Management, Activists, and Long-Term Shareholders

The WSJ article discussing a hedge fund funded in part by CEOs had a number of interesting observations with respect to the relationship between management and shareholders.   

  • the dynamic between shareholder activists and companies has evolved in recent years. Companies were once loath to entertain the suggestions of shareholder activists. More recently, managements have generally become more receptive to, or at least resigned to, these investors’ influence. Also, traditionally long-term shareholders, such as pension and mutual funds, have become more supportive of activist campaigns.

For the most part, hedge funds labeled activists do not purchase a controlling block of stock.  To implement their ideas, therefore, they must successfully convince management to do so.  To the extent that management declines, implementation may require a new board (or at least a portion of the board).    

Shareholders with a large but not controlling block can only achieve this goal if they convince other shareholders, particularly long term shareholders, to go along.  Thus, in companies where shareholders "have become more supportive" of activists, the threat of replacing at least some of management is real.

But in that statement rests management's best strategy.  The view that management has become more receptive to activist influence has two possible causes:  First, the activist is correct and management agrees with the approach.  Second, management does not agree but knows that it has already lost the long term investors, thereby giving hedge funds the room to successfully change some or all of the board.  

In the latter case, therefore, the best strategy would be to maintain strong relationships with long term shareholders.   To the extent that they do so, the ability of hedge funds and other similar investors to change management is reduced. In Britain, the chair of the board acts as a communication channel with institutional investors. The chair in this country has no similar role.  Moreover, too many boards still view shareholders collectively as a nuisance, a group that should be seen but not heard.    

The recent efforts to defeat shareholder access proposals by putting up bylaws that effectively prevented shareholder access is an example of this arguably self-defeating approach.  Shareholder access is designed to provide a modest opportunity for long term shareholders to have access to the company proxy statement for their nominees.  Few long term investors will ever actually exercise the authority.  They don't want to incur the costs of a contest and, in fact, they don't really want to participate in the active management of the company.  The authority is at its best as an unused threat, causing directors to be more aware of the interests of long term shareholders as a means of avoiding an actual contest.  

Yet rather than support the efforts of these investors, many companies have opposed them and sought to introduce proposals that effectively negate shareholder access.  When the activist shareholder arrives and long term shareholders prove "more supportive" of their views, the reason will not be difficult to figure out.   

J Robert Brown Jr.