Shareholder Activism: The Success of Few for the Few
In 2018, activist shareholder campaigns increased to a record high, with about 250 campaigns initiated over the year (up from about 210 campaigns initiated in 2017). (Gail Weinstein et al., Harvard LawSchool). Institutional investors – such as pension funds, insurance companies, endowments, banks, and hedge funds – have initiated public campaigns to attempt to influence companies and management. (Yuliya Ponomareva, Forbes). These institutional players typically own a greater percentage of companies relative to individual minority shareholders and have more leverage, capital, and incentive to pressure management to take certain actions. Such investors tend to focus on issues related to corporate governance, such as replacing management, dividend payouts, new board of director appointments and executive compensation; however, unlike previous cycles of shareholder activism, environmental and other social issues are also becoming common platforms.
The Securities Exchange Act of 1934 (the “Exchange Act”) regulates activist shareholders and the companies pressured by such shareholders. Under Section 13 of the Exchange Act, activist shareholders must comply with beneficial ownership reporting requirements, which generally require an investor who has acquired ownership of more than five percent of an outstanding class of voting equity securities to report certain information to the Securities and Exchange Commission (the “SEC”) (Trevor Norwitz et al., Lexology). Such information includes the amount of the securities beneficially owned and aggregate beneficial ownership percentage, whether voting and investment power is held solely by the investor or shared with others, the source and amount of funds or other consideration used to purchase the securities, the purpose of the acquisition, and any plans to change or influence the control of the issuer (Arthur L. Zwickel & Alicia M. Harrison, Paul Hastings). This requirement can warn companies about the voting power and intentions of potential activist investors. On the other hand, companies must comply with the disclosure requirements of the Exchange Act in their periodic disclosure and annual meeting proxy statement disclosures, which provide shareholders a minimal degree of transparency and the opportunity for activist shareholders to take action on company positions they view unfavorably (Trevor Norwitz et al., Lexology).
Recent well-publicized proxy victories have seemingly bolstered activist investors. The appointment of Nelson Peltz of Trian Fund Management to the board of Procter & Gamble (“P&G”) is recognized as a victory in one of the most prominent and expensive proxy fights in history. (Yuliya Ponomareva, Forbes). After acquiring a $3.5 billion stake in P&G in 2016, Trian pushed P&G to include a Trian representative on the company’s board (Id.). P&G’s management and directors had actively resisted those efforts and initially managed to block Peltz’s bid for directorship (Id.). Trian challenged the decision and published a white paper addressing Peltz’s proposed strategy for P&G. With both sides having spent millions of dollars on this proxy battle, Peltz’s bid for directorship finally passed narrowly (Id.).
While P&G may signal an era of companies having to deal with more challenges concerning their strategy and management, it also indicates that individual shareholders or minority investors may not be as successful, as they likely have less incentive and financial ability to bear drawn out and expensive proxy battles than institutional investors, such as Trian. Earlier this year, a proposal backed by more than 7,500 Amazon employees asking Jeff Bezos to create a comprehensive climate-change plan for the company failed when put to a shareholder vote. (Emily Stewart & Alexia Fernández Campbell, Vox). Notably, Amazon formally recommended shareholders vote against it (Id.). It remains unknown whether this pressure on the retail giant—employees have stated their intentions to introduce the initiative again next year—will be effective, as the incentives for a company as powerful as Amazon to defeat it are great. Out of a dozen shareholder proposals Amazon stockholders voted on this year, all of them were rejected (Id.). Not only are such initiatives difficult to pass, but even if passed, the effectiveness of an environmental plan or report can be questionable. Most shareholder proposals, even if passed, are technically non-binding and simply recommend board action, “but companies see them as a first step on the road toward real limits on their activities, and ultimately their profits.” (Lydia DePillis, CNN). Because of this reasoning, most companies are uncomfortable with and oppose shareholder initiatives and activism generally.
The resurgence of shareholder activism seems to be cause for concern, particularly when considering the effect of activist institutional investors on other minority shareholders. JPMorgan Chase has introduced a new analytics tool to offer its clients insight on which investors may pursue an activism strategy and how to avoid activist investors. (Laura Noonan, Financial Times). The tool aims to predict how investors may influence other shareholders by analyzing factors including how much cash a company holds or how activists have behaved previously. (Id.). “The system can isolate which shareholders are likely to support a given activist’s approach…and which are likely to sell their stakes if a given activist joins a company’s share register.” (Id.). However, companies and their advisors are not the only parties resisting the activist push. The coalition of the Business Roundtable and the Chamber of Commerce's Center for Capital Markets Competitiveness has been promoting legislation that would raise the threshold of support needed to re-submit a failed shareholder proposal. In addition, they are pushing the SEC to more tightly regulate proxy advisers (Lydia DePillis, CNN). Proxy advisers made independent recommendations as to how shareholders in a public company should vote on matters requiring shareholder approval (The Activist Investor). In order for an activist investor to get a proposal passed, they will likely need the support of Institutional Shareholder Service (ISS), Glass Lewis, or both, as the two firms are recognized as the main proxy advisers in the United States (Id.). These proposed changes would limit the number of shareholders who can vote, and would give companies more influence over proxy advisers’ recommendations to shareholders, thereby limiting adviser independence (Lydia DePillis, CNN).
The effectiveness of shareholder activism as a whole, at least in terms of its correlation to profitability, remains questionable. Though activist funds can be very profitable, recently most underperformed market indexes. “According to the HFRI Activists Index produced by Hedge Fund Research, Inc., the return to investors in activist funds in 2018 averaged -10.53% (while the average return for hedge funds overall was -6.09%). These results significantly lagged the returns of the Dow Jones Industrial Average (-3.48%) and the S&P 500 Index (-4.39%).” (Gail Weinstein et al., Harvard LawSchool). Not only does effective shareholder activism remain outside the grasp of most individual investors and minority shareholders, but the activism amongst institutional investors remains concentrated with certain large activist funds. (Id.). “In 2018, one activist (Elliott) alone accounted for 10% of the total number of new public campaigns; and the top five activists (measured by the number of new campaigns launched in 2018) (Elliott, Gamco, Starboard, ValueAct and Icahn) accounted for almost a quarter of the campaigns.” (Id.).
However, initiatives that target shareholder social causes, which are likely not proposed by institutional investors, may become the new concern for companies due to their potential to incite negative public perception. According to Sustainable Investments Institute, shareholders proposed 464 proposals in 2018 and 494 proposals in 2017 aimed at addressing social or environmental issues. (Lydia DePillis, CNN). Although there was a slight decrease in 2018, the number of proposals that were withdrawn increased dramatically, following quiet deals with management to accomplish some of the goals of the proposal without going to a public vote. (Id.). An increase in companies making under-the-table deals to avoid a vote and publicity on shareholder initiatives may indicate that the rise in shareholder activism presents an opportunity to those seeking to impose business social responsibility on traditionally unwilling companies.