Shareholder Activism: Together Is Better

Just ask Sotheby’s what it feels like to be chased by a wolf pack. In 2013, a number of shareholder activists, led by the hedge fund Third Point, banded together in an attempt to take control of the global art merchant. Sotheby’s responded with a poison pill that imposed a 10 percent threshold on the stake any one shareholder could take in the company, hoping to limit any activist from gaining an effective veto over corporate decisions. But the wolf pack, as these “clustered” activists are known, was able to accumulate a 19 percent stake in Sotheby’s without any single activist crossing the 10 percent barrier. That presence forced Sotheby’s to install three new directors on its board, including Daniel S. Loeb, the flamboyant CEO of Third Point.

Shareholder activists are certainly becoming increasingly bold. As a 2014 report by McKinsey and Company points out, activists — generally hedge funds or other investment management firms — launched an average of 240 campaigns each year from 2011 to 2013, more than double the number a decade previously. The size of the prey has expanded as well. At the end of 2010, the average firm targeted by shareholder activists had an average market cap of under US$2 billion; that grew to US$10 billion by 2013.

It seemed a logical evolution to have shareholder activists band together and pool their informational and financial resources to target large-cap firms, such as Allergan and DuPont. But, surprisingly, the phenomenon of clustered activism still is not well understood. Until recently one of the biggest gaps was in understanding how wolf packs form and operate, and how successful the strategy actually is.

A new study by Tanja Artiga González of VU University Amsterdam and Paul Calluzzo of Smith School of Business aims to address this gap. Most of their research is based on Securities Exchange Commission filings from 2000 to 2011, covering 2,435 different activists and 2,399 target firms. To spot wolf packs at work, Artiga González and Calluzzo examined no fewer than 285,701 firm/month observations from target firms, identified whether an activist was present in a firm, and then determined whether another activist targeted the firm within the following month.

A Bigger Stake

The researchers found that wolf packs tend to target larger companies, while lone-wolf shareholder activists focus on smaller ones. This suggests that by grouping together, activists can aim for larger firms: by doing so, they increase the aggregate stake in the target firms and spread the considerable costs of a campaign.

“Through cost sharing and, eventually, coordinated proxy voting strategies, activist investors who work together (implicitly and explicitly) can increase the probability of success of their campaign,” they write. Far from being isolated incidents, clustered activist campaigns are “a pervasive part of the activism process.”

Four mechanisms seem to make coordinated action attractive. One is the presence of identical or similar investment goals among multiple activists. Another is financial; activism is costly enough that the expense incurred by a solo activist can eliminate or at least greatly reduce the return. With a group of activists, the costs can be shared. There is also reputational concern; an activist may join others as a way to enhance its chance of success and thereby boost its reputation. The fourth motive is the relative ease of access to private information that the lead activist may have already generated.

Artiga González and Calluzzo say that the chances of success for a clustered campaign went up when obstacles to collaboration were absent or minimal. Geographic proximity and similar operational styles, in particular, were significant advantages.

Happy Returns

How successful is clustered shareholder activism? One of the signs that they looked for is cumulative abnormal return (CAR) for the targeted firm. CAR is the sum of the differences between the expected return on a stock and the actual return; it is often used to evaluate the impact of news or other shocks on a stock price. They found that a coordinated activist campaign produced a CAR of 16.7 percent at the targeted firm in a 41-day period surrounding the start of a campaign.

Clustered campaigns also yielded better return on assets and better cash flow from operations than single-activist interventions. And the boost in profitability carried on over the long term; Artiga González and Calluzzo found no reversal in the profitability change two years after the start of the campaign.

Capital expenditure declined for both clustered and solo activist campaigns, but the decline was three times greater for the former. Research and development spending rose when single activists intervened but declines under a clustered campaign. “This finding is consistent with the most frequent demand of entrepreneurial shareholders to change the corporate strategy and that 70 percent achieve this goal within one year.”

Artiga González’s and Calluzzo’s study applies only to wolf packs south of the border. Canada tends to be much less favourable to shareholder activism, clustered or otherwise. For one, there are regulatory obstacles, such as restrictions on share sales and an advance notice requirement that depresses a potential target’s share price. For another, there are far fewer large-cap, large-payoff targets worth pursuing.

— Andrew Brooks