Management is facing investors, engaging directly in strategy and operations. The perception of Activist Shareholders is ambivalent. The impact on the company can vary from delivering higher returns but also causing significant inefficiencies. For the management, it is a thin line, how to answer to calls from shareholders, in order not to disconnect from its investors, but also not becoming subject to minority positions. Current research identifies five different typologies of investors. The blueprint for the common perception of a shareholder is the Rational Investor, a highly analytical, emotional controlled, superhuman being, with a computer implanted in her brain, yet, being of moderate wealth and average financial sophistication. Whereas the Rational Investor is long-term oriented and passive in her behaviour, Activist Investors show a different investment pattern.
Corporate raiders or advocates for best practice in management?!
In the public view, Activist Shareholders have earned the reputation of corporate raiders. Whereas Rational Investors are supposed to be long term oriented and act only passively, Activist Shareholders are known, to focus on short term gains, and to interact with the management of the firm, to influence the strategy, operations and also the decision building processes of other investors. Yet, the role has more facets to it.
Different underlying strategies motivate investors, to interact with the management of a firm. Yet, the common driver is a disagreement with “the way, things are” and “a urge, to change the course of the firm”.
Activist shareholders pursue goals within or outside the frame of the general assembly, raising their voice “above their fair equity share.”
“Raising the voice in excess of the equity share” can include:
- Simply very outspoken characters, using various platforms
- Deploying legal means against the company and the management
- (Over) utilising the instruments of the bylaws of the company and “taking the General Assembly (GA) hostage” of their interests
- Acting in public and deploying media
- Acting in private, rallying among shareholders and collect votes and Power of Attorneys, to support a respective initiative (proxy battles)
- Intense & direct negotiations with the management
The role in the corporate environment
Active investors are perceived in an ambivalent way.
Particularly with the highly opportunistic transactions during the 1980s, earned the reputation of corporate raiders, by forcing companies on their preferred course of strategy or rid themselves of the activists through buy back campaigns at high premiums.
Self perception is always “noble & integer”
Activist investors describe their role as catalysts, unlocking value in the underlying assets. Hence, acting on behalf of all shareholders and increase corporate performance.
This claim is disputable.
According to current research, 84% of directors believe, activists do not represent the interest of all shareholders, and also 85% believe, activists are simply to focused on short term performance.
Iconic names like Carl Icahn have given faces to this impression.
Research from 2017 of the University of Oxford reveals, shareholder activism has noticeably shifted towards longer-term value creation, in recent years. This is defined as “engaged activism“, as differentiation to the short-term oriented “financial activism“.
Either group of activists intends to increase returns on their investments into the underlying assets. A third category includes non-for profit organisations deploying shareholder resolutions and other measures, to push for sustainability, human rights and other aspects of corporate social responsibility. Examples include the Interfaith Center on Corporate Responsibility (ICCR), As You Sow and Ceres (et al.).
Common sense is not so common. (Voltaire)
No matter the intention, activists cause distraction to the management of a firm.
It is save to say, a variety of thoughts and opinions can improve the strategy and execution of a firm. The general assumption is, activists base their initiatives on informed decisions, comprehensive data and command sufficient financial acumen.
A 2012 study from the U.S. Securities and Exchange Commission (SEC), regarding financial literacy among investors, concluded a “lack of financial sophistication, disabling investors to protect themselves from security fraud”. This does not hold for professional investors (e.g. asset / investment managers from funds, investment banks, private equity firms, family offices etc.), whereas, retail investors are likely to show only average or below average financial acumen.
Better performance through activists….?!
Data providing evidence on performance improvements, achieved by activists are scarce.
For listed companies
A 2012 released study from London based Activist Insight, found activist focused hedge funds, consistently outperforming the MSCI after the financial crisis of 2008, by 10.99% (2.15x) on average (average returns: MSCI 9.55%; Activist Hedge Funds 20.54%). Between 2006 – 2011, top performing activist hedge funds produced average returns up to 53.04%. These findings are supported by a research from Transaction Advisors, stating, in 2013 activist hedge funds delivered returns of 16.6%, whereas passive hedge funds returned 9.5% (1.75 x).
For private companies
The situation is more complex for SME companies.
Whereas mature and sophisticated companies are able to negotiate with activist shareholders, dealing with activists is subject to a number of specific aspects in the mid-cap market:
(Note: SME companies, which are fully or substantially owned by the management are excluded here.)
- Very often, SME companies are depending on one dominant shareholder. As such, the dominant shareholder is hiring the management, and ultimately setting the agenda for the firm. Room for disagreements on strategy or execution is very often, very limited in these settings.
- In SME companies, retail investors (e.g. friends & family, former employees, even the local bank….) may lack sophistication and financial and/or strategic acumen. This makes it easy, for Activist Investors, to bypass a thorough decision building process and find leverage to launch initiatives.
- It is the role of the non-executive-board, to also hedge for shareholder initiatives. A lack of sophistication / experience of the board or close links with the owner of the firm, is jeopardising best practice on the non-executive level and exposing the company’s actual strategy and operations to the influence of activists.
- In SME companies, management resources are limited. Engaging in investor relations (IR), is consuming time and attention from the management and distracting attention and focus.
“Over-“interaction of a dominant investor with the executive management, can further potentially lead to eroding leadership. The executive management is depending on trust, guidance, encouragement and support, to create a culture of success for mid-level managers. Distrust and distraction on the board level, are likely to spread through the entire organisation over time, jeopardising any winning team.
SME companies are poised to suffer from constraints in management and strategy. Additional know-how and diversity can help to improve the companies strategic capabilities, to foster growth and profitability. Essentially it does not matter, if additional know how is added by internal resources or by members of the shareholder community. As shareholders are often compensated only through dividends, this can be a cheap access to additional skills and resources. However, shareholder contributions can be highly value creating, but just as well, easily significantly value destroying.
Activists as catalysts
It is fair to say, activist shareholders keep boards and executives alert, and foster best practice in board- and executive management. As they exercise more intense oversight of management decisions and use of funds, this helps to hedge against Principal-Agent Conflicts.
Whereas it is generally a good thing, to keep management and boards on their toes, Acitivst Investors can also become a major risk by distracting management attention and consume significant resources, hence, cause limitations to management effectiveness and efficiency.
The good, the bad, the ugly – value creation vs. value destruction through activists
Intelligence & intention drive the role of an Activist Shareholders for an firm.
In theory: All shareholders seek for value creation of the firm.
In reality, intentions of shareholders can vary from the ideal model. Whereas strategic investors are assumed to act for the benefit of the collective asset, financial investors are considered to be notorious for pursuing primarily individual goals.
Yet, best intentions without capability are dysfunctional.
“Never attribute to malice that which is adequately explained by stupidity.” (Hanlon’s Razor)
Whatever the intention, the capability of the individual defines the impact and the outcome of Activist’s behaviour.
A lack of capabilities falls into two elements:
- Business acumen / sophistication – the capability of the shareholder to access and also understand commercial information from the company and the market. According to research, shareholders lack financial acumen. Though Activist Shareholders may raise from the more sophisticated group of investors, risk is, to face also Activists, lacking sufficient financial acumen.
- Financial capability – sufficient funding is a critical element of many strategic initiatives. Planning without access to funding, is inefficient.
Distraction & failure come in pairs
Ineligible shareholder initiatives consume time and attention from the management. 84% of directors agree, activists often create a negative distraction for the management and the board.
These inefficiencies are limiting the chances for a firm to succeed, as attention for operational challenges is diluted.
Activists are notorious, to focus on the CEO and the Board for interaction.
Dilution of the management’s attention can be reduced, through dedicated resources. Investor Relations Officers (IRO) can protect the CEO’s agenda from initiatives from Activists Shareholders.
The engagement of dedicated personell for investment relations, increases OPEX, hence, creates inefficiencies and is only available to more mature (and profitable) companies. This also underlines the importance of management-shareholder alignment, in small-cap firms and/or companies in “situations of rapid change” (turnaround, distress, aggressive growth at al.). For these companies, Investor Relations-resources are, very often, not available, whereas undiluted management attention is critical for success.
Accordingly, 86% of directors would not welcome an activist’s involvement with their company’s board.
The opposite of “good” is “meant well”.
Financial investors, are observed, to cause additional risks for the management, by challenging executives on a personal level or imposing legal threads.
These pattern of behaviour, can lead to distraction of the management, securing their individual legal positions and focusing on liabilities rather than progressing the business (this is addressing cases of executives, who act in good faith, being subject to misguided shareholder activities).
Keeping the management on their toes.
Strategic investors are often considered to act in good faith and alignment with the management; Shareholder initiatives, seeking collective benefits, are likely to push the management for better performance and act as catalyst.
Yet, from outside, to conclude a thorough strategy, bringing this to action and overseeing the impact for the firm, is not possible without alignment with and buy-in from the management.
Whereas an engaged activist shares the holistic vision and the goals of the management and the shareholder community, but may be in disagreement, how to achieve those, a dysfunctional activist, is including only selective elements of the firm’s eco-system in her vision. This can apply to: Selected assets, selected shareholders (herself), a selected part of the time horizon of the firm etc.
Differentiating between the “good” and the “bad” activists, comes down to two relevant criteria:
- Is the activist truly pursuing collective benefits?
- Is the activist capable, to understand and analyse the company data, and also, oversee the full impact of her suggestions for the firm.
It is specifically difficult for an activist, to qualify to the second criterium, as the management is engaged deeply with all details of the firm, hence, by definition holds private knowledge.
Activists come in different forms and shapes
As different motivations drive activist behaviour, also, various pattern of activism are observed:
- Direct interaction with the management – can be limited to calling up, emailing, asking for meetings with members of the executive / non-executive board. Also, this can include the deployment of legal instruments, targeted to members of the executive / non-executive board. The threat of liabilities, damages, loss of reputation, job loss, are possible levers, to influence management decisions. Also, creating a hostile environment can be a way for ousting the executive / non-executive board. Whereas the replacement of directors is among the top results of shareholder activists, legal means are accessible, regardless the actual equity share. Hence, even the owner of a single share, is in the position, to create serious discomfort for the management.
- “Vote-No”ers chose for a slightly more subtile way of resistance. Blocking management decisions, is exposing the company to a similar situation, as the deployment of legal instruments, yet, the process is taking more time, and causing less noise to the market. For the management, a “dead lock” can be critical, as this can put strategies and operations at stake. Very often, “Vote-No”ers are observed to use this instrument, for an ousting of the board (as they cause the ineffectiveness of the board to successfully execute, which can be used to argue its dismissal), hence, engaging into subtile power play. This may happen fairly unnoticed from outside the company, hence, not realise immediate impact on the investment proposition of the firm, yet, cause limitations to the operational performance of the firm. “Vote-No”res are value destroying for the firm! To be effective, “Vote-No”res require a certain amount of votes, to create relevant impact. If they do not command those voting rights themselves, rallying among shareholders, to collect POAs (proxy battles) or creating alliances can be observed. These activities can be limited to inter-shareholder communication or include public campaigning, as leaking information to the media, taking positions against the management in public etc.. Also, it is noteworthy, this strategy requires little to no financial acumen, hence, may be pursued by opposing, incapable investors.
- Proposers, heavily (over-)utilise shareholder proposals to influence the strategy of the company. Herewith, the GA is taken hostage on behalf of the activist shareholders. This can be tiering for both, the management and also other shareholders. The probability to agree to proposals, which are in favour of activists, in order to close an issue and continue with the general agenda is likely. Again, this is not visible from outside. Any misaligned decision processes are source for inefficiencies and, hence, value destroying to a firm.
Underlying causes for conflicts
Whereas it is easily said, an engaged activist is considered to challenge the strategy and/or the execution of the company, whereas elements, leading to value maximisation (say-on-pay) are in the focus of a financial activist, the underlying elements are more differentiated.
Misalignment among shareholders may be caused through three major areas of conflict:
- Different investment horizons (short vs. long term) – specifically financial investors may follow a clear timeframe to manage their investment portfolio. This can be misaligned to the investment strategy of other investors.
- Different strategic visions – different strategic visions can result from various sources:
- Shareholders can have a different philosophical point of view, e.g. for aspects of social responsibility (CSR), environmental aspects, gender equality etc.
- Different conclusions from shared market data, may be leading to different visions for the long term growth perspective of a company. To nurture their investment, shareholders may bring those forward and try to convince the management of their vision.
- Different portfolio positions, can lead to different strategic assessments. Specifically strategic investors with complementary portfolios and string interest in synergies, are likely to have a different view on an asset, than e.g. financial investors.
- Different cultural values – things are getting more complicated, if conflicts are not based on factual aspects, but different cultural perceptions serve as starting points for power play between dysfunctional personalities. Reasons can include, but are not limited to individuals, originating from different cultural backgrounds, legacy of the firm with a shareholder group, family ties, other controversial characteristics, such as generational gaps, differentiating management styles etc. Tangible symptoms can be found in severe disagreements about the definition of the respective roles (decision rights of the management, information rights of shareholders, inclusion in decision processes etc.), or in disagreements about the organisation’s “behaviours, relationships, attitudes, values, and the environment” (BRAVE concept). A power struggle is causing severe inefficiencies for the organisation, hence, increasing the risk profile for the investment. It is imperative for the (non-executive) board, to avoid, the evolution of these phenomena, and / or resolve those within due time.
Different motivations can lead to activist behaviour. Among those only engaged activists are long term oriented and pursuing collective benefits. They are likely to create value for the company by hedging for principal-agent conflicts.
The short term gain focus f financial activists, is notorious to lead to inefficiencies and consuming and diluting management attention, hence, potentially decreasing progress and growth of a firm.
To nurture success, shareholder alignment is important.
The Praetorian Guard, to fence SME firms against Activist Shareholders.
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