Deal Professor Envisions Corporate Gadfly

Gadfly Proposals Reduce Value?

Deal Professor Envisions Corporate Gadfly

Starting with Corporations

Gadfly proposal on your corporate proxy? One implicit conclusion from a recent academic study is that you should short the company as soon as the SEC disapproves the company’s no-action request, since a proposal from a gadfly is likely to reduce the company’s value. Even though their intent is primarily to show why managers generally oppose proposals, that is the takeaway investment strategy one might conclude from a paper by John G. Matsusaka, Oguzhan Ozbas and Irene Yi entitled Why Do Managers Fight Shareholder Proposals? Evidence from No-Action Letter Decisions. (Why Do Managers Fight Shareholder Proposals, pdf)

Investors Skeptical of Gadfly Proposals

Researchers found a statistical correlation between Securities and Exchange Committee (SEC) staff decisions to block a no-action request and negative abnormal returns over the period of 2007-2016, “suggesting that investors agree with managers that these proposals are value-destroying.” “[O]ur main finding is that the market responded positively to the granting of a no-action letter.” “Investors are not particularly skeptical of proposals by unions and public pensions, but appear to view proposals by individual ‘gadfly’ shareholders as value-destroying.”

Possible Problems with the Research

Am I going to start shorting my stocks as soon as the SEC grants a no-action request? Of course not. The authors argue that managers fight shareholder proposals because they are value destroying. They think their event study of the “arguably unpredictable decision” by SEC staff to block or allow a proposal to go forward “can be interpreted as causal,” allowing statistically significant predictions going forward. After reading the evidence, I feel safe in predicting that no one will form a hedge fund based on no-action results on proposals from “gadflies.”

Their event study purports to show the market selling off shares in companies with shareholder proposals allowed to move to a vote from a corporate gadfly. However, the market is not some force of nature — it is made up of real people, making investment decisions. Do you know ANYONE who is selling off stock or shorting it on the basis that SEC staff denied a no-action letter? Find me a case. Let me talk to that person, if he or she still can afford a phone. Correlation is not causation.

The researchers find that companies only request a no-action letter for 31% of proposals they receive. Researchers write that managers seek no-action relief because “these proposals are value-destroying.” OK, so does that imply the other 69% are value-additive or at least value neutral? Seen in that light, shareholder proposals do not look so bad, since most move to a vote without an appeal to SEC staff.

I am a little confused by some of the numbers in the paper. On page 2, they write, “the SEC decides to grant a no-action letter permitting omission of about 67 percent of the time.” Yet, on page 4 they write, “the probability of being denied a no-action letter is 42 percent.” Looks like their universe is 109 percent, not 100 percent. In addition to the number issue, authors seem to believe the SEC makes these decisions. They generally do not. No-action decisions are decided by staff.

The authors discuss various other studies and appear to look most favorably on a one by Cuñat et al. (2012), which found an abnormal return of 1.3% on average for successful proposals on the meeting date. However, that study was limited by “not capturing the indirect effect that proposals have through negotiations,” given that 40% of proposals are withdrawn. Additionally, the study only examines governance-related proposals, not social or environmental proposals. In my own experience as a ‘gadfly,’ I normally withdraw a proposal when negotiations are successful, so that would just add more abnormal returns, as measured by Cuñat, conflicting further with the findings of Matsusaka et al. that gadfly proposals destroy shareholder value.

With regard to Matsusaka et al., I suspect the study underestimates the number of proposals settled, since the authors appear to believe ISS is aware of all proposals. They are not. I am routinely contacted by ISS seeking to learn what proposals I have filed. Frequently, I am too busy to respond. In many cases, neither proponent or the company informs ISS of a proposal. If it is negotiated away, ISS frequently never learn of the proposal.

Additionally, the Matsusaka study only finds statistical significance in the data on gadfly proposals because the numbers are robust only in that proponent category. However, the gadflies mentioned as most prominent with respect to number of filings (myself included) only submit governance proposals, so including social and environmental proposals in the study added nothing of statistical significance.

Another limitation of the study is that researchers exclude instances where SEC staff make more than one decision on a no-action request at the same company on the same day. Companies with multiple proposals might reasonably be more in need of the actions suggested by shareholders than those with only one proposal. Multiple issues may be symptomatic of poor governance, environmental or social problems.

Looking at the basic findings reported in Table 4, the authors note cumulative abnormal returns ranging from 0.23% to 0.89%, statistically significant at 1% level, where no-action letters were granted. They then dismiss mean annual return ranges from 0.05% to 0.63% that were found where no-action letters were denied because the numbers, although “puzzling,” were not statistically significant. Of course, that is because 67% of no-actions were granted, so the 33% denied leads to a smaller sub-universe for denials. Maybe the authors should be subtracting the denial scores from the granted scores to get a more meaningful measure?

I would not be so quick to dismiss this “puzzling” finding that investors seem to welcome both the granting of no-actions and the denial of no-actions in almost equal proportions. That should be a sign to look elsewhere for an explanation. Maybe companies targeted by shareholder proposals are more likely to experience abnormal returns? As one of the frequent filing “gadflies,” perhaps I am more selective than most investors in what I add to my portfolio. Since I only file at the 80 or so public companies where I own shares and those companies outperform the market, it is not so puzzling that issuers with both no-actions granted and denied show abnormal returns. Maybe gadflies are not so dumb.

When the authors analyze the results of their statistical analysis on specific proposal topics, such as creating the right to call a special meeting or lowering the ownership threshold for such a right, they frequently find results not statistically significant. However, it appears they cannot resist editorializing with statements such as the following:

There is no evidence that investors welcome increased proxy access; rather it seems they dislike it.

Again, maybe they should look elsewhere for explanations, since the same investors who appear to “dislike” proxy access based on market response (although infrequently statistically signifiant) also seem to be voting in favor of such proposals. Maybe proxy access is likely to be harmful to shareholder returns in the short run but beneficial in the long run?

Another minor criticism of the paper is the following statement: “[T]he SEC does not post or otherwise make public company requests for no-action letters.” It makes me wonder if the professors actually spoke with any practitioners. Such requests have been routinely posted on the SEC’s website under the heading Division of Corporation Finance Incoming No-Action Requests Under Exchange Act Rule 14a-8.

Unconvinced Gadfly

Given all of the above problems, I am not alarmed or convinced by the study’s findings that “investors consider proposals from individual shareholders to be value-destroying on average,” while the number of proposals from hedge funds, SRI funds, labor unions and public pensions are generally too few to allow for reaching conclusions based on statistical significance. Unlike the study, which looks at an event and measures the market response in terms of days, as a long-term investor I am more concerned with years and decades.

Unlike the authors, I doubt many investors are focused on the announcements by SEC staff of no-action decisions. However, I do believe that investors, at least smart investors, want to ensure they have a voice, at least collectively, in how their companies are governed. Stock with voting rights generally command a premium over stock without voting rights. I remain convinced that shareholders want proxy access, declassified boards, majority voting requirements to elect directors, the right to call special meetings, etc. Proposals to establish accountability mechanisms are gradually winning the day through shareholder votes in favor, even when the proposals are put forth by so-called gadfly proponents.

Author Feedback to the Gadfly

John G. Matsusaka

John G. Matsusaka

I sent a draft of the above post to the authors are received the following kind response from Professor Matsusaka:

Much thanks for sending along your reactions to our paper, and for reading it so carefully. The version you saw is our first working draft — we are now revising and your comments give us some good questions to try to nail down. As we tried to suggest in the title, we aren’t so much interested in trading strategies as in how the broad market views shareholder proposals. I confess to being somewhat surprised about what we found concerning “gadfly” proponents — the sort of governance proposals that they (you) usually sponsor strike me as having merit — but the data are what the data are, and I would have thought the market would embrace them. If you have have any other thoughts about why we find what we do, or suggestions in general, they would be most welcome.

This corporate gadfly responded as follows:

I do appreciate the fact that people are researching an important issue, although I doubt approval or denial of no-action has much measurable impact. I would still look to wether or not just having various provisions — classified board, proxy access, majority vote, special meeting, etc. — are associated with return on invested capital. Since you appear to have the data, you might try measuring further out… like a year or two. I know you are interested more in how the broad market views shareholder proposals but the market is made up of investors. If investors really thought such proposals reduced value, not only would they vote in against them, they would short companies with such features. 

James McRitchie

James McRitchie

In my experience, I may have to file the same or similar proposal for many years at a company before it finally passes. Once it passes, it is infrequently revoked. It is just like any other fight for democratic rights. Once Blacks are given the right to vote, it is hard to take it away (although not impossible, as we can see from recent passage of voter ID laws and other such barriers). 

One of my current battles is over improving proxy access provisions once adopted. For example, it may have been a tactical blunder to initially agree to a 20 member cap on nominating groups but both Scott Stringer’s staff and I felt it was important to get some initial wins. Now, I’m going back in a mop up effort to ensure proxy access is actually workable. We have been successful in moving from provisions allowing nomination of 20% of the board to 20% or 2, whichever is greater.  Anyway, the point is that bylaw provisions evolve. Most boards and most in charge of proxy voting for institutions just want to stay in the middle of the pack, so any shift on the fringe takes time. There may be many votes against before there are votes in favor. 

Of course, this is all aggravated by the fact that most retail shareholders don’t vote, when they do vote they often leave items blank (which get automaticaly filled in as votes for the board position), and when they do vote they almost always vote with the board’s position. When I speak to people, their rationale is that they bought the stock because they like the company… so they vote in favor of whatever the board recommends. If they become in any way displeased, they sell. They will spend days researching companies to buy, not so much time to sell…. but are unwilling to spend any time at all to research the issues surrounding proxy votes. 

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