Rose, Paul and Sharfman, Bernard S., Shareholder Activism as a Corrective Mechanism in Corporate Governance (September 11, 2013). Ohio State Public Law Working Paper No. 225. Available at SSRN.
Research Issue: How can activism be utilized to allow corporate decision making to be executed in the most efficient manner?
Findings: Managerial capitalism is fighting a rearguard action against shareholder-centric capitalism. While insiders have advantages with regards to having superior firm-specific information, offensive activists may possess superior information regarding competitors or other important inputs. Studies have demonstrated most hedge fund activism yields a short-term run up in stock prices, with little or no evidence of abnormal negative returns over a five year period.
Implication: There is little, if any, empirical research supporting the idea that activist hedge funds are out for short-term profits to the detriment of long-term shareowners.
Takeaway for Practitioners: “It is hard to understand the logic in having a two or three year holding period that favors passive investors such as liquidity traders over information traders such as offensive shareholders activists. For example, what makes investors who have held large amounts of company stock for 20 years in one or more portfolios using passive strategies, and therefore do not analyze information about the company targeted for proxy access, more qualified to utilize proxy access than investors who have held company stock for six months but made their decision to invest based on fundamental analysis and the desire to implement significant change at a corporation?”
Rose and Sharfman review recent history and the empirical research to arrive at several important conclusions:
- Most of the battles occur not in the “market for corporate control” described by Henry Manne but in the “market for corporate influence.” While boards remain in control and are usually resistant to demands from shareowners, in discrete situations authority is at least temporarily shared.
- Shareowners can be usefully categorized as insiders, liquidity traders, noise traders, market makers, and information traders. Information traders who, unlike traditional “value investors” are willing to devote substantial resources to their efforts are in essence “the agents who render markets efficient.” “Offensive” shareholder activists, such as hedge funds, are proactive, while “defensive” shareholder activists, such as most pension and mutual funds are generally defensive, advocating for change only when company fortunes decline.
- Studies by Boyson and Mooradian, and Brav, Jiang, Partnoy, and Thomas have demonstrated that the short-term run up in stock prices after hedge funds file a Schedule 13D persists for at least a year. A more recent study by Bebchuk, Brav and Jiang shows no abnormal negative returns over a five year period. No study reviewed provides conclusive proof that proxy access or any other change pushed by activists will add value at any specific company but the evidence suggests most won’t result in losses.
- Strategies advocated by offensive shareholder activists, such as sale of the company or changes in business strategy have generally enhanced shareowner value, whereas there is little evidence that the normal corporate governance reforms offered up by pensions have enhanced value. Still, I believe these more modest governance reforms enable hedge funds to gain access.
- General research offers no proof that activism will add value “at any specific company at any specific time” and activists bear a higher burden in overcoming the presumption in favor of the board because of their inside information.
Boards may have inside information and they may be in the best position to evaluate other board members but they may know little about their competitors and might be unwilling to take the necessary steps to evaluate and renew their membership. A recent PwC survey found that thirty-five percent of board members surveyed say someone on their board should be replaced (compared to 31% in 2012). The top three reasons cited are diminished performance because of aging, a lack of the required expertise and lack of preparation for meetings.
The same survey found replacing a fellow board member can be difficult; nearly half of directors (48%) cite impediments to doing so. The top reason given, and cited nearly twice as often as any other factor, demonstrates the importance of board leadership. Specifically, the directors said that board leadership is uncomfortable addressing the issue. It makes me wonder, if they are such wimps on this issue, what else are they afraid of? Aren’t they also likely to be wimps in dealing with an underperforming CEO?
My own takeaway from Rose and Sharfman is that there is far too much fear of hedge funds and activists. With regard to proxy access, I now see even more advantage to having it available at every firm. I don’t see why shareowners should sit back and let their companies fail to realize their full potential because directors are uncomfortable confronting serious issues. We can’t wait 2-3 years to take action while the value of our corporations crumble. We must be proactive. I like their argument for nothing more than perhaps a six month holding period for proxy access proponents. Let’s hope proxy advisors and the large institutional investors influential in setting corporate governance “best practices” wake up and examine the evidence.