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The real problem at eBay: corporate governance

March 21, 2014: 5:00 AM ET

Carl Icahn's issue with the online retailer isn't PayPal, but rather the capability and interests of its leadership and board of directors.

By Paul Hodgson

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FORTUNE -- If your mother read about it in the Wall Street Journal, would she yell at you about it? That's the governance test used by Icahn Enterprises for the directors of the companies it invests in. The firm believes that the board of directors are there to represent shareholders, and if they are secretly representing their own interests, they become an Icahn target. But is governance the driver behind the activist investor's actions, or is it the company's bottom line? The message from the firm was very clear that eBay's (EBAY) financial performance drives its decisions. Icahn has said that eBay is underperforming its peers and that the most profitable action to take for shareholders would be to sell off PayPal as a separate company. And that's what's driving the current proxy fight with eBay, where Icahn has established a 2.2% stake, has nominated two directors to the board, and is calling for the selloff of PayPal.

But at the same time, in a series of open letters to shareholders, Icahn has been questioning the loyalties of two directors -- Marc Andreessen and Scott Cook -- as well as the competence of the CEO John Donahoe. These are governance issues, but, if they turn out to be real problems, they are also problems that could affect the financial performance of the company because conflicts of interest can cause directors to take actions that will damage eBay's profits.

Icahn's problems with Andreessen are that he directly invested in and profited from two eBay subsidiaries -- Skype and GSI Commerce -- and is invested in and advises four companies that are in direct competition with PayPal. eBay has responded by saying that Andreessen recused himself from any discussions about the disposal of Skype, but his position as a director of eBay gives him access to large amounts of non-public information about strategic decisions being made about PayPal such as the board book and the five-year plan that provide a fairly substantial conflict of interests between his duties to eBay shareholders and his duties as investor and adviser of its competitors.

Exactly the same types of conflict of interest lie at the base of accusations against Scott Cook, Intuit's (INTU) founder, former CEO, major shareholder, and current executive chairman, which also has a division, GoPayment, that is also a direct competitor of PayPal. These conflicts are even more black and white. We all know that the Valley is fairly incestuous, but, it might be added, so is Detroit, and you can't imagine Ford putting the General Motors CEO on its board.

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"You have to decide which team you are playing for," said an Icahn Enterprises insider. "You can't play for one team for the first half and the other team for the second half." And it would seem that shareholders of both parties are ill-served by such a situation.

So that's the governance situation, but how can it harm eBay's profitability? The effect on eBay's bottom line could be negative if potentially conflicted board directors take insider information and use it to boost the market share or product development or some other strategy of PayPal's competitors by sharing it with them.

Icahn has had quite a year so far, even where he has not been 100% successful. He precipitated a major stock buyback at Apple (AAPL), and with the acquisition of Forest Laboratories (FRX) by Actavis, he more than doubled the value of his initial investment. And the initial acquisition of Forest -- although based on financial concerns surrounding the company's lack of scale, inefficient sales structure, and lack of planning for expired licenses -- was also driven by governance concerns at the company, including the need for more outside board members and problems with succession planning. Of course, Forest initially rebutted all of these claims, but the changes, including the election of Icahn-nominated directors and an Icahn-approved new CEO, certainly seem to have paid off for all shareholders, not just Icahn.

Neither Icahn's views on strategy or governance receive universal support from other investors in the firms he targets, some are questioning the long-term value effects of divesting PayPal, for example. eBay, which did not return calls for this story, is vigorously defending Andreessen and Cook, as well as its strategic decisions in selling Skype. But the combination of financial and governance activism appears to be extremely effective at getting everyone's attention. And it may be that the governance activism is an add-on, developed after financial analysis. But I believe that governance and financial activism are about the same thing -- improving returns to shareholders. Poor succession planning, conflicted directors, unlocking value through divestments, they're all about the money.

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