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The basics of shareholder activism and why it manifests.
As the first of a three-part series which will answer the question “What is Shareholder Activism?”, this article will aim to set out the foundation of activism, and why activism happens.
Importantly, this series will only address economic (or value) shareholder activism. “ESG” activism, which may be motivated by an agenda other than maximizing shareholder value, is not covered.
The foundation of shareholder activism relies on the acceptance that a company should be run in the interests of its owners - shareholders. More recently this view has broadened to include society. However, from a legal perspective in most jurisdictions, and the rights afforded to shareholders to hold company directors accountable, the fiduciary duty to the owners of a company remains front of mind.
For a publicly listed company, shareholders can have a broad diversity of views. However, one common interest is held above all others – investments must generate returns.
This drives all investment decision making, and many of the world’s largest institutional investors also embed this language into their approach to stewardship, and in assessing individual vote decisions at contested situations. As referenced in AQTION, the following investors communicate this message:
Activism is a catch-all term used to describe the actions taken by those active investors who, when their investments are not meeting the standards demanded, apply pressure for change.
All active investors defending their investments could therefore be classified at some point as activists. Those most commonly referred to under this moniker, however, are investors with highly concentrated portfolios who apply this pressure more frequently, and to a much higher degree – a group dominated by activist hedge funds.
Some of the most notable activists are some of the most potentially aggressive – Third Point, Elliott Management, and TCI. However, especially with the emergence of the focus on governance, companies have increasingly been targeted by traditional long-only funds – EssilorLuxottica is a prime example.
Institutional investors are in continual engagement with their portfolio companies on issues ranging from strategy, capital returns, sustainability and governance. However, the intensity of these conversations varies from investor to investor, and from company to company. Higher pressure engagement and the potential for activist investor to emerge comes from (for the most part) relative underperformance and perceived complacency.
Investors will single out a portfolio company by taking issue with share price performance and capital returns (together known as Total Shareholder Return) and other key financial metrics against those of a peer group. In effect, focusing on this issue raises the question “is the board acting in shareholders’ best interests?”, i.e. is shareholder value being prioritized?
This is the basic concept on which all activists will launch a campaign. This is underlined by the influential proxy advisor, Institutional Shareholder Services (“ISS”). The first assessment when determining whether to support an activist’s demands or not is “Company performance relative to its peers”. More information on proxy advisor behavior and decision-making processes can be found on AQTION.
This point is simple and important. Economic (or value) activists are increasingly drawing the connection between poor financial performance, poor sustainability records and poor governance. However, poorly governed companies or those with questionnable sustainability records will rarely be targeted by economic activists unless they begin to underperform.
The best defense against economic activism is a strong share price (and probably not a poison pill). Companies under attack may try to achieve this reactively, however, reactive actions tend to be viewed with skepticism from most investors and can cause more harm than good.
Relative underperformance can be the result of a number of issues. Companies can expect the following rationale to underpin stronger engagement from active managers and potential activists:
An activist’s full rationale for approaching a company will likely contain a combination of these criticisms, and they will inform the demands made to promote better performance.
Notably, the criticisms may also be shared by other institutional investors. Given that activists are seeking the same ultimate goal as institutional investors – to increase shareholder value – issues raised by activists will often have been made aware to a company by one or more of its “friendlier” investors. This demonstrates the significant value to be gained by companies through their engagements with active investors, and, therefore, the need for this exercise to be made as effective as possible.
With the appreciation that the pool of potential activists sit within the active investment strategy, activists should be initially treated as an engaged active manager. Activists at the beginning of engagements are seeking the same outcomes as other active managers – a deeper explanation for decisions being made, and responsiveness to concerns raised.
If the company fails to reach this alignment with an investor, and friction begins to increase, various tactics and escalations can be implemented on both sides. These topics will be covered in the second article in this series.
Authored by: Will Samuels and Andrew Brady of SquareWell Partners
