Home > Shareholder Activism > Is shareholder activism in controlled firms possible?

Is shareholder activism in controlled firms possible?

We recently refered to this in our recent post (1), when analyzing the evolution of activism and particularly in Europe where controlled companies are common.

This is the question to which Kobi Kastiel, (a Fellow of the Program on Corporate Governance, and Terence M. Considine Fellow at the Center for Law, Economics and Business, Harvard Law School), tries to answer in a paper published in 2015 (it received The Victor Brudney Prize for June 2015) under the title “Against all Odds: Shareholder Activism, in Controlled Companies”, (1).

The author refers to the New York Times Company and its engagement with shareholders after a 2008 activist campaign led by Harbinger Capital Partners, Firebrand Partners, and Morgan Stanley. The company ended hiring two directors named by activists, selling non-core assets, reducing its Capex, lowering its operational costs, etc. But this company was not the typical target of such a campaign as it remained controlled by the founding family, which according to the broadest opinion should have prevented an activist campaign to succeed, (it would have needed a dispersed stock ownership).

The author reviews data from a number of activist campaigns against controlled firms (from now on, CC`s) in order to discover the facts permitting the activists` success, to list the ways activist deploy their efforts in these companies, and to assess the role of reputation as a discipline mechanism.

First, (and after slightly introducing the case for activism`s benefits), the author settles his initial thesis: the expected return for an activist decreases as the ownership stake of the controller rises, and for two reasons: first, the controller could be having private benefits that could be higher than his expected return from change; and second, the threat of a proxy fight is not too credible.

Then, (after giving references to previous research, not relevant in the case of controlled companies), he presents the data collection process (only US campaigns so that legal aspects possibly affecting activism are discarded) and results, that I include below:

  • A negative correlation between activism and controller stakes is very clear, as “Only 18.4 percent of the controlled firms faced activist interventions compared to 46.9 percent of the widely held firms”.
  • CC`s are not fully insulated from activism, though.
  • Differences in activism by:
    • Activism nature: neither is activism in CC`s only about Corporate Governance, (laying aside operational, financial or strategic management aspects) nor it is only low-profile, engaging or non-hostile.
    • Activist player: not relevant differences with not CC`s.
    • Percentage of control: not relevant either.

The next part of the study shows the formal channels through which activism acts in controlled firms with a remarkable success:

  • Electing minority Directors: an independent director has access to information, can raise the hand in conflicting cases, and alter the dominance by the controller. If minority shareholders can elect some, this is an open door for activism.
  • Challenging M&A announcements, asking for higher valuation, executing appraisal rights, and using the trade-off between entire fairness review-business judgement rule alternatives, and voice for minority shareholders, potential conflicts of interest.
  • Filing lawsuits arguing breach of fiduciary duties, unilateral actions against the activist, etc.
  • Challenging effective control situations, where the controller`s stake is under 50%.

Kobi Kastiel then analyzes one of its most promising arguments, regarding informal channels for activism, and mainly the controller`s reputational concerns. Given the stronger (that those of managers) ties of controller stockholders to the firm, and the fact that formal channels are relatively blocked in CC`s, informal channels could hold more share of the activists` fire power.

The reputational concerns may affect: (i) the controllers` image as a successful manager; (ii) their image of fair dealers, (when dealing with minority shareholders); (iii) their image as perceived by consumers and general media audiences.

The related sanctions may affect their labor market as board members in other companies, (low effect) or their personal wealth through a decline in the stock price, (a strong incentive).

Kobi Kastiel analyzes Reputation as a complimentary mechanism, and concludes that in this case it is usually effective. Hedge funds usually lead strong media campaigns where controller shareholders and their managers ability to maximize shareholders` value is questioned, but also their fair treatment of other constituencies and stakeholders, (remember the case of Ebay where Carl Icahn accused the board and some directors, Mr. Andreesseen for instance, of mismanaging the company and breaching their fiduciary duties). But when the power of reputation is evaluated in isolation the case is not so clear. When the controlling stake exceeds 50%, there is no right to elect minority directors, no claim to file, and no particular veto-power, the engagement by activists does happen, but its effectiveness is much lower, (five times lower as estimated by Prof Kastiel).

Yet another question from Mr Kastiel: why would controllers reject (more than widely help companies) value enhancing activism if the (wealth) incentive is so strong? Sometimes, he argues, because the fact that the stake is not equal in vote and cash flow appropriation; in other cases controllers may have interests that are in conflict with the rest of shareholders.

He finds that campaigns can be divided into (i) those related to the controller and minority interests in conflict, where sometimes activists get certain “sweetening gifts”, such as price increases in M&A, for all shareholders; (ii) board representation campaigns where minority shareholders can benefit but can also oppose activists and (iii) value-related campaigns, where other shareholders also take a profit. In general Prof Kastiel finds support to the idea that “disruptive activism” (where a quick profit can be extracted for the activist only, after his stake is rebought ar a premium), is not a frequent nor a successful case.

And finally, Prof Kastiel derives certain policy implications:

  • there is a need for some regulation promoting activism in controlled campaigns. First, because activism is lower in this kind of company; second, campaigns are less effective where there are no formal levers (possibility to elect directors, etc);
  • a proposal for regulation should include at least the possibility for non-affiliated shareholders to elect directors.

 

 

  1. See: https://joaquinbarquero.wordpress.com/2015/05/30/the-international-evolution-of-activism/
  2. The article can be downloaded here http://www.law.harvard.edu/programs/corp_gov/papers/Brudney2015_Kastiel.pdf
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