Shareholder activism is the proactive attempt by equity investors, usually large financial institutions, to change some aspect of firm behavior or governance. While the goals of activist shareholders vary, they primarily revolve around monitoring and attempting to bring about changes in firms believed to be pursuing goals that are not shareholder wealth maximizing. The move to shareholder activism, especially in the United States during the 1990s, is arguably an outcome of the weakening of an active market for corporate control in the 1970s and 1980s through anti-takeover stratagems and legislation, modifications in executive remuneration schemes and the requirement for shareholder approval, and changes in the attitudes and motivations of traditionally passive institutional investors. Shareholder activism can take any number of forms, but typically includes proxy battles, publicity campaigns, shareholder resolutions, litigation, and negotiations with management.
The fundamental basis for shareholder activism, and one reason for the apparently wide variation in activity around the world, is differences in corporate governance mechanisms. In the Anglo-American model (exemplified by the United States, United Kingdom, and Australia), corporate governance emphasizes a well-developed stock market, strong investor protection, substantial disclosure, and arms-length banking relationships. In contrast, the Germany-Japan model (prevalent in Germany and continental Europe, Japan, and parts of Asia) assigns a greater role to long-term manager-investor and firm-bank relationships, concentrated ownership, and cross-shareholdings among firms and between firms and financial institutions. The latter clearly favors entrenched management and leaves little room to maneuver for independent activist shareholders.
The primary motivation for shareholder activism rests on the principal-agent relationship between shareholders and firm managers arising from the separation of ownership and control. Assuming that managers are rationally interested in furthering their own ends, the central problem for shareholders is how to motivate the managers to act in shareholders’ interest, not their own; typically, in terms of shareholder wealth maximization. A variety of mechanisms provides incentives for managers in this regard. First, the market for corporate control disciplines managers to better shareholder interests or risk their position because of the hostile takeover of an underperforming firm. Second, the market for managerial talent entails incentive compensation in the form of stock options and performance-related pay. Last, the active monitoring of management decisions in compliance with shareholder wealth maximization. Primarily, this is through the firm’s board of directors, but also institutional and block shareholders, and indirectly through banks and other debt holders. If any or all of these mechanisms break down or are compromised, shareholder activism may take place.
The question naturally arises that if a firm is underperforming in terms of shareholder wealth maximization, why do investors not simply sell their shares (“vote with their feet”) and avoid the anticipated information gathering and legal costs associated with shareholder activism. While institutional investors especially engage in some monitoring of the firms they invest in by analyzing financial and strategic statements, and occasionally meeting with and questioning management, to go beyond and try to control management (by acting directly to influence the structure, processes, or decisions of the board) would appear to be prohibitively expensive in relation to the potential return. One answer lies in the notion of exit and voice and the influence of two types of information. The first type of information, speculative or value-neutral information, is backward looking and has no direct bearing on the firm’s future decisions. Holders of this information will have little incentive to attempt to monitor and control the firm and may choose exit as a cost-effective means of coping with poor performance.
The second type, performance or value-enhancing information, is information that bears on the optimal wealth-maximizing course of action for the firm and is naturally forward looking. Investors with this information may engage in active monitoring and attempt to exert control, formally through the composition of boards or voting at general meetings, or informally through shareholder activism if denied avenues are more formal. For these investors, the anticipated benefits of activism outweigh the costs, especially in investor-focused governance systems that increasingly provide a variety of cost-effective means to discipline management. Concomitantly, in recent decades the proportion of firm ownership held by institutional investors (especially pension, mutual, and hedge funds) has steadily increased, reducing the free-rider effect of monitoring, and making it harder for block investors to deal with problems simply by selling because of investment illiquidity and the impact on market value.
While the primary motivation of shareholder activism is economic, nonfinancial concerns may also compel investors. These may include disinvestment from countries with a record of human rights abuses, the adoption of environment and labor friendly policies, and the avoidance of particular products or services, like tobacco, alcohol, gambling, uranium, and weapons. Thus, at least some episodes of shareholder activism link with the broader push toward socially responsible investment—investment strategies that attempt to maximize both financial return and social good, primarily practiced by socially responsible mutual funds. These efforts may include initiating conversations with management on issues of concern, submitting and voting on proxy resolutions, and engaging in publicity campaigns that bring together similarities of interest held by shareholders and other stakeholders.
Shareholder activism in the United States currently employs two main approaches. These are presenting (or threatening to present) a shareholder proposal on a corporate governance issue, and petitioning the firm’s managers or board of directors to achieve a change in management or strategy. For the former, the most common proposals concern the removal of poison-pill provisions and staggered board terms, the abolition of share classes (so that all ordinary shares have the same voting rights), separating the positions of chairperson and chief executive officer (CEO), making shareholder voting confidential, and other antitakeover measures, along with proposals to sell the company.
In the United States, shareholder proposals are typically under Securities and Exchange Commission (SEC) Rule 14a-8—Proposals of Security Holders. This entails a recommendation or requirement that the company and/or its board of directors take action after approval at an annual or special meeting of shareholders. If the proposal is on the company’s proxy card, the company must provide proxy means for shareholders to choose between approval or disapproval (or abstention). To be eligible to submit, the shareholder must have continuously held at least $2,000 in market value or 1 percent of the company’s securities for at least one year before the date of submission of the proposal. The company may exclude the proposal, however, for the following reasons. It would cause the company to violate law, it employs false or misleading statements, it entails a personal grievance or special interest not shared by other shareholders, is not significantly related to the company’s business, or the proposal deals with a matter concerning ordinary business operations. The main advantage of this approach is that the shareholder can avoid the expense of making a proxy statement and soliciting its own proxies; the main disadvantages are the limits applying to the types of proposals made and that proposals must be submitted at least six months before the meeting.
Perhaps the earliest and most well-known example of institutional shareholder activism in the United States is the California Public Employees Retirement System (CalPERS). CalPERS—the largest public pension fund in the United States with assets totaling more than $235 billion and some 1.5 million members—set in place an organized program of institutional shareholder activism with the establishment in 1984 of the Council of Institutional Investors (CII), an umbrella organization for U.S. institutional investors. Membership of this body now includes more than 140 public, union, and corporate pension funds with combined assets in excess of US$3 trillion, with members using proxy votes, shareholder resolutions, and pressure on regulatory bodies, discussions with companies, and litigation to change firm governance.
CalPERS itself compiles a list of focus firms each year from the fund’s internal portfolio where it has concerns with their stock and financial performance and corporate governance practices. It uses a variety of mechanisms to screen the nearly 2,000 U.S. corporations initially assessed, including long-term stock performance and economic value-added (EVA). For example, the five focus firms selected in 2008 (11 firms in 2007 and 6 in 2006) comprised Standard Pacific Corporation, La-Z-Boy, Invacare Corporation, Hilb Rogal & Hobbs Company, and Cheesecake Factory Incorporated. CalPERS highlights its particular concerns with the focus firms in fact sheets made publicly available on the fund’s Web site. For instance, La-ZBoy (with 7 percent of market capitalization held by CalPERS) was targeted for severe stock underperformance relative to the market and industry benchmarks, deteriorating trends in revenue growth and operating margins, and a lack of board accountability for permitting a classified or “staggered” board structure (arguing that annual elections for directors provided greater accountability for shareholders). However, under pressure from CalPERS, the firm had already agreed to remove supermajority voting requirements and adopt a majority vote standard for director elections.
While early efforts at activism, like the CalPERS focus list, focus on governance issues more broadly by attempting to make the market for corporate control work better, recent efforts have aimed to intervene directly in strategic decision making and the selection of company managers. These include specialist engagement funds targeting a small number of relatively poorly performing firms where governance or strategic change could conceivably improve shareholder value. Indeed, CalPERS itself was an early investor in one of these funds, Relational Investors, in 1996. Other activist investment funds include Icahn Management, Santa Monica Partners, and Opportunity Fund.
Unlike the broader activism exemplified by CalPERS and the CII where the low exposure to individual firms brings with it a sizable free-rider problem, the engagement fund approach increases exposure (and hence the return from any improvement) to the targeted investment. Probably the most well-known of these funds is the Hermes UK Focus Fund (HUKFF) established as a joint venture between Hermes (the British Telecom Pension Fund) and the U.S.-based LENS Fund. HUKFF takes significant positions (about 5 percent) in a small number of underperforming companies (four to eight each year) it believes it can successfully engage with, expecting to receive at least 20 percent more value than the current share price (after which it divests). For the most part, HUKFF’s engagements include the sale of noncore divisions of diversified firms and the sale of noncore assets or the stopping of diversifying acquisitions. In nearly half of its engagements, HUKFF has been involved in replacing the CEO and/or chairperson.
Notwithstanding the variation in investor motivations, one empirical question is whether shareholder activism actually improves firm performance, for which an emerging body of evidence is now available. An important qualification is that in many instances, firms targeted for shareholder activism may also have high levels of institutional ownership, and as evidence already exists that these firms also have relatively higher performance, the impact of shareholder activism itself may be confused with an institutional investor effect. Putting this aside, several studies have attempted to find a link between contemporaneous and lagged firm performance (as measured by abnormal returns or the return on equity or assets) and instances of shareholder activism. One possibility is to consider those firms targeted by CalPERS or the CII in their focus lists. Nevertheless, current evidence is ambiguous with no clear indication of an improvement in future firm performance or in the current stock price.
Exactly why performance post shareholder activism does not improve is unclear, but more than one study has suggested that the different measures of firm performance in different studies may account for the wide variation in results. Another complication is that they invariably draw their sample firms from firms targeted through shareholder proposals and other readily visible forms of activism. This ignores the fact that shareholder activism can take subtler, less-public forms like in-person meetings with the CEO and board members. A final difficulty is the wide variation in the characteristics of the activism. For instance, even with shareholder proposals, we could compare and contrast confrontational versus no confrontational episodes, shareholder proposals augmented with attention by the media, and proposals by shareholders with the minimum legislated criteria of ownership to more substantial minority shareholders.
However, there is strong evidence that shareholder activism influences the actual behavior of firms with studies finding an increase in assets sales, spin-offs, company restructuring, and employee layoffs. This body of work has also found that successful shareholder proposals aimed at removing takeover defenses are associated with an increase in takeovers. This is consistent with the hypothesis that shareholder activists target firms already considered for takeover and that the episode of activism signals the market that existing shareholders are open to a takeover offer. More recently, hedge funds have been considered, with the finding that hedge fund activists target more profitable and financially healthy firms than other activists (with most prior studies on pension fund activism almost always finding that they are more likely to target poorly performing firms). The results of this body of work suggest that activists employ similar screening mechanisms, but that hedge fund activists target different types of companies.
- Anat R. Admati and Paul Pfleiderer, The “Wall Street Walk” and Shareholder Activism: Exit As a Form of Voice (Graduate School of Business, Stanford University, 2007);
- Bernard Black, “Shareholder Activism and Corporate Governance in the United States,” in The New Palgrave Dictionary of Economics and the Law, vol. 3 (Macmillan, 1998);
- Alon Brav, Wei Jiang, Frank Partnoy, and Randall Thomas, “Hedge Fund Activism, Corporate Governance, and Firm Performance,” Journal of Finance (v.63/4, 2008);
- Thomas Briggs, “Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis,” Journal of Corporation Law (v.32/4, 2007);
- Diane Del Guercio and Jennifer Hawkins, “The Motivation and Impact of Pension Fund Activism,” Journal of Financial Economics (v.52/3, 1999);
- Fabrizio Ferri and Tatiana Sandino, The Impact of Shareholder Activism on Financial Reporting and Compensation: The Case of Employee Stock Options Expensing (Division of Research, Harvard Business School, 2007);
- Stuart L. Gillan and Laura T. Starks, “Corporate Governance Proposals and Shareholder Activism: The Role of Institutional Investors,” Journal of Financial Economics (v.57/2, 2000);
- Harvey J. Goldschmid, Shareholder Activism: Finding the Balance (Practising Law Institute, 2007);
- Michael Smith, “Shareholder Activism by Institutional Investors: Evidence From CalPERS,” Journal of Finance (v.51/1, 1996);
- Jean Tirole, The Theory of Corporate Finance (Princeton University Press, 2006).
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