Shareholder Activism

Shareholder activism is the proactive attempt by equity investors, usually large financial institutions, to change some aspect of firm behavior or governance. While the goals of activist shareholders vary, they primarily revolve around monitoring and attempting to bring about changes in firms believed to be pursuing goals that are not shareholder wealth maximizing. The move to shareholder activism, especially in the United States during the 1990s, is arguably an outcome of the weakening of an active market for corporate control in the 1970s and 1980s through anti-takeover stratagems and legislation, modifications in executive remuneration schemes and the requirement for shareholder approval, and changes in the attitudes and motivations of traditionally passive institutional investors. Shareholder activism can take any number of forms, but typically includes proxy battles, publicity campaigns, [Page 1436]shareholder resolutions, litigation, and negotiations with management.

The fundamental basis for shareholder activism, and one reason for the apparently wide variation in activity around the world, is differences in corporate governance mechanisms. In the Anglo-American model (exemplified by the United States, United Kingdom, and Australia), corporate governance emphasizes a well-developed stock market, strong investor protection, substantial disclosure, and arms-length banking relationships. In contrast, the Germany-Japan model (prevalent in Germany and continental Europe, Japan, and parts of Asia) assigns a greater role to long-term manager-investor and firm-bank relationships, concentrated ownership, and cross-shareholdings among firms and between firms and financial institutions. The latter clearly favors entrenched management and leaves little room to maneuver for independent activist shareholders.

Motivation

The primary motivation for shareholder activism rests on the principal-agent relationship between shareholders and firm managers arising from the separation of ownership and control. Assuming that managers are rationally interested in furthering their own ends, the central problem for shareholders is how to motivate the managers to act in shareholders' interest, not their own; typically, in terms of shareholder wealth maximization. A variety of mechanisms provides incentives for managers in this regard. First, the market for corporate control disciplines managers to better shareholder interests or risk their position because of the hostile takeover of an underperforming firm. Second, the market for managerial talent entails incentive compensation in the form of stock options and performance-related pay. Last, the active monitoring of management decisions in compliance with shareholder wealth maximization. Primarily, this is through the firm's board of directors, but also institutional and block shareholders, and indirectly through banks and other debt holders. If any or all of these mechanisms break down or are compromised, shareholder activism may take place.

The question naturally arises that if a firm is under-performing in terms of shareholder wealth maximization, why do investors not simply sell their shares (“vote with their feet”) and avoid the anticipated information gathering and legal costs associated with shareholder activism. While institutional investors especially engage in some monitoring of the firms they invest in by analyzing financial and strategic statements, and occasionally meeting with and questioning management, to go beyond and try to control management (by acting directly to influence the structure, processes, or decisions of the board) would appear to be prohibitively expensive in relation to the potential return. One answer lies in the notion of exit and voice and the influence of two types of information. The first type of information, speculative or value-neutral information, is backward looking and has no direct bearing on the firm's future decisions. Holders of this information will have little incentive to attempt to monitor and control the firm and may choose exit as a cost-effective means of coping with poor performance.

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