Shareholder activism—including the number of activists, the amount of capital deployed by activists, and the tactics used by activists—has exploded in recent years. The costs and risks of encountering activist investors are rising, and they are enough to scare some companies away from going public. All companies considering an IPO should be aware of shareholder activism, be familiar with common activist tactics, and prepare for encounters with activists. This article provides companies approaching an IPO with knowledge to begin preparing for activist investors now.
Overview of Shareholder Activism
Activism in the corporate world is characterized by a shareholder or group of shareholders that advocate for change within a company. However, not all activists are the same; activist investors have a range of goals. Performance-driven activists focus on increasing a company’s share price, while corporate governance activists focus on corporate structure and management decisions.1 These activist investors urge company leadership to do things like sell a business division, stop operations in certain geographies, find a new CEO, change compensation packages, be more socially or environmentally conscious, increase share buybacks, or change dividends.
Activist investors could be subject matter experts, hedge funds, powerful individuals, large investment firms, or even just common stockholders. The 1980’s saw the rise of “corporate raiders,” activists notorious for leveraging large equity stakes in companies to force drastic changes, often breaking companies apart for financial returns.
Over time, activists have developed new tactics, and many have attempted to refresh their images to appear more long-term oriented. Rather than enacting change through brute force, activists now frequently employ strategic measures to create change based on ideas with merit. One of the most prominent ongoing debates involves the economic consequences of activism on long-term shareholders. A study published at the end of 2018 provides a summary of the widely debated issues and gives the following abstract:
First, we find that equal-weighted long-term returns [for companies engaged with activists] are driven by the smallest 20% of firms, with an average market value of $22 million. The larger 80% of firms experience insignificant negative long-term returns. On a value-weighted basis, which likely best gauges the effects on shareholder wealth and the economy, we find that pre- to post-activism long-term returns insignificantly differ from zero. For operating performance, we find that prior results are a manifestation of abnormal trends in pre-activism performance. Using an appropriately matched sample, we find no evidence of abnormal post-activism performance improvements. Overall, our results do not strongly support the hypothesis that activist interventions drive long-term benefits for the typical shareholder, nor do we find evidence of shareholder harm.
The study finds increased long-term returns for companies involved with activists. However, the study notes that this occurrence is more frequent in smaller companies and concludes that the overall effect, when adjusting for the size of the companies, is essentially zero, or neutral.2 This study is just one of many attempts to determine the long-term effects of activism, with many studies yielding different conclusions.
More recently, large institutional investors have begun wielding their powerful influence on companies to support activists and push for changes. The Organisation for Economic Cooperation and Development (OECD) issued a report in 2019 describing trends in corporate stock ownership around the world. The report states that 41% of global market capitalization is held by institutional investors.3 As these institutional investors become more active, they can use their overwhelming ownership to enact change within the companies they invest in.
- Publish a disclosure in line with industry-specific Sustainability Accounting Standards Board (SASB) guidelines by year-end or disclose a similar set of data in a way that is relevant.
- Disclose climate-related risks in line with the Task Force on Climate-Related Financial Disclosures’ (TCFD’s) recommendations, which cover climate-related governance, strategy, risk management, and targets.5
BlackRock took it a step further, indicating that “In the absence of robust disclosures, investors, including BlackRock, will increasingly conclude that companies are not adequately managing risk.” It also disclosed its activist intentions in the last line of the letter:
Given the groundwork we have already laid engaging on disclosure, and the growing investment risks surrounding sustainability, we will be increasingly disposed to vote against management and board directors when companies are not making sufficient progress on sustainability-related disclosures and the business practices and plans underlying them.
Rise of “Shareholderism”
Shareholders have drawn an increasing amount of power and attention from corporations, leading to a recent rise in shareholder engagement. In fact, the Harvard Law School Forum on Corporate Governance noted the following regarding large investors6:
In prior years, engagement was mostly between the portfolio manager and the company’s investor relations team or members of management and focused largely on company performance. Today, investors’ corporate governance teams are often driving the meetings—sometimes alone and sometimes in combination with portfolio managers. At times shareholders ask to meet with directors. They may have identified issues in the company’s executive compensation plans, its governance policies or practices, or its strategic plan. Other times, shareholders are looking to lay the foundation of an open dialogue with the directors so that when issues do arise in the future, they have an existing relationship upon which to build.
The following are some of the reasons for this shift7:
- Sarbanes-Oxley and Dodd-Frank created changes in board composition, meeting frequency, and qualifications.
- Management and investor relation teams have become more present at conferences and have listened more to shareholders.
- Board members have started purchasing more shares to align their incentives with shareholders.
- Transparency from corporations, including compensation disclosures has risen.
- Legislation has given additional power to shareholders (shareholder proposals, shareholder interactions, etc.).
Strategies of Activist Investors
The tactics used by activists to accomplish their goals vary widely. Strategies range from closed-door negotiations to very aggressive public encounters with management. Activists will often work their way up the spectrum of aggressiveness until they are heard. The following are explanations of some of the common strategies8, including real-world examples, starting at the less-aggressive end of the spectrum and moving up.
Activists are increasingly able to launch closed-door negotiations with company management and boards. This ability is largely derived from the leverage activists hold:
- Public fights can affect a company’s image and holding private conversations with activists can help companies manage the situation more closely.
- More aggressive forms of activism can be costly, both in time and money.
Closed-door negotiations are often the first attempt activists make to get a foot in the door before moving to more aggressive tactics. It is hard to know exactly how widespread this form of activism really is, due to its nature, but it has certainly grown in popularity and effectiveness.
ValueAct, a prominent activist hedge fund, began significantly investing in Citigroup (Citi) near the beginning of 2018. By the end of 2018, ValueAct owned about 1.3% of the outstanding Citi stock, which had lagged behind other large financial institutions, with the goal of pushing for improvements. The two entered into negotiations and finalized an information sharing agreement. The agreement was extended at the end of 2019 and the ValueAct CEO said the following:
We have been very impressed with (Citigroup CEO) Mike Corbat and the entire management team … Citi remains the top position in the fund and we have strong conviction in its long-term potential.9
The SEC allows any shareholder owning more than $2,000 or 1% of a company’s stock to submit a shareholder proposal.10 By law, the company generally11 must then add the proposal to its agenda to be voted on during the next annual shareholders meeting. This presents an opportunity for activists to advocate for change based on the merit of their ideas. Valuable proposals can lead to change if enough shareholders vote in favor of it.
Alphabet (Google) has faced an increasing number of shareholder proposals at its annual meeting. At its June 3, 2020 meeting, Google shareholders voted on 10 different proposals, including equal shareholder voting, human rights, bylaw amendments, sustainability metrics, director elections, gender/racial pay equity, and whistleblower policies. Each of the proposals was voted against by a majority of shareholder power. However, activist investors will continue to push for changes as they believe they are getting closer to productive dialogue with the company.12
Frequently, activists can get enough votes to force change without purchasing massive amounts of stock themselves. Proxy fights are when activists lobby other shareholders, some of whom are completely uninformed, who then vote in the activists’ favor. Activists often seek to influence votes regarding corporate governance, namely board seats and management. Successful proxy fights often lead to changes in management or the instatement of a specified person to the board of directors in place of someone else. With every seat activists win on the board, their power grows.
In May 2020, Marathon Partners reportedly decided to launch a proxy fight against e.l.f. Beauty. The activist investor had accumulated approximately 5% of e.l.f.’s stock since becoming a shareholder in 2018. For several months, the two engaged in discussions about the company’s core business operations and future strategic options. However, Marathon decided to escalate the relationship to a proxy fight by planning to nominate three directors—including Marathon founder Mario Cibelli—to e.l.f.’s board, which has eight directors.13
Another tactic activists employ is litigation. This strategy is time consuming and costly for all parties involved—both financially and from a company image standpoint. This option is generally the least desirable and is often the result of poor communication between management and an activist.
Legion Partners, an activist investor, decided to pursue a lawsuit against Bed Bath and Beyond. A May 2019 report explains that Legion and two other large activists have proposed several changes—including selling underperforming assets and enhancing the supply chain—and have nominated a set of board members to help carry this out. The activists believe that Bed Bath and Beyond is risking financial catastrophe with lenders just to keep the activists from winning board seats.
The lawsuit claims that Bed Bath and Beyond has refused to approve the activist candidates to campaign for votes because it fears a debt trigger. According to the lawsuit, a change-of-control trip in the debt agreement makes it such that the election of activist candidates to the board could trigger a $1.5 billion debt obligation. The activists claim that Bed Bath and Beyond simply has to certify14 the candidates to avoid the trigger, but it refuses to make that certification. This is an example of how activists can turn to litigation when negotiations fail.15
Preparing for Shareholder Activism
Management should consider shareholder activism as they plan an IPO because nearly every public company has the potential to be targeted by activists. The way companies prepare for activist situations will largely shape whether those occurrences lead to positive, lasting change.
The following are three practical ways companies can set themselves up for success when facing shareholder activism:
Form an Activist Response Team
Companies often form a team dedicated to shareholder engagement that acts as the core response channel to activist investors. The teams generally include legal counsel, employees who are willing and able to contribute, and other advisors.16 This group meets often to discuss needs, review perceived weaknesses, develop a plan, educate employees, and report regularly to the board of directors and management.
One of the activist response team’s most important roles is to make sure that management and board members are well-equipped to handle conversations with activists and are aware of any investor confrontations. Sometimes, activists seeking to engage privately with company management will approach board members individually. These board members need to be well-prepared to engage productively.
These teams also regularly monitor shareholder activity, earnings call attendance, press releases, etc. to anticipate activist moves. Simply forming an activist response team that allows individuals to come together and formulate a plan is an important first step for any company considering an IPO.
Assess Weaknesses and Vulnerabilities
One of the most effective ways companies can prepare for activist investors is by thinking like an activist. As management becomes aware of perceived deficiencies in corporate governance, business operations, social policies, etc., they will be able to anticipate activist advances and respond quickly. Both the response team and management should regularly identify areas that could use improvement. This step is especially important when preparing for activists that target environmental, social, compensation, shareholder, and board changes.
Develop Defense Mechanisms
A common defense strategy against activists is to shore up the company’s bylaws. Advance notice bylaws dictate what and how things can be proposed for a vote, usually requiring shareholders to give sufficient notice of their intents. The provisions can also require detailed information about the shareholder and any proposals they plan to make. Another defense mechanism is the use of staggered boards, which structures the members of the board of directors such that they have different term lengths and focuses.
Companies also have been known to institute shareholder rights plans (or “poison pills”), a type of defense mechanism in which existing shareholders have the option to purchase discounted shares in the event that a new shareholder accumulates a significant block of shares. This essentially dilutes the holdings of the new investor and deters activists seeking to gain control through stock ownership. With the COVID-19 pandemic causing public share prices to become significantly depressed, investment bankers have advised many public companies to “consider adopting shareholder rights plans to prevent strategic buyers from being able to acquire them on the cheap (at prices that do not reflect their long-term intrinsic value).”17 Even during more normal circumstances, companies may benefit from creating a shareholder rights plan and putting it on the shelf to activate at a future time.
It is important to note that some of these tactics can be damaging and could actually make the company a target of activists. Companies are being pushed towards unstaggered boards and bylaws that are more shareholder friendly. Many of these structural issues are much easier to institute early on, rather than in the years following an IPO. Companies should evaluate all aspects of their business and make changes accordingly, both prior to and subsequent to an IPO.
Monitor Financial Performance
Monitoring share price and overall financial health is extremely important to prepare for activists that focus on boosting shareholder return. Activists often see a poorly performing (financially) company as a target for them to promote changes.
Of course, financial performance can be a subjective measure. By developing strong benchmarks for comparison, companies can better monitor their financial performance and get ahead of necessary changes. A company seeking to go public should identify a group of peer companies against which it can consistently measure itself.
All companies considering an IPO will benefit from learning about and planning for shareholder activism. Potential costs of activist investor advances deter many companies from going public. However, understanding where activists are coming from, what common tactics are used, and how to both protect your company and engage in productive, change-provoking dialogue will help minimize the risks. Companies that are well-prepared to engage with activist investors will be better prepared for an IPO and for positive shareholder relationships.
- PWC, Governance Insights Center
- Sullivan & Cromwell LLP. “Effectively Dealing with Shareholder Activists: Learn from the Trenches.” 9 November 2019.
- Harvard Law School Forum on Corporate Governance
- Paul Rose and Bernard Sharfman – Shareholder Activism as a Corrective Mechanism for Corporate Governance – Introduction
- Study by the Rock Center for Corporate Governance at Stanford University can be found here: “Long-Term Economic Consequences of Hedge Fund Activist Interventions”
- OECD: “Owners of the World’s Listed Companies”
- See the letter here: BlackRock – “A Fundamental Reshaping of Finance.”
- For more information, visit TCFD Hub: Recommendations Overview
- This Harvard Law School Forum on Corporate Governance reference can be found in the following article: “The Changing Face of Shareholder Activism.”
- NAPABA 2019 Convention: Effectively Dealing with Shareholder Activists – Learning from the Trenches
- For more information about common strategies, see Corporate Finance Institute: “Activist Shareholder”
- Citigroup.com Press Release: “Citi and ValueAct Capital Extend Information Sharing and Engagement Agreement”
- TheShareholderActivist.com – “What is a Shareholder Proposal?”
- The SEC provided guidance on Rule 14a-8, listing 13 substantive exceptions. The exceptions involve proposals that are improper under state law, violate proxy rules, further personal interests, or are already substantially implemented, among others. The full list can be seen here.
- Visit Morningstar: “Human Rights on the Ballot at Google”
- Wall Street Journal: “Marathon Partners to Launch Proxy Fight with e.l.f. Beauty”
- Certifying the candidate means asserting that if the candidate is elected, the debt obligation would not be triggered due to the “change-in-control” mechanism. The mechanism is in place to avoid significant and undesirable ownership changes. However, the existing management team can state for the record that this is not the case by certifying the candidate. See the article in footnote 14.
- Wall Street Journal: “Activist Investors Turn Up Heat on Bed Bath & Beyond”
- McKinsey: “Preparing for Bigger, Bolder Shareholder Activists”
- Winston and Strawn LLP: Is Now the Time for Companies to Adopt a Shareholder Rights Plan?