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.