Investment Activism: an Overview

Abstract

During the last 5 years activism investing, a way to increase shareholder return through influencing management’s decisions and a notion previously associated with corporate raiders, has been rapidly gaining popularity. Recent activism campaigns have includes such household names as Heinz, McDonald’s, Motorola, Time Warner, General Motors and Yahoo. While theoretically the management of public companies strives to nothing else, than maximization of shareholder’s value, in practice that is sometimes not the case. Due to various reasons managers fail to address the best interests of all shareholders. When those failings become significant enough that they materially impact the value of the firm an opportunity for activism arises. Most of the times activists pursue generic goals that are easily understood by the market. These goals usually include changes in capital structure (recapitalization, buy-backs), changes in strategy (operational changes, refocusing strategy, preventing the sale of the company, acquisition of other companies), sale of the company (sale of the whole company or its parts), and improvement of corporate governance (abolishing take-over defences, getting rid of the current management/board, achieving greater transparency). Of course an activist can pursue more than one goal at a time. Companies, targeted by activists, usually exhibit similar characteristics: stable cash flows, high cash reserves/low leverage, lagging capitalization, readily available strategic opportunities and the company is well known by the market. Several factors have contributed to the increasing presence of activism investing. Firstly, the rise of hedge funds, which are more active in their approach than mutual funds. Secondly, certain changes in legislation have forced asset managers to vote their shares. Thirdly, pension funds have started taking a more active approach to their holdings. In US, Europe and even Japan activists are rapidly increasing in numbers. In US the number of activist hedge funds has increased at 28% CAGR during the 2001 – 2007 period. There is an opinion that today’s activists are just glorified US raiders of the 80’s. And while indeed some of today’s activists, like Carl Icahn and Nelson Peltz, were well known in the past for their raiding activities, today’s activists are characterized by some important distinctions. Firstly, they do not seek to gain control of the company, usually acquiring a 5 -15% stake as opposed to a controlling stake. Secondly, the holding period of modern activists is longer, 2 to 3 years. Thirdly, activists strive to increase the value of the company as opposed to greenmailing and other dubiously lawful tactics of the raiders. There are different approaches that activists use to implement their agenda, ranging from a friendly private conversation with the management to outright disruption of the corporate strategy and court battles. There is an ongoing debate about the net benefit of activism to the society. The proponents of activism argue that: (i) shareholders are the ultimate owners of the company and have every right to defend and express their interests, (ii) activists play an important role in identifying ineffective companies, bad management and opaque corporate governance, (iii) activists-investors receive gain only when the value of the company increases, this benefiting all shareholders. The opponents believe that: (i) activism forces the board of directors to focus on satisfying “near-sighted” shareholders instead of looking after the long-term value of the company, (ii) activism creates conflicts in the board of directors, leading to an atmosphere of hostility and lack of trust in the board and the company, (iii) activism has led to a decrease of investments in R&D, which will later result in lower economic growth. During the last two years both the number of activism campaigns and their success have significantly increased. A number of recent legislative initiatives in US should be able to further promote shareholder activism by giving shareholders more rights and facilitating a more open dialogue between investors and the management of the company. In Russia shareholder activism is still in its fledgling state. There are several reasons for that: -Weak defence of rights of minority shareholders -Smaller proportion of public companies -Short history of the Russian stock market -Concentrated ownership -High share of government ownership in public companies, with the government being traditionally hostile towards activism. However, the ongoing financial crisis might force rethinking of the current economic and political paradigm, leading to a friendlier environment for activists. In conclusion, shareholder activism is capable of generating higher returns. The recent rapid rise in shareholder activism seems to be caused by changes in US legislation, higher activity of institutional investors and the proliferation of hedge funds. The current financial crisis will force the management of public companies to pay more attention to proposals from shareholders, making activism as an investment strategy more attractive. Key words: investment activism, corporate governance, activism investing, activist hedge funds, pension funds activism