It is the way these profits are made that is the focus of the activists’ critics. Activists usually buy a block of shares, make a public call for change and lobby management and other shareholders to implement it. When they do, the activists sell at a profit. Martin Lipton, a lawyer who has long helped protect incumbent management, not least by inventing the “poison pill,” a potent defense against takeovers, argues that activists encourage firms to do things that boost their share price in the short run but harm their long-term performance. This critique has plenty of adherents, in academia, business and government.
Where’s the Evidence?
Yet empirical proof that activists exacerbate short-termism is strangely elusive. Indeed, such evidence as there is suggests the opposite. “The Long-Term Effects of Hedge-Fund Activism,” a recent paper by Lucian Bebchuk of Harvard Law School and others, examined the roughly 2,000 interventions at companies by activist funds from 1994 to 2007. Over the five years following an intervention both the share price and the operating performance of the target company improved, on average. The operating performance got stronger towards the end of the five-year period, not weaker.
This is the sort of evidence that has convinced Mary Jo White, the chairman of America’s Securities and Exchange Commission, to argue in a recent speech that activist shareholders should no longer be automatically viewed negatively. These days, she said, “There is widespread acceptance of many of the policy changes that so-called ‘activists’ are seeking to effect.”
A recent article in the Columbia Law Review, “The Agency Costs of Agency Capitalism: Activist Investors and the Revaluation of Governance Rights,” argues that the activists have become a vital adjunct to the institutional investors who own most shares, and who are “willing to respond to governance proposals but not to propose them.” Activists have thus become “governance intermediaries,” who find underperforming firms and offer their managers and institutional shareholders “concrete proposals for business strategy through mechanisms less drastic than takeovers.”
So it is crucial, the authors argue, to pass reforms that help the activists do their job. Lipton and others are pressing for a rule change that would have the opposite effect, by obliging activists to disclose stakes at a lower threshold (2 percent of a firm’s shares rather than the current 5 percent) and more quickly (within a day rather than the current ten). That would force them to show their hand before they had built a big enough stake to make a decent profit if and when their proposals succeeded.
Boards have an obvious motive to back curbs on troublesome activists. But a better strategy — and one that big firms are increasingly adopting — is to talk to them, consider their ideas and even invite them or their representatives to become directors, as firms from Microsoft to Mondelez have done. If a board’s strategy is in fact better than that proposed by the activist, having the debate in public may strengthen the incumbent management, as happened when activists took on firms such as AOL, Target and Clorox.
Indra Nooyi, the boss of PepsiCo, chose to work with Ralph Whitworth, a veteran activist who took a stake in the company. By doing so she was able to head off calls for a break-up of the firm (led by Peltz), while still boosting its shares, thereby restoring her authority. Donohoe’s encounter with Icahn may prove less nightmarish if he treats his ideas about eBay on their merits rather than dismissing them out of hand.
© The Economist Newspaper Limited, London (February 15, 2014)