15. What is “shareholder activism” and what is the significance of “institutions as shareholders”?
Shareholder activism refers to the situation where large shareholders of a company exert influence or control over the actions of the directors or officers of the corporation. Activist shareholders are generally concerned with improving returns on their investment through improved corporate performance or other structural changes. They may attempt to influence the company to make certain operational or governance decisions, to adopt goals or causes that the activist investor values, or to undergo a merger, acquisition, divestment or other structural change.
• Example: Yowser Corp is a online media and Internet search company. Yowser also has major asset holdings, such as a large stake in China Retail Online. Yowser has been declining in profits in recent years. Yowser has several activist shareholders who seek to maximize their profits. They seek to encourage the board to streamline the product offerings and to divest Yowser’s ownership stake in China Retail Online. This will return a healthy dividend to shareholders, but the board fears that it will gut the company. The activist shareholders threaten to replace directors who appose the proposed plan.
Activist investors play an increasingly important role in corporate governance. In the 1920s, approximately 20% of US stocks were owned and held by institutions. Today, nearly 80% of US stocks are held by institutions (mutual funds, pension plans, hedge funds, banks, foundations, endowments, and other investment companies). Individual wealth is largely held by these third-party firms that invest a portion of those funds in corporate shares. Large corporations often directly invest their retained capital in corporate shares of other corporations, or they pay third-parties (such as State Street Corp.) to invest those funds on their behalf. This results in an inordinate amount of corporate stock holdings resting with institutional investors. This model of investment seeks to insulate the underlying investor from the risks associated with investing. More specifically, it spreads risk more evenly across large groups of investors and does not rely solely on one investment class. There is worry, however, that these arrangements place too much authority in the managers of these investment funds with regard to corporate decision-making.
• Note: The inordinate amount of authority that comes from holding large quantities of voting stock in corporations creates the fear that corporations and institutional investors will enter into self-serving arrangements to maximize their mutual interests. Corporate governance mechanisms attempt to mitigate this threat and protect the rights of all shareholders.
• Discussion: How do you feel about activist investors? Should these investors be allowed to wield so much power over the organization? Why or why not? Does it affect your opinion whether the activist investors are individuals investing personal wealth or investment funds investing the wealth of others? Why or why not?
• Practice Question: Daryl is a finance manager. He is not happy with the management performance in ABC Corp. He is contemplating raising an investment fund with the purpose of establishing an ownership stake in the company. What are Daryl’s objectives and how would he be able to achieve them through this process?