholders to institutional...…They should be able to view a company’s approach and see whether it is in the company’s long-term interests or not. However, there are challenges here as well. For example, an audit for a publicly held firm by one of the "Big Four" accounting firms will easily run into the eight figure range (McDonald's for instance, paid EY about $14 million for their audit last year), and this creates a major conflict of interest since the firm should want to do a correct audit but at the same time it does not want to offend the company that hires it, as offense would endanger a contract of that size.

Thus, the "influencer" deals with the conflict of interest by working with the accounting firm doing the auditing and helping focusing the company on new strategies. At the same time, the firm puts pressure on the board to make the "right" judgment call that would please the large shareholder. KKR as an influencer thus complicates what should be a simple process of corporate governance by bringing the matter of chasing the ROI into the matter. The external auditor that should be focused on helping the company to chase down any problems in accounting or record keeping is instead twisted around into doing the bidding of the influencer because the prospect of not being hired back is one the auditor cannot risk.

Conclusion

Influencers and activist investors like KKR and others pose a significant ethical risk to the issue of corporate governance. They represent a shareholder first mentality that not only flies in the face of stakeholder theory but that also flies in the face of shareholder theory if one is going to take a long-term vision. The fact that KKR and other activists and influencers will put pressure on a board to authorize share buybacks by taking on more debt so as to inflate the price of the stock is evidence enough that a serious conflict of interest exists. The corporate governance system of the US does not place many strict regulations on this type of activity; on the contrary, it encourages it and has done so since 1982 when share buybacks (once illegal) were permitted and public companies…