Archive for the ‘Investor Participation’ Category

The increase in strategic and operational activism by shareholders.

December 26, 2013 Leave a comment

Scott Hirst, co-editor at Harvard Law School Forum on Corporate Governance and Financial Regulation, recently published at the HLS blog a post that brought forward the increase in the number and volume of shareholder activist actions connected with strategy or operational matters. (1)

As the author outlines, activism is just one of the features of the transition or rebalance of power from directors and boards, (director-centric model) to shareholders. And, even if a majority of shareholder proposals or interventions might follow their own interests or agendas, there is an increase in the number of actions that are mainly focused on the firm`s agenda, and particularly on operational or strategic matters.

These actions are the result of a relevant investment in research and analysis, so that these investors, even in big market cap firms, risk to invest large amounts of money in the hope that their views on how these companies could be restructured are favored by other investors but mainly understood by boards. Read more…

The short-selling activities as a market mechanism for monitoring managers

October 14, 2013 Leave a comment

In the last decades, many efforts have been deployed to understand the way market forces help control managers` activities in a corporate world where shareholders are absent from managerial activities in the firm. As a result of the early 2000`s scandals in corporate governance, (Enron, Worldcom, etc), and some other arising later, (Olympus, but mainly the 2008 financial sector debacle), many countries regulated corporate governance structures in favor of shareholders, who were said to hold and use (at least) the power to monitor and in extreme cases eject directors if a dysfunctional board did not generate satisfactory results in terms of shareholder wealth.

The problem emerges when shareholders do not react soon enough with the responsibility to use the power they have been granted. Let`s have a comment on that. Read more…

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.

One Share, one Vote.

March 5, 2013 2 comments

According to Professor Colleen Dunlavy of the University of Wisconsin-Madison, corporations were not governed by this principle during the first 19th century decades, so that big shareholders did not hold as much power as they did afterwards. Shareholders were more equally treated than their investments would have suggested. By the middle of the century, democratic norms were pushed and the huge power concentration so  normal at the end of the century started. The change was presumably led by wealthy lobbies, which were able to make legislation passed through.

Anthony Kammer thus argues it is not so rare to propose a different system.

Some realities in the capital markets today lead to rethink the principle. Firstly, decoupling, that is, the split of voting and economic rights, (through derivative markets, share lending activities, and so on), forces to reconsider the principle as “empty voters” have a different interest than “full owners”, the last ones still holding an economic interest and risk, so that the two groups would vote differently. Secondly, a difference might be done between long-term shareholders and short-term ones, so as to avoid the kind of bad behaviors and performance deeply responsible for part of the damages generated by the 2008 financial crisis. Regulation is being pushed in that sense, in the EU and beyond.

In fact several endogenous mechanisms allow some shareholders to hold higher voting rights that those corresponding to their investment and risk exposure: dual-class share systems, pyramidal structures, cross-holdings and so on.

Since the 1990`s, the principle has been dominant, and separation from it has been narrowed, even in those countries where a dual class share system was possible, (Sweden in 2004). But their presence gives room to some empirical studies.

First, what are the reasons for that separation from the principle? Some ideas follow:

–         Shares with higher voting rights usually extract a higher premium in acquisitions.

–         Founders launching an IPO usually want  higher proportion of voting rights than cash-flow risk, having cashed-in for the free-float.

–         Some control of private benefits for controlling shareholders might be guaranteed.

–         The cost of capital tends to be higher in dual-class firms, so a reduced need of funds might be present.

A critical point in assessing this kind of proposal, concerns the effects of the disproportionate allocation of voting rights to some shares. Does it affect shareholder value? Although not empirically irrefutable, it is widely accepted that outside equity loses value, because there is a tendency towards private benefits being extracted by controlling shareholders, and because of a higher cost of capital in these economies/firms.

In terms of social welfare, disproportionate control seems to have certain effects, basically connected to the underdevelopment of the financial markets, (the current political trend is probably populist, or led by recent financial events, so that this fact will probably be disregarded). We also refered to the increase in the cost of capital, so these economies would eventually face a certain underinvestment.

A factor worth being considered is the extent to which the level of disproportion in the allocation of voting rights affects the results, and it appears to be relevant, so that a reduced disproportion could have little shareholder value and welfare effects, and so allow for the current regulatory proposals to have some acceptance.

Consequently, the case for extraordinary allocation of voting rights to long-term shareholders can be made. The aim of enhancing long-term shareholding and behavior is laudable, and the effects could to some extent be disregarded. It exists in some countries and companies, (in Sweden, France, Germany), with a degree of success, (as in the case of LVMH, Volkswagen, L`Oreal, and so on). Some unwanted effects can follow if also extraordinary dividend rights are granted, -as proposed in the EU-, (think of the difficulty to calculate the dividend cost and adequate policy).

But the main discussion concerns whether the measure is the best to guarantee the desired result: a cost and benefit analysis should be done to compare it versus other tools to that purpose.

This post follows several articles or comments in HBR, FT, Anthony Kammer, Adams and Ferreira, and others.

Shareholder Activism: acting persons, aims, themes, targets, and behavior

December 29, 2012 Leave a comment

Shareholder activism is the effort by owners of equity capital to use their shares’ voting power to change the behavior of corporate management. They use to act through Shareholder Proposals.

  1. Shareholder proposals, (which -in the US- any owner of shares valued at $2,000 or more, and held for one year, can introduce at the annual meeting of a publicly held corporation, -one per shareholder and company-); investors vote in person or by proxy. In 2012, at the USA, proposals were submitted by:
    1. Labor or union pension funds, (36%). Most of these cases, proposals have nothing to do with performance, but with union`s agenda. In the USA, though, they are forced to pursue the best for the value of the investment, so they shouldn`t and are not so free, to follow different objectives.
    2. Socially responsible investors, 22%. Religious, or public policy, or political involvement agenda, …the base being the idea that directors have fiduciary duties not only to shareholders, but to other stakeholders.
    3. Institutional unaffiliated investors, (1%). Hedge funds, mutual funds and the like, with guiding stars such as Ackman, Icahn, and others. They are well-known since the 80`s, (Nabisco, and so on), and look for improving shareholder value, to the benefit of all shareholders.
    4. Other normal individual investors, (10%).
    5. Four “gadflies”: Evelyn Davies, John Chevedden, William Steiner, and the Rossi family. 31%.
  1. There is interaction between social activism, the kind that forces companies to enhance corporate governance, (majority voting, declassified boards,…), and activism pursuing shareholder returns. The first one, has enabled the second activists, because their costs and efforts have been reduced. Also, by SEC and NYSE regulation, brokers cannot vote on uncontested elections by their beneficial owners`shares.
  1. The objectives are more or less by thirds, these ones:
    1. Executive compensation: proposals pursue to enhance shareholder control on theses matters. The number is going down, as disclosure has been enforced by regulation.
    2. Social objectives: environmental, social, labor relations, animals and human rights, ….independently of the shareholders interests. Both a and b, are substance-based proposals: a specific theme to be dealt and changed.
    3. Corporate governance: they pursue to differently allocate power among Board, management and shareholders. The number of these process-based proposals is going down, because of a certain success in previous years. Usual topics are:

                                                          i.      Shareholding voting rules: majority vs. plurality and super-majorities; cumulative voting; declassified boards.

                                                             ii.      Independent chairman

iii.      Rules allowing shareholders to act out of General Meeting: special meetings or written consent,

  1. Targets of shareholder activists:
    1. Larger companies.
    2. Company industry: financial services and energy.
    3. Where organized labor is interested, (unions). Retail, telecom and finance, mainly.
  1. How do proposals fare: they normally fail, when substance-based, and succeed when process-based.
  1. Among institutional investors, we can find Hedge Funds. They can be classified for type and style:
    1. Types of Hedge Funds: among equity focused hedge funds, we may distinguish: hedge equity, (hold long and short positions, normally keeping a net long position), market neutral, (try to produce results not correlated with any market), event-driven or macro funds. There are also fixed income funds, etc.
    2. Style: equity hedge, short selling, event-driven, and long-short.
  1. How do hedge funds usually act? Their behavior is determined by certain factors:
    1. Their investor base: the more they rely on super-rich wealth, the more they accept volatility. But more than two-thirds of their funds come from pension funds, endowments, and the kind, too risk-averse for the 80`s hedge fund industry`s behavior.
    2. Leverage: it is at its low in these times.
    3. Rigidity: funds owners require stickiness to the known manager`s strategy, not accepting changes.
    4. Funds allocated to hedge funds have soared from $ 0.5 trillion in 2000 to 2.2 trillion in 2012, so that many second-rate bets are accepted; thus, profitability is not expected to be so high now.
    5. Hedge funds normally charge a 2% management fee plus a 20% on profits. With the current low-level in interest rates, this seems high, so they need to compete with mutual funds, exchange-traded funds and so on.
    6. As for activist funds, $ 57 billion are said to be dedicated to activist strategies.It is interesting to follow some of the main hedge fund managers`strategies, so as to be aware of their acting pattern, for instance Carl Icahn, Bill Ackman, and others.
  1. How do equity hedge funds usually act? It is interesting to follow some of the main hedge fund managers`strategies, so as to be aware of their acting pattern, for instance Carl Icahn, Bill Ackman, and others. The following steps can be identified:
    1. Fund starts purchasing a stake in the company, normally under 10%, for profit disclosure reasons. Share is normally undervalued.
    2. Fund then discloses its stake and agitates for change: strategy, M&A options, and so on. Usually at this moment, fund is already in the money.
    3. It the target company resists to adopt suggested change, the fund manager usually proposes a minority slate of directors, (that with shareholder approval will replace current ones and agitate adopt changes).
    4. Failure is usually followed by new election campaigns, (normally with a full slate of directors now).
    5. Finally, fund manager may decide to cash-out, or to make a bid for the company stock.
    6. If the bid succeeds, funds need to be prepared to manage the company.
    7. A different approach involves using derivatives, (short positions), when discovering a negative feature in a company, (Ackman`s case in Herbalife, when he made the case the company had accounting wrongdoing to cover a Ponzi-kind performance).

The power of shareholders. Ballots, and the option for staggered or declassified boards

December 1, 2012 Leave a comment

The shareholder franchise, (right to vote), is the ideological support for directorial power in a company with dispersed ownership, so that whenever shareholders think directors do not deserve their trust anymore, they can use democratic tools to oust them. But, are director elections really available and adequate for this? We are going to follow the debate between Bebchuk and Lipton on this matter, as in other previous posts, (noting that they mainly refer to the US).


Why is the shareholder franchise relevant?


Boards have a role in correcting the agency problem between shareholders and managers. Given their functions, their selection is a critical decision, and compensating them so that they stay aligned with shareholders, is a must. The power to replace directors by shareholders has a role in both points, (in particular Courts do not judge directors` decisions, but shareholders need to do that). Some corporate decisions are reserved to the Board, precisely on the ground that directors can be replaced, and even director independence is not enough to provide incentives to work in favour of shareholders` interests.


When analysing Contest Solicitations, the number of directors challenged to be replaced by others still seeking to manage the company independently but differently,  is very small, (mainly in middle-sized or small companies), and a majority of them fail. When those numbers are compared to the number of public companies, the number is low. Mr Lipton considers this a fact, not a proof of difficulties to ballots. But…


The more outstanding obstacles to elections are the following, according to Mr. Bebchuk:


  1. The costs are high: sending the proxy to shareholders, and receiving it back; filing the proxy statement with the SEC, and communicating the proposed strategy, through costly proxy solicitors. But only a fraction of the eventual benefits would flow to the challenger, (according to his ownership percentage).
  2. The uncertainties under the challenger`s flag: the strategy, the Ceo that will be hired, etc.
  3. Staggered boards, where only a fraction, (usually a third) of directors comes for re-election each year. Controlling that board means winning two elections, which is more expensive, reduces the challenger`s chance, and makes shareholders reluctant to vote for, so as to avoid one year of unrest and uncertainty.


Bebchuk`s reform proposal


Consequently Mr Bebchuk proposes elections should be allowed to take place annually for all directors:


  1. The frequency would not necessarily be annual, (because of costs, short-termism being imposed on directors, etc).
  2. Access to the ballot should be opened to shareholders trespassing some ownership thresholds, and committed to keep its position for a certain time, (after the proposed director is elected).
  3. Reimbursement of funds spent in the contest, would be granted to those gaining sufficient support.
  4. Shareholders should be able to replace all directors, although unless a shareholder revolt takes place, elections could be consistent with a staggered board.
  5. Some arrangements for all elections:
    1. Directors should not remain when more votes are against than in favour. First, shareholders need to be able to cast “against” votes, and not only “withhold” ones; second, majority voting needs to be implemented, against the plurality system, because most elections are uncontested.
    2. The vote should be confidential
  6. Legislators should facilitate shareholders to initiate certain bylaws changes for introducing the proposed reform, and prevent directors from doing the same when the objective is making their ousting more difficult.


Staggered boards defendants (and Mr Lipton) concerns follow:


  1. The associated costs of annual contests,
  2. Certain major shareholders could happen to launch elections in order to pursue their own agendas,
  3. Directors would be invited to abandon their long-term focus, and the board in general would be disrupted by internal dissent and “electoral” attitudes,
  4. Director recruitment problems could arise from the permanent election forecast.
  5. Independence of Independent Directors and their stability and experience could be undermined.


The activism for the Power of Shareholders has been developed by Harvard`s Professor Bebchuk through Harvard`s “Shareholder Rights Project”, which advises some institutional investors, and in particular helps them submit proposals for declassification.


The main argument in favour of declassified boards, and against staggered or classified boards, is an empirical one, and the debate should mainly be kept in this area. There are some empirical studies which help link staggered boards with a lower firm valuation, lower returns in case of a hostile takeover bid, less pay and managers` turnover correlation with performance, and so on.


Those favoring staggered boards, attack this empirical evidence. But they also validly argue the concerns included above, and the loss of value captured by shareholders in the case of a hostile takeover bid. This last point is clear when a staggered board is combined with a poison pill. We will deal with that part of the debate in a forthcoming post, because it is critical: in fact, Professor Bebchuk`s ballot proposal is compatible with staggered boards, but not with its combination with poison pills as a hostile takeover bid defense.

The case for and against Poison Pills

November 11, 2012 Leave a comment

A poison pill can be defined as a security issued by a target company and granted to current shareholders, convertible into ordinary shares in case that a not friendly investor surpasses a certain ownership threshold, and was a 1982 invention by Mr. Lipton, (ML) a partner in Watchell, Lipton, Rosen and Katz. The security can be issued when the investor reaches 10% and may be converted in case he hits 40%, for instance.

In June 2002, Professor Bebchuk (PB) published an article against that practice, that we will follow in its main aspects, as we will follow (ML) Mr. Lipton`s answer, published only a short time after.

The question is whether boards should have the power to block unsolicited takeover bids. PB first argues the existence of mechanisms assuring undistorted choice by shareholders, is a valid argument against that board veto. A poison pill implies a hostile bidder would only succeed if he won a ballot to replace incumbent directors for others that would redeem the pill. The board should only have time to prepare alternatives for shareholders`consideration. Other veto tools often used are staggered boards, dead hand pills, deferred redemption pills, etc.

In 1985, the Delaware Court, in four cases stated the following, in favour of the poison pill, supporting ML`s proposal:

–         Directors would be forced to use a judgement on the value of the corporation, not the market value when deciding on takeover issues,

–         Directors should use an objective business judgement, being responsible for their good faith, when deciding on takeover issues,

–         Directors duty entails maximizing short-term value after deciding for a takeover, not before,

–         A poison pill is said to be acceptable until shareholders decide to replace directors,

Ensuring an undistorted shareholder choice.

PB proposes a “Voting and no Board veto system”:

  1. In a takeover bid, the pressure to tender is huge, as a lonely shareholder can expect the value of his illiquid stock after a bid has succeeded, would be minor than the bid price. Enabling owners to vote separately (i) on a takeover, and (ii) on selling the shares if a takeover takes place, is a clean way to downsize the pressure.
  2. Preventing structurally coercive bids, though restrictive, could also favour undistorted choice. Limiting bids to all-shares offers with a later same price freeze-out, could do, but is still worse than the previous solution, (intertemporal discount rate can`t be optimal for all shareholders).
  3. Actually, a blockholder or bidder sometimes is restricted to a previous ballot by other shareholders, on his capacity to vote his shares, which prevents some bidders to invest. With a poison pill, the vote is really on directors replacement.
  4. In case an undistorted choice system is in place, board should not have a power to veto a shareholders` vote, should not distort the outcome of that vote, nor block the takeover once it is approved. A poison pill is consistent, if a vote on it can be held, even with a system of enough written consent.

The case against or for the Veto

The first thing to be clarified is the perspective under which this topic is considered:

–         Target shareholders` perspective: ex post and ex ante agency costs are against the Board Veto, (BV). BV supporters argue against the efficient capital markets theory, and also point out that directors, given their insider information, are the best placed to decide on whether to accept and offer or not. They also think of veto as a bargaining tool; of excessive short-termism when takeover threat is real; and of compensation schemes as being a valid tool to correct managers`self interest in using the veto.

–         Target`s long term shareholders` perspective: those favouring board veto support the idea that laws should rather favour long-term shareholders, (although empirical evidence that takeover resistance has been positive for them, is not conclusive).

–         Total Shareholder`s wealth perspective: according to this, total corporate wealth including the bidder`s wealth should attract lawmakers. A transfer of a premium can`t be considered a net benefit, and the case of a rejection would bring into the equation the huge costs that failed bidders afford. This perspective does no favour the veto argument.

–         All corporate constituencies` perspective: other stakeholders` interests should be considered. This could justify a veto, but it is perhaps not the best way to protect stakeholders, and the doubt remains as to whether managers would defend them or their own interests, while using veto power.

ML, argues first, that poison pills allow managers not to manage an “always for sale” company, thus avoiding the related costs; second, he considers PB`s proposal is weak: a referendum is not needed, as a proxy fight option is always available; besides, directors have a duty to pursue the best interests of shareholders, and they are accountable for their actions before courts; moreover, a referendum should be strongly conditioned to be operative, (bids should be serious, not excessively conditional, approved by regulatory bodies, and so on).