June 25, 2018
Can good corporate governance reduce the chance of activism?
Yes. And no.
Activist investors are not philanthropists. If they choose to take a position in your company it is because they can see a route to making money for their own shareholders.
But is it true that businesses with sub-par corporate governance offer more opportunities for activism and therefore value creation? Probably.
There are a number of academic studies indicating possible correlation between good corporate governance and better company performance. For example, in 2012, Harvard University published a paper1 which showed that while good corporate governance does not directly correlate to share price growth, it does translate into improved Key Performance Indicators, such as return on assets, net profit margin and sales growth.
But assuming the validity of the academic studies indicating that good governance is a factor in value creation, is governance a factor in activism?
Activists have to be effective consensus builders if they are going to create a pathway to value. They can’t win on their own. They need to persuade the entire shareholder landscape of the merits of their approach to ensure that they are able to win the intellectual debate and force change.
Today, shareholders can have very different motivations. Some activists say they categorise the shareholder landscape into four buckets: actively managed funds; ‘passive’ or index funds; retail investors and employee investors. The first two categories are typically dominant on a company’s share register. The activists deploy strategies designed to appeal to each group.
Actively managed funds are naturally attracted to the activist’s story by the value creation opportunity and the detailed fundamental analysis of a company that activists live and breathe. Actively managed funds have probably built their own value models of your business and they will be very curious to see how the activist views the value gap. They absolutely care about governance2 but value is the big motivator.
Passive or Index funds, which are becoming an ever larger part of the shareholder landscape, don’t do the same level of fundamental analysis as an active fund. Their shareholding in your company usually depends purely on your place in an index, for example, the S&P 500, FTSE 100 or CAC40. If you go onto an index, they invest. If you fall out, they sell.
This doesn’t mean they take an entirely passive approach to investing. As they recognise the political and societal pressure on them to be responsible investors, they are increasingly interested in ESG issues. Funds like Vanguard, Blackrock and State Street have their own highly developed ESG voting teams and other Index players employ groups like ISS and Glass Lewis to assess how they vote.
Retail and Employee investors are also more naturally inclined to favour positive ESG narratives, although yield and employment prospects are also core drivers.
It is also true that activists themselves are facing increased pressure from their own investors, which may include large pension funds and asset managers, to show their commitment to ESG objectives.
The net result on activist strategies is that to be successful and to win the intellectual debate they need to give full consideration to value AND governance. If a company has substandard governance, there may already be a value gap. This makes an activist approach more likely.
While poor corporate governance can increase a company’s risk of being targeted by activist investors, value remains the key driver for activists. If a tech player has poor governance but a soaring valuation then they are probably safe until the share price falls to earth. At that point activist alarm bells will be ringing all around the investing world and the Board should get ready to meet the activists.
Managing Partner, Finsbury London
1 ‘Learning and the disappearing association between governance and returns’
2 Actively managed funds now have explicit ESG objectives. Assets under management in U.S. based funds with socially responsible investment objectives now represent 20 percent of all investments under professional management in the country; and in the UK in 2017 investors ploughed a record £1bn into active ethical funds, an almost 500 per cent increase on the volume of ethical funds purchased by retail investors in 2008.
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