Shareholder Activism: New Wine in New Bottles
It seems that every day brings news of another shareholder agitating to change a company’s strategic direction. Campaigns at eBay, Apple, ThyssenKrupp, Men’s Wearhouse, CommonWealth REIT, Abercrombie & Fitch, and Itaú Unibanco are a few recent examples where activists have pressed their case for change.
“Shareholder activist” is an old term with many meanings. It is sometimes used to evoke images of hedge-fund “barbarians at the gates” who represent only their own short-term interests, ready to damage companies for the sake of a quick profit. At other times it is intended to conjure forth the idea of a lonely governance gadfly riding his hobby-horse, or a pension fund representing some “special interest.” It is becoming clear, however, that today’s “activists” are a far broader group, looking more and more like owners and less like barbarians or gadflies. Activism has changed – in its goals, in its tactics, and in its reception from the broader body of institutional shareholders.
There are four interlocking trends that help illustrate and make sense of this transformation:
The activist agenda has changed – and broadened. Activists are looking more seriously at issues of corporate governance and paying more attention to longer-term value creation. To be sure, much activism is motivated by the thought of returning some of the record levels of cash on company balance sheets to shareholders, or taking advantage of relatively easy credit to fund share buybacks and dividends. This kind of “balance-sheet activism” is just one of the strategic objectives of activists, however; many activist campaigns focus on more operational issues, such as cost control and product focus, that they believe will generate longer-term value. Still more activism focuses on governance issues – the qualifications and focus of board members, for example, and the processes by which the board and management operate.
Activists do not always get it right, as examples like Pershing Square’s stinging losses at J.C. Penney or Herbalife illustrate. And activist interests are not always aligned with long-term shareholders. Notably, activist focus on increasing stock price or returning money to shareholders via share buybacks or special dividends can threaten – in some cases – to divert a company’s resources away from longer-term investments. At the same time, research from Harvard’s Lucian Bebchuk, among others, into the outcome of shareholder activist situations finds a positive relationship between activist campaigns and longer-term operating performance. At bottom, activists are proposing that companies take risks, just as incumbent boards and management do. They are just proposing a different bet. What activists do add to the mix, however, is that they force both sides to argue these different bets before shareholders.
Activist tactics have evolved. With funds flowing to activist strategies, activists have been able to take on bigger targets. For instance, Apple, one of the largest companies in the world by market capitalization, was the subject of successive campaigns to unlock its enormous cash hoard for shareholders. That activists can take on a $500 billion company – and be heard in the process – speaks volumes about the reach of current activism.
This reach is extended by some new plays in the activist playbook. Letter-writing and jawboning campaigns are still important, and we still see proxy contests such as at CommonWealth REIT, where the full board was removed. But activists have increasingly turned to partial proxy contests with short slates of directors, campaigning not for control of the company, but for a seat or two in the boardroom. This approach has appealed to many investors who might fear unseating management or changing control, but may see little harm or positive benefit in putting an alternative voice in the boardroom. This in turn raises the pressure on companies to settle with activists, providing a seat or two on the board rather than continuing to fight.
Some recent shareholder campaigns have taken this soft-sell approach even further, proposing that advisory votes on key strategic issues be put to shareholders, rather than (or in addition to) the blunter instrument of board nominations. Last year’s campaign by CalSTRS and Relational Investors at Timken was notable in this regard, yielding a shareholder vote that set the company on the path of splitting up. Carl Icahn has borrowed from this idea at eBay, where he is nominating directors and proposing an advisory vote to split off eBay’s PayPal subsidiary. At Darden Restaurants, Starboard Capital wants a shareholder vote on the divestiture of the restaurant group’s troubled Red Lobster chain. At the same time, shareholder focus – from activists across the spectrum – has remained squarely on directors, with notable shakeups at Hewlett-Packard and JPMorgan Chase in 2013.
Companies are less insulated from shareholders. Takeover defenses and other devices that insulate boards have dramatically declined over the past decade. Classified boards are well on the road to extinction within the S&P 500, where most firms also have a form of majority voting. Poison pills have become scarce everywhere. To be sure, these changes do not leave boards naked before their perceived enemies; poison pills, for instance, remain a potent defense that most companies keep on the shelf, and few directors actually leave boards even after they have been rejected by a majority of shareholders. But together they do raise the general level of accountability from boards of directors to their shareholders.
An additional and perhaps unexpected wild card is say on pay, which has spread to most developed markets. Pay is typically a secondary focus, if at all, of activist campaigns. But directors pay an enormous amount of attention to pay votes, and the result has been more engagement between directors and their investors, including on issues beyond compensation. This means that directors have the opportunity to hear directly from their shareholders regarding which issues are of concern, and to better understand where activist campaigns might resonate.
Shareholders are listening. Activist campaigns have resonated for many investors. Part of this is driven by long-term trends affecting institutional investors: greater attention to proxy voting, but also greater levels of shareholder engagement with companies and a keener sense of the responsibilities of ownership and stewardship. As a result, many investors no longer see the “Wall Street Walk” – selling shares – as the primary way to assert one’s ownership rights.
The rise of passive investing plays a role here as well. Investors have become more willing to hear out dissident arguments, especially when these arguments seem to be the best chance at long-term value creation at a firm. When dissidents can make their case, these large investors are increasingly ready to support their calls for change.
Perhaps the word “activism” no longer accurately describes these investor campaigns. Activism has taken its place alongside – and indeed, overlapping with – other well-known ways by which the owners of companies exercise their oversight over boards of directors and hold them accountable, together with familiar mechanisms like board elections, proxy voting, shareholder proposals, traditional engagement, and litigation. The owners of companies may find they need any or all of these mechanisms to protect and forward their interests.