Should Shareholders Have a Say in Darden's Red Lobster Spinoff?

The owner of the Red Lobster, Olive Garden, and Long Horn Steakhouse restaurants is resorting to pleading with investors to not support the activist shareholders seeking to call a special meeting to discuss the proposed spinoff of the seafood chain. They say there are other avenues investors can take, and the door is always open to submit questions.

Darden Restaurants (DRI 0.46%) is pushing back on the call by Starboard Capital to hold a special shareholder meeting, saying this would cost a lot of money and divert management's attention from running the company. For its part, the activist hedge fund says all it wants is to give shareholders a chance to voice their opinion on the proposal since it will likely be completed before the annual shareholder meeting that's typically held in September. It's not asking for its support of the alternative proposals it put forth, per se, only a vote in favor of having the gathering.

In part, it's an exercise in showmanship. The special meeting, if held, would be asked to vote on a nonbinding referendum calling on Darden's management to halt its efforts to separate Red Lobster from the rest of the portfolio. The company would be under no obligation to follow the outcome of the vote even if it passed by large margins. Just like the "say on pay" proposals that annually come up for a vote, boards don't have to abide by what the shareholders say. But even in the case of the uproar over Jamie Dimon's lucrative pay package, opponents couldn't sway enough JPMorgan Chase investors to oppose it.

Because it's an operational matter being debated with Darden, it really might be a matter best left to management than run as a popularity contest. Darden wants to shed the ailing restaurant; Starboard seeks to divvy up the chain into thirds, with one portion housing a REIT that holds all of Darden's real estate, another portion comprising its slow-growth Red Lobster and Oliver Garden concepts, and the third portion consisting of the fast-growing chains like Yard House, Capital Grille, and Bahama Breeze. One way or the other, or even a third path, is not necessarily something that should be put to majority rule.

The influential Institutional Shareholder Services recently noted that 92% of respondents to its annual survey believed a board of directors "should be free to exercise its discretion to respond in a manner that it believes is in the best interest of the company" so long as it discloses the reasons behind the actions it's taken.

Last summer, a review of ISS' shareholder proposals for the first half of the proxy season found that though there were hundreds of matters submitted for a vote, fewer than 20% received majority support. Of those that did, most of the proposals dealt with how a board operated (declassifying a board, removing supermajority requirements, etc). That certainly seems in line with Darden's complaint that it's going to end up spending a lot of time, money, and effort on a diversionary tactic that will likely have little effect on how the company proceeds.

For although Starboard and fellow hedge fund Barington Capital disagree with management's position on Red Lobster, they can't even agree among themselves on the best course of action. All Barington wants Darden to do is stop and consider a holistic approach to fixing the problems in the Red Lobster chain. They say they have growing support for calling a special meeting, which is why the board might be pleading for investors to oppose it, but in the end, it may all be sound and fury signifying nothing.

Because Olive Garden is also faltering -- though not to the extent of Red Lobster -- I've expressed reservations about Starboard's plan to lump them together and send them off on their own, noting that two sickly businesses don't make a healthy one. There may be other ideas out there (I've suggested spinning off the successful Yard House as one possible alternative), but management's plan to pluck out its offending eye that is Red Lobster could be the right way to do it after all.

I'm just not sure forcing a popularity contest that drains scarce shareholder resources is ultimately the way to go about it.