Shareholder activists take bold steps to manage corporate behavior

In his research, Stuart Gillan, a visiting assistant professor of finance at the W. P. Carey School of Business, writes that some shareholders register their reaction to a company's performance by simply buying or selling stock. Then there are those who buy into a corporation through takeovers and institute changes in the way the company is operated.

Shareholder activism is nothing new on the corporate landscape. The amount and intensity of such activism comes in waves usually dictated by economic forces and the missteps of a corporation's management team. And right now, the wave is at a crest. "Over the last few years we've seen a number of corporate scandals, including problems at Enron, WorldCom, and Xerox among others," says Stuart Gillan, a visiting assistant professor of finance at the W. P. Carey School of Business.

"Part of this tracks back to what investors perceive to be poor corporate governance. But at the end of the day, it comes down to poor performance and declining shareholder value. One response has been an uptick in active shareholders pressuring corporate managers for increased accountability and improved performance."

According to Gillan, who studies shareholder behavior, shareholder activism is part of a continuum of responses to the way a corporation performs. In his paper, "A Survey of Shareholder Activism: Motivation and Empirical Evidence," Gillan writes that at one end of the continuum are shareholders who register their reaction to a company's performance by taking the "Wall-Street-Walk" — simply selling their stock. At the other end are those who institute changes by buying the company outright and firing poor managers.

"What we're seeing now is a range of activity in between those two extremes," Gillan says.

"For the most part, activists today don't plan on taking firms over. But they are certainly prepared to pressure managers by submitting shareholder proposals to be voted on at the annual meeting." While shareholder proposals aren't binding, Gillan says if 40 to 50 percent of shareholders vote for a proposal, it sends a powerful message to corporate managers — one that they ignore at their own peril.

"Increasingly, the activists have a menu of alternatives. They'll try to enter into a dialogue with the management team," he says. "If that doesn't work, the more aggressive activists aren't shy about escalating all the way up to fighting for board representation."

The shareholder police

For example, billionaire financier Carl Icahn is considering a proxy contest to get board representation at media giant Time Warner. Gillan says part of Icahn's motivation is to improve the company's bottom line, thus improving shareholder value.

"In his case the perception is that the current board of directors and management team are not doing their jobs, rather, they've been destroying shareholder value," he says. "In that sense, Icahn's putting pressure on them to turn the company around."

The situation is reminiscent of what happened at Sears, Roebuck and Co. in the early 1990s. That was when wealthy investor Robert Monks ran for the retail company's board of directors. His aim was to refocus the company's energies back on the retail industry and away from unrelated businesses that were performing poorly.

"Monks didn't win a seat on Sears' board, but soon after the election, Sears's management undertook a dramatic restructuring and huge value was realized for shareholders," In their paper "Value Creation and Corporate Diversification: The Case of Sears Roebuck & Co.," Gillan and his co-authors estimated the gains at close to $1.5 billion. "Monks lost the battle, but won the war," said Gillan

In the process, Monks became one of the nation's most prominent shareholder activists and ushered in this current era of shareholders policing corporate management and boards. Now, a threat alone from shareholder activists can shake things up at a company.

"It's like a lion chasing a herd of wildebeest," Gillan says. "It's not that you get one or two on the move, it's that you get the whole herd to run. The idea is that the threat of either being taken over or the threat of a contest to get outside representatives onto the board of directors holds management's feet to the fire and can force changes." 

Institutional players step in

It isn't just high-powered individual investors who are causing corporations to sit up and take notice. In recent years, institutional investors, such as public and private pension funds, have also stepped up their levels of activism. Gillan writes that although public pension and union funds are dominant in submitting shareholder proposals, mutual funds have tended to avoid public activism.

"There are also legal restrictions that generally restrict institutional investors from getting too heavily involved in the affairs companies they invest in," said Gillan. "So they tend to focus on voting their shares or submitting shareholder proposals — toward the left end of the activist continuum. But given that institutional investors as a group can easily own 50 percent of many firms, they're a force to be reckoned with and a potential catalyst for change at many companies."

While most shareholder activists are interested in increasing their investment's value, some activism is rooted in social causes, such as environmental, ethical or moral issues. In recent years, the influential religious right has taken up the cause of the environment — a development that is starting to be felt to some degree in corporate America.  

"This very much consistent with a 'stakeholder' view of the firm — the idea that corporations need to be accountable not only to shareholders, but also customers, employees, suppliers, and the communities in which they operate," Gillan says. "To the extent that the social issues can be related to the economic fundamentals, there is a compelling argument to try to get shareholder support more generally."

Activism here to stay

For the most part, however, Gillan believes that while shareholder activism will increase at large companies, issues directly related to the company's performance and corporate governance will be what drive it. One of those issues is compensation for company executives. Gillan says there already is a perception that some corporate CEOs are overpaid — and when that is coupled with a company's poor performance, shareholders will be more likely to act.

"We've seen an increase in shareholder proposals on compensation issues, and votes on the 40-50 percent range. That level of support, on any issue, provides a strong signal to the board or management team that they are being monitored," he says. "Given the level of pressure, the level of scrutiny, it's just common sense for board members to have an open ear to understand what the issues and concerns are."

Other ideas that have gained traction over the last year or two include opening up the director nominations process to shareholders and changing the way in which board members are voted on.

"In either case," says Gillan "making the election process more contestable swings the balance of power back towards shareholders — and we'd likely see more activism going forward." Regardless of such proposed changes, shareholder activism is certainly here to stay.