Increased shareholder activism and the changing landscape of corporate governance

Citation

Reed, R. and Storrud-Barnes, S.F. (2015), "Increased shareholder activism and the changing landscape of corporate governance", American Journal of Business, Vol. 30 No. 1. https://doi.org/10.1108/AJB-02-2015-0002

Increased shareholder activism and the changing landscape of corporate governance

Article Type: Editorial From: American Journal of Business, Volume 30, Issue 1.

As noted in previous editorials, at the AJB we are interested in research dealing with phenomena that affect business, the response of business to those phenomena, and the effects that they have on our business theories. The recent and continued rise in investor activism is one such phenomenon. It is not the activism of the 1980s when individuals – corporate raiders – were using the assets of target companies as collateral for loans to acquire them, then break them up and sell off the pieces to make a quick profit. Today’s activism tends to have a longer term focus that targets the strategy and governance of firms that are underperforming. Neither does today’s activism have the excesses of the corporate-raider days. The days of insider-trading, stock manipulation, inaccurate filing of Schedules 13G, and the “Predator’s-Ball” have been replaced by a more transparent activism that, arguably, seeks to create value. The notoriety surrounding those corporate raiders and their bankers has been replaced with the more-sober images of activists such as Carl Icahn, Daniel Loeb, Nelson Peltz, Barry Rosenstein, and Jeffrey Ubben, and by the invested capital that the activist partnerships and hedge funds use to acquire blocks of firms’ stocks.

The excesses of the 1980s led, in part, to the curbing of that early form of activism. But also occurring was a shift in the investment landscape. In the 1990s the confluence of companies using the internet to disseminate information, the emerging practice of earnings conference-calls, and the establishment of on-line trading allowed small investors to access information on companies and to quickly buy or sell securities. However, it was clear that some large investors – blockholders who had privileged access to management – were able to get information on earnings and firm strategies before the rest of the market and were thus able to trade on that information. To level that playing field, in October of 2000, the Securities and Exchange Commission ratified the rule on Fair Disclosure (FD). What has become known as Regulation FD mandated that all investors receive information at the same time. Because selective disclosure was effectively banned, Regulation FD eliminated information asymmetry among investors. Large investors no longer had an advantage in trading stocks. That meant that they had to find another way of improving returns on their investments, which inspired the rapid growth of activist partnerships, activist hedge-funds, and activism by pension funds such as CalPERS and TIAA-Cref. Although the global financial crisis of 2007-2008 hurt the partnerships and funds by, among other things, limiting the private capital that was available to them, they have since returned stronger than ever.

Activist Insight (2014) reported that activists targeted 237 companies worldwide in 2013, which represents an increase of 9 percent over 2012. Over two-thirds of the targeted companies are in the USA, which also has the most activists. Europe had some 19 percent of the targeted companies, and Canada had 6 percent. The objectives of the activists are primarily capital related or governance related, with the latter being focussed on changes in management and strategy, board representation, or both. That is not to say that larger dividend payments and stock repurchase programs are not included on their agendas, but they tend to be less prominent. The performance of these individual activist and groups has been impressive. Activist Insight (2014) reported that their index of 30 activist funds returned 21.7 percent on investment for the first three quarters of 2013 compared to 16 percent for the MSCI world index. They also reported that where activists had forced the removal of a CEO, stock prices increased by 83.6 percent, and where they gained board representation the average annualized increase was 47 percent. The targeted companies for the activists in 2013 were across a range of industries (technology, financial, services, materials, healthcare, consumer goods, industrial goods, utilities), and a range of sizes. It is no longer just the smaller companies that are being targeted. The number of large-cap companies (>$10 bn market capitalization) increased from 17 in 2010 to 42 in 2013. Well-known companies such as Apple, Microsoft, Sony, Sotherby’s, and Darden received attention from activists, along with lesser known companies such as Ashland, Compuware, and Sevcon. As activists have improved stock returns through their actions, they have not only attracted a lot of private capital but they have also received a lot of attention from the business media (CNBC, Bloomberg, Fox Business News). Consequently they have collected a following of passive investors. For example, Carl Icahn, who invests substantial amounts of his own money in firms he targets, and the hedge-fund manager, Daniel Loeb, are watched and imitated in terms of investments by both institutional and individual investors alike.

While today’s activists do not have the bad name of the 1980s corporate raiders, they are still seen as disruptive and there exists a dislike for them (Activist Insight, 2014). As a result some firms that think they may be targeted put in place defenses. The tactics include adopting staggered boards and poison pills, which is ironic given that those are also reasons why activists target some firms. However, the nature of the poison pills has changed. Instead of protecting shareholder rights from low-priced offers in hostile takeover situations, some poison pills are now aimed at stopping activists from acquiring larger quantities of a firm’s stock by changing the company’s bylaws to restrict the number of shares that can be owned by filers of Schedule 13D. All of that being said, some firms are taking a more proactive stance and asking what activists may see that needs to be improved. In a move called “proxy access” Hewlett Packard and Verizon have permitted owners of blocks of stock to put forward director nominations. Similarly, General Electric recently announced in an SEC filing that it had changed its bylaws to allow individuals or groups of up to 20 people that owned 3 percent or more of the company’s stock for a period of three years to nominate up to 20 percent of the board’s directors. Clearly, firms are starting to listen to activists’ demands for more-responsive management and boards.

The research on activism has two streams – one dealing with social environmental issues and the other with firm performance and governance. Goarnova and Verstegan Ryan (2014, p. 1232) provide an excellent summary of the research on both types of activism and note that “scholarly output on shareholder activism has doubled over the last five years,” which corresponds with the increased influence of activist partnerships and hedge-fund activism. Greenwood and Schor (2009) found that hedge-fund activism resulted in large gains in stock value, but it arose primarily from forcing target firms into takeover situations. As scholars continue to dig deeper into activism, new findings come to light. For example, Clifford (2008) found that firms targeted by hedge funds filing Schedule 13D (compared to those filing Schedule 13G) earned higher abnormal returns at the time of filing and had better improvements in subsequent ROA, which he attributed mainly to the divestiture of non-performing assets. He also found that the hedge funds targeted low-cash firms, thus excluding the motive of activists only wanting special dividends, and that funds with longer lock-up periods for withdrawal of investor money were more likely to be activist rather than passive. For a sample of UK firms, Filatochev and Dotsenko (2015) discovered that performance effects vary according to form and type of activist, as well as the type of proposal that the activist is putting forward. They found that board and strategy demands by hedge funds led to gains in stock price, whereas “public debate” on management remuneration by activists such as pension funds had no effect. Meitzer and Schweizer (2014) examined the effects of hedge-fund activism vs activism by private equity groups and determined that performance effects were greater for the latter, which they attributed to a longer term perspective. These research findings are undeniably interesting, but the phenomenon of increased activism is in desperate need of even more research. Goarnova and Verstegan Ryan (2014) state that:

[T]he financial and social streams [of activism] not only rely on different theoretical foundations and pose divergent research questions, but also reach different conclusions. While the two streams could be viewed as complementary, with both acting to deter or remedy managerial deficiencies, the issue of shareholder versus stakeholder primacy has generated its own debate (p. 1231).

Obviously, there is a question of whether or not recent activism results in Pareto superior outcomes where shareholders and other stakeholders all benefit, or whether the outcomes are Pareto inferior. Garonova and Verstegan Ryan go on to note that Agency theory, which underpins much of the financial stream of research on activism, assumes homogeneity among shareholders when, in fact, heterogeneity is a more likely scenario. That raises the question of whether or not current forms of financial activism benefit both short-term investors and long-term investors, or does one group gain at the expense of the other? Meitzer and Schweizer’s (2014) conclusion on the more patient capital of private equity groups would suggest so, but that hypothesis needs testing. There are a plethora of other questions that also need addressing. For example, do the defense mechanisms used by some firms help or hinder improvements in longer term firm performance, does proactivity in the form of proxy access help or hinder performance, what are the dynamics of director interaction after new members are forced onto boards, and what are the effects on decision making? Clearly, there is much work to be done. The AJB is open to Guest Editorships of Special Issues, and we would welcome a Special Issue dealing with this important topic that is highly relevant to today’s business.

Richard Reed and Susan F. Storrud-Barnes

Acknowledgements

The authors are grateful to Steve Kirk, who is the Executive in Residence at Cleveland State University, for his insights on the issue of activism. Any errors in this Editorial are the authors’, not his.

References

Activist Insight (2014), Activist Investing. An Annual Review of Trends in Shareholder Activism, Activist Insight with Schulte, Roth and Zabel LLP, New York, NY

Clifford, C.P. (2008), “Value creation or destruction? Hedge funds as shareholder activists”, Journal of Corporate Finance, Vol. 14 No. 4, pp. 323-336

Filatochev, I. and Dotsenko, O. (2015), “Shareholder activism in the UK: types of activists, forms of activism, and their impact on the target’s performance”, Journal of Managerial Governance, Vol. 19 No. 1, pp. 5-24

Goarnova, M. and Verstegan Ryan, L. (2014), “Shareholder activism: a multidisciplinary review”, Journal of Management, Vol. 40 No. 5, pp. 1230-1268

Greenwood, R. and Schor, M. (2009), “The evolution of shareholder activism in the United States”, Journal of Applied Corporate Finance, Vol. 19 No. 1, pp. 362-375

Meitzer, M. and Schweizer, D. (2014), “Hedge funds versus private equity funds as shareholder activists in Germany – differences in value creation”, Journal of Economics & Finance, Vol. 38 No. 2, pp. 181-208