Bridge over ocean
1 February 2010 CFA Institute Journal Review

Returns to Shareholder Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund (Digest Summary)

  1. Hue Chye Ling

In the United States, no empirical evidence exists that shareholder activism can positively affect performance. The authors examine whether regulatory framework plays a part and draw from the experience of a U.K.-based fund. They find that successful shareholder interventions add value to the performance of underlying stock holdings as well as to the fund.

The legal environment in the United Kingdom offers greater scope for shareholder activism than that in the United States in four areas: (1) rights relating to changes in basic governance arrangements, (2) director removal rights, (3) direct shareholder involvement in hostile bids, and (4) speed of shareholder action.

Previous studies have failed to demonstrate a link between U.S. institutional shareholder activism and performance. These results are attributed to three factors: free riding, conflicts of interest, and legal obstacles.

The authors examine the effect of shareholder activism on performance when the legal environment is less restrictive. They draw on the actual activism carried out at the Hermes U.K. Focus Fund (HUKFF) from 1998 to 2004. The HUKFF overcame the free-riding disincentive by increasing its stakes in and actively engaging underperforming stocks that the parent Hermes Group already owned.

The authors were given access to all private and public records of the HUKFF’s activities. They designed a methodology to determine the contributing factor to performance from shareholder activism. Shareholder interventions are classified as collaborative, confrontational, or a mixture of the two.

The authors find that, contrary to previous reports, shareholder activism usually takes the form of private, not public, interventions. These interventions manifest mostly as restructuring, board changes, or policy changes. An intervention is attributed to shareholder activism only when the intervention was specifically spelled out as an objective before investing by the HUKFF and was stated as such in private correspondence with the target company management. The authors measure the effect of a successful intervention on stock returns within a 3- to 11-day window around the announcement date.

When a seven-day window is used, the underlying stocks that the HUKFF successfully engage with deliver a mean cumulative abnormal return (CAR) of 3.9 percent. After the authors remove the effects of profit warnings or earnings results, which frequently coincide with the announcement of successful interventions, the stocks’ mean CAR increases to 5.3 percent. The results are statistically significant.

Apart from the effect on stock prices, operating performance was different in three areas after an intervention: (1) smaller assets plus higher return on assets, (2) leaner employee workforce, and (3) higher market-to-book value. These differences are not statistically significant, but the economic effects of the changes are noticeable.

At the fund level, the HUKFF delivered an outperformance of 4.9 percent per year over the FTSE All-Share Index during the observed period of 1998 to 2004. The authors calculate that 92 percent of the outperformance can be attributed to the successful interventions by the HUKFF. Dissecting by type of intervention, the authors show that the greatest returns come from mixed engagements, followed by confrontational interventions. The smallest returns are derived from collaborative engagements in which stock holding periods tend to be the shortest.

The authors further find that free-riding public investors fare even better than the HUKFF.

They conclude that where the legal environment allows, shareholder activism may be able to reap substantial benefits for both active and outside shareholders.

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