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  • Shareholder Activism Background Literature Review

    IMD: 35+ YEARS OF BOARD E D U C AT I O N E X P E R I E N C E

    Prof. Dr. Didier Cossin & Dr. Jose CaballeroJuly 2013 IMD, All Rights Reserved

  • Background .......................................................................................................................5

    The Landscape ...............................................................................................................5

    Activists .....................................................................................................................5

    Motivations ................................................................................................................5

    Demands ...................................................................................................................6

    Strategy .....................................................................................................................6

    Firm Responses .......................................................................................................6

    Impact .......................................................................................................................7

    Lessons .....................................................................................................................7

    Frequency, Objectives, Strategies and Success Rates of Activism .................................8

    Activist Performance and Target-Firms Performance ................................................. 10

    Appendix 1: References .................................................................................................. 12

    Appendix 2: Selected Abstracts .................................................................................... 14

    Table of Contents

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    I. Background

    Shareholder activism refers to the active influence on firm policy and practices through the use of ownership

    position (Sjstrm, 2008). It enables shareholders to exercise and enforce their rights to enhance shareholder

    value in the long-term (Low, 2004). Activism can be conducted via direct dialogue with corporate management

    or the board, during open sessions in corporate general meetings, writing open letters or by filing formal

    shareholder proposals (Sjstrm, 2008).

    Activism can be defensive or offensive (Armour and Cheffins, 2012). Defensive activism takes place when

    investors holding a stake in a company (e.g., pension funds and mutual funds) become dissatisfied with

    corporate performance or corporate governance practices and thus react by lobbying for relevant changes.

    This can be done behind the scenes or publicly challenging management; for example, activists can propose

    the election of directors they support. This type is defensive in the sense that activist seek to protect pre-

    existing investments. In offensive activism investors lacking a substantial stake in a company, build up their

    holdings offensively on the assumption that organizational changes will overcome failures and, thus, maximize

    shareholder returns. Investors will agitate for change if management does not react and take the initiative.

    Shareholder activism follows evolutionary patterns (Graves et al., 2001). Issues can follow different paths over

    time; some can arise and decline abruptly, others can remain substantially important without resolution or

    disappearing over relatively long time. This pattern may depend on the shifting regulatory environment or on

    factors that are internal to the company.

    II. The landscape

    Activists

    Activism can be a single minority investor or a block holder, or they can be institutional investors with

    majority stakes in the organization (Judge et al., 2010). Among the latter are pension funds, mutual funds and

    hedge funds (Armour and Cheffins, 2012). In addition, labor unions and labor affiliated organizations can act

    as shareholder activists (Prevost et al., 2012). Sovereign wealth funds act also as activists (Ghahramani, 2013).

    In a wider environment, observers identify an activist shareholder community (Logsdon and Van Buren III,

    2008). This is primarily composed of non-profit, nongovernmental organizations. This community advocates

    for social issues, broadly defined, and it includes religious, environmental, labor organizations, and interest

    groups. The aim of the community is to influence corporate behaviour.

    Motivations

    The motivation behind shareholder activism can be financially driven or socially driven (Judge et al., 2010). This

    type of activism focuses on the financial performance of companies and seeks to pressure management for

    an improved portfolio performance.

    SHAREHOLDER ACTIVISM

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    Financially motivated activists can be entrepreneurial (as elaborated by Klein and Zur, 2009). These activists

    include asset management groups, hedge funds, private equity funds, and venture capital funds that are

    differentiated by their investment strategies. Individual investors are also included among entrepreneurial

    activists. Entrepreneurial activists are independent from corporate and financial power structures. Thus

    they experience lower levels of risks in terms of economic or political reprisals. They are able to operate

    through small entities, such as investment partnerships, which also limit their levels of risks and provide

    them with significant control over the investment strategies they adopt. Entrepreneurial activists are relatively

    undiversified and can risk a relatively large proportion of [their] wealth on individual ventures ... are wholly

    unrestricted in how they can invest in terms of diversification, illiquid assets, short-selling, and leverage.

    Moreover, they do not need to have the necessary capital to cover redemptions and they are able to restrict

    investors if the latter attempt to exit their funds. Finally, entrepreneurial activists are exempt from disclosing

    their investment strategies, short-selling positions, or leverage ratios. As a result, entrepreneurial activists

    have employed the stock-lending or derivative markets to acquire voting rights without owning a long

    position in the companys underlying stock. This allows them to acquire voting rights in a target company to

    support a threat of an imminent proxy fight.

    Socially driven activism focuses on economic equity issues and seeks more justice in society; particularly, when

    the latter aligns with the financial interests of the activist (Judge et al., 2010). CalPERS activism, for example,

    advances in parallel a financial and a social agenda. Socially motivated activist may include the shareholder

    community or non-profit nongovernmental groups including religious, environmental, labor organizations, and

    interest groups that pursue social issues for principle-based purposes (Chung & Talaulicar, 2010).

    Demands

    Activists demands can be related to the companys strategic direction and its alternatives. For example, the

    sale of the company to a third parties, the firms operational inefficiency, and restructuring. Demands can also

    be made about the companys capital structure; for example, about dividend, debt restructuring, or the firms

    recapitalization. Activists could also advocate opposition to proposed mergers. Antitakeover-related demands

    could include a vote on golden parachutes. Demands can also focus on corporate governance matters such as

    CEO dismissal, the separation of the CEO/Chairmans roles, increase board independence, excessive executive

    compensation and additional disclosure (see Gantchev, 2013; and Prevost et al., 2012).

    Strategy

    Some of the most influential activities are lobbying activities, and media and judicial activities (Girard, 2011).

    For example, activists may seek media coverage of the issues that they advocate; judicially, activists can file

    civil law suits or class actions.

    Firm responses

    Organization can react proactively and engage in a direct dialogue with activist groups. Companies can assume

    an accommodative position in which the activists resolution is withdrawn because of the firms acquiesce to

    demands for corporate policy or behavior changes. Others react defensively and allow the resolution go to a

    vote by all shareholders. Finally, company can be reactive by requesting the omission of the resolution to the

    relevant authority (e.g., the SEC) (see Logsdon and Buren, 2009; and Rehbein et al., 2013).

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    Impact

    Some observers are optimistic about the effectiveness of activism. Hedge fund activism, for example, has been

    found to result in increased dividend pay-outs, and improve firm financial performance (Brav et al., 2008).

    Other observers are inclined towards a sceptical position (Sjstrm, 2008). Arguably, the effectiveness of the

    impact of shareholder activism depends on the targeted companys culture, the power and influence of the

    activist group and the political climate in which the resolution is filed (Hoffman, 1996).

    Lessons

    On the one hand, companies may take two lessons from engaging activists in a direct dialogue (Logsdon &

    Buren, 2009). First, engaging activists show that firms take seriously the concerns of their critics; and second,

    mutual understanding and expertise can positively converge by participating in such dialogues. On the other

    hand, activists assuming a conciliatory position may