It’s impossible to read a newspaper, magazine or blog, or watch the news without hearing about shareholder activism. It’s an industry unto itself with activist funds, attorneys who represent activists, activist defense lawyers, activist-focused investment bankers, activist conferences, activist newsletters, activist databases, and, of course, there are Messrs. Bebchuk and Lipton.
As a former institutional investor turned corporate governance author/advisor, I regularly get calls from media, and am cornered after speaking engagements to talk about activists. It’s arguable that no topic in recent memory has been discussed by so many in the presence of so few facts. It’s eerily reminiscent of when cloud computing first overtook the technology vernacular. You know, when 8 out of 10 people who were earnestly discussing moving to the cloud, cloud infrastructure and so forth, had no idea what the “cloud” actually was.
At a recent corporate governance event where a veritable who’s who of institutional investors and respected governance aficionados were in attendance, I realized that most attendees had formed an opinion – “activists = good” or “activists = bad” – with little appreciation for the nuances of shareholder-board dynamics. Here’s my take on what many are missing.
The Good of Shareholder Activism
- Addressing deplorable governance. There are lots of exchange-listed U.S. companies with superior corporate governance (more than you might think given the dour reporting). That said, there are scores more with anywhere from ineffective to illusory boards. Nowhere is this more evident than where 74% of activist campaigns were waged in 2014 – small-cap companies. There are some activists that do a terrific job of constructively reorienting floundering boards for the benefit of all shareholders, and they should keep doing it.
- Collateral effects. The flood of capital into activism (north of $200 billion according to some reports) has had two helpful side effects. Public companies realize that if they don’t fix their corporate governance, it’s likely to get fixed for them (and, saliently, without them). It has also awakened many previously passive institutional investors to what others have known for years – better-governed companies are likely to outperform their peers.
- Globalism. Shareholder activism isn’t a U.S. phenomenon. Activist conferences around the world are bringing together directors, investors, academics, and service providers to exchange ideas about optimizing corporate governance in a way that’s never happened before. Not every practice in every country is exportable. But the rich dialogue will surely inure to the benefit of investors collectively.
The Bad of Shareholder Activism
- Novices. Despite recent media fascination, there is nothing new about shareholder activism. What is new is that many of those flooding into the strategy are arbitrageurs who have opportunistically rebranded themselves as activists to take advantage of plentiful new capital. Those with first hand experience with these ranks (this author included) see investors who sometimes know strikingly little about financials, operations, or corporate governance, and who (sometimes recklessly) fire off letter after letter, scream, and demand that every target put themselves up for sale immediately. While markets need arbitrageurs, yelling isn’t really an investment strategy.
- Reactions. Like it or not, activists are here to stay. Smart boards listen – really listen – to what activists have to say, discuss the same extensively with insiders and advisors, and come to reasoned conclusions (which may or may not be consistent with activist demands). Unfortunately, those boards continue to be in the minority. Much more common are boards that “engage” with activists, only to hire lawyers, communications firms, and proxy solicitors whether activist requests are reasonable or not. And then there are the boards that ignore activists altogether. Memo to board members: smart or not, activists rarely show up for no reason (i.e., investors are fed up with your stock being in the toilet, and you should be also).
- Myopia. Though there are myriad corporate governance professors and lawyers who are exceedingly bright, there is an increasingly unhelpful divisiveness between the “pro-activists” and the “board-centrics.” The binary approach makes no sense. Sometimes activists are right, and sometimes boards are right.
The Ugly of Shareholder Activism
- FOMO. There are intensely smart institutional limited partners (LPs) that invest in activist managers with track records of success. Then there are institutional LPs that are being forced by their constituents to chase “alpha” in an extended low interest rate environment. There also are LPs that thought it was smart in 2006 and 2007, for example, to invest gobs of money in investment firms, that miraculously all became renewable energy experts almost overnight, for fear of missing out on that craze. For insights into what might happen when you plow money into “activist-come-latelies,” those LPs might want to see how the renewable energy “experts” are doing a decade later.
- NDAs. Particularly among the swelling novice activist ranks that believe every underperforming company should be acquired, it would save an awful lot of time, money, and distraction if these investors would sign carefully crafted nondisclosure agreements with target companies at the front end of their interactions (I thought you were “long term” investors?). If they did, they might be able to avoid regularly (and embarrassingly) showing up at their first board meeting following a Sisyphean proxy contest only to find out that the company had been shopped numerous times by reputable investment banks unsuccessfully in the recent past on a confidential basis. Oops.
- Advisors. There are hundreds of lawyers, investment bankers, and consultants that advise boards about how activists think, and how companies can avoid being targeted by them. But there is a glaring problem with this blossoming industry that’s eluded scrutiny – the preponderance of those peddling this very expensive advice have no experience as institutional investors. Yup, all those boards are just purchasing educated (and not-so-educated) guesses. Would you hire a guy who occasionally hangs around with carpenters to build your house?
Guest Post: Adam J. Epstein advises the boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. He speaks monthly at corporate governance and investor conferences, and is the author of The Perfect Corporate Board: A Handbook for Mastering the Unique Challenges of Small-Cap Companies(New York: McGraw Hill, 2012). Publisher: The words are from Epstein. I added the links and graphics, including those wonderful Google ads.