Shareholder activism debate: A force for good or bad?

BC (University of Cambridge)

Institutional investors owning large stakes in companies were prepared to arm-twist boards on topics such as dividend policy and rights offerings, and to orchestrate the removal of chief executives in troubled companies. Rarely, however, was there offensive shareholder activism. Building up a stake in a publicly quoted company with the intention of agitating for change was futile because among institutional investors the default rule was to back management.

Over the past decade, pension funds and insurance companies have wound down their holdings. The vacuum has been filled by shareholders less inclined to back management, such as hedge funds and international institutional investors. It’s also commonplace for investors to buy equities with the intention of supporting initiatives proposed by insurgents. The result has been a surge in offensive shareholder activism.

This surge could fall victim to the credit crunch. Pressure on companies to take on debt to repurchase shares or make large dividend payments is potentially less credible as borrowing has become so much more expensive. Lobbying for companies to break themselves up is arguably a less viable strategy now that private equity firms’ capacity to carry out buyouts is constrained. However, shareholder activism does not seem to be a passing fad, as indicated by Eric Knight’s campaign for change at HSBC.

AS (Kinetic Partners) Now is the time for a code of conduct for activists. There are two drivers for this; the global political environment, and a desire among activists for more clarity about market abuse regulation.

The G8 is chaired by the German authorities, some of whom described the hedge funds as locusts during the Deutsche Börse takeover a couple of years ago.

Many in the German political establishment have concerns about hedge funds. Those concerns revolve around financial instability and shareholder activism.

There is already a code of conduct for financial instability but there is a gap in shareholder activism. German authorities are pushing to have more regulation of hedge funds. If the industry wants to head that off it needs to propose a code of conduct.

So far the Germans have not got far. The UK and the US have pushed back any attempts to bring in further regulation. But the events of the summer will strengthen the Germans’ hand. Although these events are related to leveraged credit funds – entities such as CDOs and CLOs – rather than hedge funds, that subtlety will not carry much weight with the Germans at the G8. They will see this as justifying their concerns about unregulated offshore funds and their ability to threaten the stability of the global financial system.

It’s time for European regulators to get their act together on CFD [contracts for difference] disclosure. We’ve had the upheaval and cost of implementing the Markets in Financial Instruments Directive. A framework is in place for shareholder notification through the transparency directive. All it would require is for the Committee of European Securities Regulators to bring in Level 2 measures to have consensus across Europe on CFD disclosure.

I detect a desire for more clarity in the industry. The Market Watch article issued by the FSA in May is a manifestation of that.

Activists have been so successful that if they publish a letter to a board calling for change, they’re almost certain that the share price will move. Should there be a blackout period before issuing such a letter, during which they are unable to trade? It could be seen as a form of insider trading. In the article, the FSA also discusses other participants’ understanding of the activists’ strategy. There must be no suggestion of concert parties or other people knowing what the major activist is going to do. Again, it’s not clear what that knowledge would entail.

HH (Eclectica Asset Management) Markets are falling. We’re in jeopardy. I’ve got redemptions. And do you know what? I’m not an activist investor. I’m an opportunist contrarian investor. I can see brass where others can see muck.

The contrarian in me has been feeding the turmoil that may be undermining the hedge funds and may be calling for these stiffer regulations.

I’ve found myself buying a large shareholding in EMI. It was a curious case. EMI was bidding for Warner Music Group, and Warner was bidding for EMI, and they were identical businesses. It was trading at the same price as 26 years ago, at the beginning of the bull market, when the Dow Jones was only 1,000 points rather than 14,000.

But there were two problems: what the internet has done to the profit stream of music royalties and recording music profitability, and secondly, it had been very poorly managed. I built a position, we had 2.2% of the shares. There was a debate and it’s good to talk.

I wrote a letter to the Financial Times, telling them the exact number of shares, and that part of our shareholding was in the form of CFDs.

We even told them that the 2% represented almost 20% of our fund. No secrets. As they seemed to be identical businesses, I said the only way to differentiate was in the actions of the management teams. Warner seemed to have a sizeable proportion of their wealth invested in their shares. EMI had a lamentable investment in the underlying business. This seemed to explain the poor decision set taken by the British counterparty, and I supported Warner Music.