Does shareholder activism create value?

In a recent paper, Enrique Schroth (EDHEC), Rui Albuquerque (Caroll School of Management) and Vyacheslav Fos (Boston College), show that an activist campaign increases share value, on average, by about 4.75%. But there is no single source of these superior returns: Activists deliver higher valuations by enhancing growth, increasing operating efficiency, refinancing, improving governance or by enacting change quickly. The single best predictor of added value is not related to the activists’ focus on specific industries or targets but on who is the activist. Significant campaigning costs to less experienced activists imply that the profits are concentrated in few activists and that more activism would be optimal.

Many public companies are now facing pressure from one or more activist investors, who acquire a minority stake in a company to influence its governance. Such form of engagement has gained strength steadily since the mid 90s, now constituting a major source of influence in corporate governance in the United States. Similarly, the total number of activist campaigns is currently breaking records in Europe.

Activist investors' engagements last on average about a year. The activists will remain invested while trying to influence management towards their well-defined goals. They can have friendly discussions with management or use the popular press to be heard. They can increase their involvement by seeking to have representatives in the board. In the extreme, activism may turn hostile when management ignores or refuses to engage with activists. In such cases, activists may force a vote on their own proposals, sue, or eventually replace management.

In the US, for example, the co-founder of the exercise bike company Peloton was forced to step down under pressure from activist hedge funds after the company's market value collapsed. Similarly, the CEO of the Hugo Boss brand announced his resignation in 2020 following pressure from activist investor Bluebell Capital. This fund was also instrumental in ousting Danone CEO Emmanuel Faber in 2021.

In the good scenarios, the campaign ends with an agreement to execute the activists’ proposals immediately. Proposals include reforms to the company’s corporate governance or changes to the business strategy and the production process. But does this strategy of influence produce concrete results on corporate governance? More specifically, does it create value? In our recent article "Value creation in shareholder activism", published in August 2022 in the Journal of Financial Economics, our answer is `yes’.

Performance bonus

On average, the market reacts positively to announcements of an investment with intention to influence a public firm’s governance: for all filings with the US Securities and Exchanges Commission (SEC) between 1996 and 2017, the share price of the target firm went up by 6.34%. But this reaction may include not only the expected value creation, but also the correction of an underpriced stock, a transfer of value from long- to short-term investors, or a biased or noisy reaction. To isolate the value added by activist by directly influencing corporate policies and governance, known as the treatment effect,  from the return expected if the same investor had acquired an equally large stake in the same company but remained passive, that is, a pure stock picking effect, we use a statistical and economic modelling technique known as structural estimation. With this technique, we were able to identify all other disclosed passive investments, i.e., acquisitions of minority stakes without intentions to influence the company’s governance, by the same investor over the same period and in similar target firms. The premium return from announcing the intention to engage with the target’s management, over the return from remaining passive is, on average, 4.75%. That is, almost 75% of the observed returns are due to value creation.

Where does the added value come from?

How are activists able to deliver such gains? How are they ‘treating’ the target firms firm to unlock that much value for their and the shareholders’ benefit? Answering this question is harder than the previous one: it involves a painful review of the stated goals and long-term achievements of all activist campaigns on record. Thankfully, researchers Alon Brav and Wei Xiang have done much of the work already. Through a collection of important articles they show that there activist campaigns can have very different objectives and achieve different goals. Indeed, activists may add value by improving the target firm’s operating performance, increasing productivity by selling underperforming assets, or optimizing their R&D expenses.  

Our work confirms that there is no single source of value creation by activists. We show that our measure of value added is a good predictor of improvements in ROA and in sales growth one or two years after the activist’s exit. Hence, added value comes from enhanced productivity or increased investment and growth.

We also find that additional value comes from efficiency in running the campaign itself: the engagements with the highest amount of value creation are also more likely to be friendly and short, avoiding the uncertainty and delays of proxy fights.

Finally, we found that the amount of value added per engagement is concentrated amongst the very few activist hedge funds who have completed many more campaigns than the rest. In fact, the activist’s experience is a far better predictor of value creation than attributes of the target.

Is activism affordable?

Activist campaigns are expensive, both in terms of the effort and time to influence or gain control of a company, and in financial terms (consultancy fees and legal fees). And an activist fund will only engage in a campaign on a given target company if the expected return exceeds the cost of activism. We reckon that activist investors obtain on average a net return of 1.74%. All other shareholders, on the other hand, save the costs of activism but benefit from the full announcement return. The implication is that too little activism goes on: many suitable targets exist but value is not created because activist funds pass on the deals because they are not privately profitable.

We conclude the study with a though experiment: suppose that the costs of activism were shared equally amongst all investors by reimbursing the activist for campaign expenses or by improving the transparency of the due diligence process. In that case, many more campaigns would be launched, especially by the novice activists. For the companies concerned, large passive investors would instead engage in activism and unlock additional substantial gains.

The future

The bigger implication of this study is that cooperation between activists and shareholders is key to increasing value creation further. Reaching a settlement quickly, while including reimbursement clauses and information sharing provisions will often be in the best interest of both parties. Such provisions are appearing more frequently on settlement agreements but they are far from being standard. And including them is easier said than done: companies have good reasons to be patient, waiting to be selected by the best activists. It appears therefore that the future of shareholder activism, an important mechanism of corporate governance, will depend a lot on innovations to the contracts between activists and their target companies.

This article by Enrique Schroth, EDHEC Professor and director of the PhD in Finance programme, Rui Albuquerque, Seidner Family Faculty Fellow Professor of Finance at the Carroll School of Management, Boston College and Vyacheslav Fos, Associate Professor in Finance, Boston College, has been initially published in French in The Conversation under Creative Commons licence. Lire l’article original.

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