Home > Investor Participation > On the benefits of Shareholder Engagement

On the benefits of Shareholder Engagement

On November 9th 2012 I wrote a post on Blockholder Disclosure: a case for transparency or for monitoring benefits?, where I gave arguments for and against a proposed regulation in the USA to limit the power of activist investors to hide their stakes, (both in volume and disclosure delay). Also on September 22nd 2012 I wrote about the engagement concept in my post Engagement: concept, objectives, and phases.

It is now time for Canada to think of an initiative similar to the one in the USA, and proponents advocate for a disclosure obligation once a shareholder reaches 5%, (instead of the previous 10%), in a lapse of two days, (full disclosure, not just a press release, which they ask to be required immediately).

As s response for the Administration`s requirement for comments, two associations of the institutional investor community (Managed Funds Association and Alternative Investment Management Association), sent a letter which shows their discontent with the measures, and in particular refers to:

1.     Benefits of shareholder engagement,

2.     Regulatory history and comments on the effects of the previous regulation,

3.     Regimes in other countries,

4.     The substance of the proposed changes, and their view.

We will in this post refer to the first part of their commentary, the benefits of shareholder engagement, thus the reasons why their economic incentives should be preserved. But we will just make a quick commentary on the different systems applied in the main financial economies.

1.     Different regulatory regimes.

United States. Section 13 of the 1934 Act establishes a 5% reporting threshold, and obligations to disclose plans by the acquirer in a 10 day period, during which shareholders are not prevented from dealing with shares, and further increase their stake, so their economic incentive in engaging with the company. Only derivatives granting the right to acquire the beneficial ownership of shares in 60 days need to be disclosed and included in the percentage calculations.

United Kingdom. The threshold is 3% for UK issuers, (5% for non UK ones). It applies to all shares, whatever their class, (it is not applied within each share class). The maximum delay is 2 days for UK issuers and 4 days for UK issuers, but the wording refers to the moment the acquirer is aware of the fact, which allows for some more time. Disclosure is just for the fact, not the plans, and there is no prohibition to trade in any period. Derivatives are counted if they give the right to acquire shares, or the right to vote.

Australia. It refers to relevant interest upper then 5%, so that it leaves aside most derivatives not entailing the power to dispose of the share or the vote. The acquirer has 2 days for “a soft” disclosure after being aware of the fact, with no moratorium on trading.

2.     Benefits of shareholder engagement.

Engaged shareholders exchange views and management recommendations with managers and boards in the investee companies; they monitor management, and are a tool against the agency problem, thus adding efficiency to the way companies are managed, and increasing their performance and value creation.

But before considering their benefits and costs, we will explore their objectives.

What are their objectives?

They look for under-valued companies in which to invest their funds, acting so that the market anticipates changes and corrects the undervaluation, thus generating a profit. Their engagement can be reactive, (when an otherwise passive investor accumulates concern, so that instead of selling it calls for change), or proactive, (where an investor has identified an inefficient company, has bought a stake and has called for change). In both cases the usual way to do things is through quiet conversations.

They usually own a minority stake, so that they usually target companies with enough institutional investor power, from which they try to obtain support. Proxy contests that pursue the substitution of directors are costly and thus rare. Successful activists obtain support for their reasoning on the change needs, and do it in a long-term and value perspective that guarantees the support of a majority of shareholders.

What are the benefits of engagement?

The most relevant are:

·       They provide a check on management that other investors, (retail or passive institutional investors) do not provide, so that they force efficiency and shareholder value up.

·       They push for improved corporate governance: they help not only targeted firms, but all others that consider they could eventually be the target of an “attack”.

·       Superior returns on investment: the market clearly recognizes a probability that share price or any other metric, (like TSR), increases after an activist campaign takes place.

·       Improved productivity: Roa and other operational metrics are said to improve as a result of activism, as some studies demonstrate. More relevantly, those improvements use to be preserved in the long-term.

·       A more efficient asset allocation: activists use to have a deep capital allocation experience, which benefits target firms. They help firms divest and refocus, and particularly help them match divisions with the correct expertise.

In summary, targeted firms reduce their size and improve their productivity KPI`s such as Roa and others.

What are the costs of engagement?

Costs of engagement include reputational risk, transaction costs, brokerage costs, legal fees, communication and printing costs, and the costs of soliciting the support of fellow shareholders. In the USA a campaign ending in a proxy contest can reach a cost of $11 million, (this is an average, but there is quite a lot of dispersion in figures). Of course, activists have previously afforded research costs.

This is why activists ask for enough time to accumulate a large enough stake with which to make a large profit that offsets all costs. The sooner they are forced to disclose their stake, more difficult for them is to make that profit.

Do all shareholders benefit from engagement, or is there any discrimination that should be dealt with?

In principle, engagement benefits activists if they succeed to convince enough shareholders, or simply if they make a decent profit; also, stable shareholders who remain in the company after the attack absorb their share of the long-term value unveiled; as for shareholders selling their shares to activists, the doubt that they can be harmed is slightly unfair, as they obtain a price which in any case is higher, due to the bidding pressure by the activist investor.

At the end, who is negatively affected?

Managers in inefficient firms, mature firms not adapting soon enough to market changes, are generally the only ones to suffer from the activist shareholder practice. This should not justify their protection against the huge benefits cited above.

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