In its new report titled “Rising Tide of Global Shareholder Activism,” the Financial Strategy and Solutions Group of Citi observes that shareholder activism has spread to companies in all sectors, of all sizes and across all geographic regions.
As the report suggests, activist hedge funds have accumulated their funds and, in order to put this financial firepower to work, are exporting their activism abroad. On the so-called “supply side” of the phenomenon, shareholder interventions are increasingly encouraged by the presence of undervalued targets with conservative financial strategies and a lack of top-line growth, dispersed share ownership, and reforms that enhance shareholder rights.
Several studies distinguish shareholder activism between the “offensive” and the “defensive” variety, and hedge funds have earned notoriety for being considered squarely of the former. These activist interventions may have different objectives. First, they target undervalued corporations anticipating to unlock shareholder value when the market correction occurs. Second, interventions are aimed at corporate governance changes like replacing a top manager or changing a board’s composition. The third category of shareholder activism may be aimed at changing the capital structure of the target. And fourth, activist interventions involve change of control transactions, including encouraging the target to sell itself or preventing the target from selling itself.
Shareholder activism in the United States dates back to the 1940s, and the Securities Exchange Commission’s adoption of Rule 14a-8 which entitles shareholders to include certain proposals in the company’s proxy statement. Most Rule 14a-8 proposals initially fell into two categories—proposals relating to corporate social responsibility and those relating to corporate governance issues. In the mid 2000s, shareholder activism surfaced as a major vehicle in corporate governance objectives.
Corporations, on the other hand, may exclude certain shareholder proposals from the proxy statement based on grounds set forth in Regulation 14A, such as the right to exclude proposals relating to matters of ordinary business, which is considered the board’s domain. Companies may attempt to pre-empt a proxy fight by reaching an agreement with the shareholders, failing which, the proposal goes before the shareholders for vote. Shareholder advisory firms have recently gained significant influence over this process and consequently, there are increasing calls for regulation of these institutions as well.
The proponents of shareholder activism argue that constructive shareholder interventions increase overall shareholder returns by holding the corporate boards accountable and point to several empirical studies that reflect higher stock returns in companies targeted by activism. The opponents, on the other hand, allege that activist hedge funds pursue their personal agendas to make short-term profits at the expense of the interests of other stakeholders and the overall health of the firm—the so-called “myopic activists” claim. In order to benefit from the short-term spike in stock prices, the activists (allegedly) push for changes that may well increase short-term prices at the expense of long-term performance. However, shareholder activism advocates have questioned the empirical validity of this argument. Further, the defenders of corporate boards argue that heightened activism undermine the system of centralized decision-making by the board. Simply stated, the debate on director-centric corporate governance versus shareholder-centric corporate governance continues. Interventions by hedge fund activists are also criticized to have negative ramifications on other corporate stakeholders like employees and customers.
Corporations can pre-empt shareholder interventions by adopting certain vigilance strategies, including:
- Monitoring trading patterns in its shares and ownership reporting to the Securities Exchange Commission
- Staying aware of activist identities and their agendas
- Having an ongoing outreach program and dialogue with the prominent shareholders
- Maintaining the shareholders’ trust in the management
- Maintaining a relationship with proxy advisory firms
- Conducting self-assessments of governance strengths and weaknesses
- Considering additional techniques, such as supermajority vote requirements, classified board structures and adopting “poison pills”
Notwithstanding corporate boards’ efforts to pre-empt shareholder interventions, investors have become increasingly media savvy, skilled in financial engineering and with the traditional institutional investors actively participating in shareholder democracy, the growing and global tide of shareholder activism is here to stay.