Do institutional shareholders support shareholder activists’ campaigns?

1. Introduction¹

Shareholder activism has increased during the last years in its origin country, the US, but also in Germany.² Activist shareholders are investors that specifically buy small stakes in companies and start campaigns, aiming for increased performance and higher returns of targeted companies. Once invested, they run campaigns on the targeted company and seek different actions in companies strategy, and management.³ Since activists only own between 6% and 7% of the companies’ shares on average and cannot force change by themselves, they request support from institutional shareholders to gain negotiation and voting power.⁴ Institutional shareholder ownership in companies also increased during the last years, so that they recently became a more powerful player in activists’ campaigns.⁵ Historically, shareholders used the “Voice-or-Exit” option to express disagreement with corporate governance or management, whereas nowadays, supporting activist shareholders can become an additional option to express dissatisfaction and force change.⁶ Driven by the increased institutional ownership during the last years and, consequentially, growing issues with corporate governance, corporates face proxy fights backed by institutional shareholder votes as well as institutional shareholders actively approaching activist shareholders more often.⁷ Proxy fights are the voting on the activist demands with proxies in place, since many shareholders vote on behalf of their investors, for example asset managers, or representatives representing larger groups of shareholders with the same interest, for example proxy advisors or banks. The proxy fight is the ultimate step of an activist forcing change, which follows different attempts to cooperate with management.

To assess whether activists’ campaigns become more powerful due to the potential support by institutional shareholders, a thorough analysis of the voting results of institutional shareholders in the course of proxy fights, especially in German campaigns, was conducted. In total, the analysis reviewed 1,065 campaigns in the US and Germany between 2015 and the first half year of 2018 by activist shareholders and conducted two expert interviews to identify the support rate for activist-initiated proxy fights, also at the individual proposal items.

2. Shareholder activism

Shareholder activism activity has increased globally during the last years. Campaigns addressing corporates publicly increased by 41% from 2013 to 2017 (from 570 to 805), which is mainly driven by more activists’ capital which can be deployed.⁸ Activist shareholders are “investors who, dissatisfied with some aspect of a company’s management or operations, try to bring about change within the company without a change in control”.⁹ The activist campaigns typically, but not necessarily, start with exceeding a threshold of ownership where a legal filing and information about the investors’ aim of investing has to be disclosed and therefore could also be observed publicly. Once a campaign has been started, activists seek individual changes in companies’ strategy and management, also called demands, which could be the replacement of executives, the disposal of stakes or cutting costs.¹⁰ Even though activism can increase performance, it most often meets strong resistance from companies’ management and attracts public awareness.¹¹

 In contrast to activist shareholders, non-activist institutional shareholders are long-term oriented and manage their assets passively. When dissatisfied with companies’ management, institutional investors have limited ways to affect corporate governance. Supporting an activist shareholder and pursuing the same change allows institutional investors to express their specific disagreement. For a long time, the “Voice or Exit” or so-called “Wall-Street-Walk” channel was used to express dissident opinions.¹² In this context, the “Voice-or-Exit” channel refers to interactions between investors and management (voice) or selling the shares (exit). The channel bears some problems for certain types of shareholders or constellations of ownership structures, for example index funds¹³. Therefore, institutional shareholders in general insist on their fiduciary duty to exercise governance in informal meetings with management and/or vote at general meetings.¹⁴ In activist situations, institutional shareholders used to vote often in favor of management proposals or recommendations. Recently, however, there is a broader recognition that non-activist institutional shareholders partner with activist shareholders to change corporate governance and other matters more often. When maintaining their stakes in contrast to selling it, shareholders will seek more influence over governance and strategic decisions made by listed companies when dissatisfied with the management.¹⁵

Overall, shareholders and companies’ management have a principal-agency relationship, which means management (agent) is engaged to run the company on the behalf of the shareholder (principal).¹⁶ Divergence between both parties cause additional cost (agency cost), which shareholder activism, in addition to the existing governance structure, tries to reduce with secondary monitoring and control mechanisms.¹⁷ A close monitoring by meetings and casting votes at AGMs could align the interest of management and shareholders again, resulting in a corporate stability and longevity.¹⁸ Thus, managers cannot ignore dissatisfied shareholders and must face the campaign demands.¹⁹

3. Investment stewardship

With the increasing shareholdings of institutional shareholders, they also developed a more direct communication with companies and further stakeholders, which forms the so-called investment stewardship. Investment stewardship means the engagement of shareholders with companies to promote corporate governance practices and therewith support the creation of long-term value for shareholders in the company. Both, engagement and voting provide the opportunity to express disagreement and propose changes to the management. In the investment stewardship ecosystem relevant stakeholders are asset owners, asset managers, proxy advisors, and index providers who play key roles. Investment stewardship enables shareholders to express their opinions with engagement or voting and is most of the time related to governance topics based on internal guidelines and policies. Proxy voting decisions are made by asset owners or by asset managers, if delegated, and are based on their own perceptions and decisions or on the research and recommendation of proxy advisors. If voting authority is delegated, regulations and stewardship codes require asset managers to vote proxies on behalf of their clients. In the US, the SEC issues guidance and require asset managers, as fiduciaries, to vote in the best interest of their clients. In the EU, the forthcoming Shareholder Rights Directive will require asset managers, pension funds and insurers to disclose their voting rationale for significant votes.

Often, proxy voting is first associated with investment stewardship even though the engagement with management is also an important component of it. Typical tools of engagement in this context are one-to-one meetings with company boards or management representatives, writing letters to the company and further activities. How asset owners and managers approach companies differs from shareholder to shareholder and depends on various criteria, such as investment strategy, objectives or horizon.²⁰ Transparent examples are BlackRock and The Vanguard Group who make their investment stewardship approaches accessible on their websites.

4. Empirical evidence on institutional shareholders’ impact on activists’ campaigns

In 30 years of research, shareholder activism was analyzed empirically from many different perspectives. Besides recent empirical proof of positive effects of activism on targeted companies’ valuation and performance, there is only few research about the impact of non-activist institutional shareholders on the campaigns’ success.²¹ The main research contributors are Apple et al. (2016): The Effect of Passive Investors on Activism, Kedia, Starks, Wang (2016): Institutional Investors and Hedge Fund Activism, and Foroughi (2017): Hedge Fund Activists’ Network and Information Flows.

Apple et al. researched the impact of the presence of passively managed mutual funds on activism resulting in more hostile tactics and higher success rates of campaigns. Kedia, Starks, Wang further broaden the findings to all shareholder types (not only limited to passively managed mutual funds) and analyze the impact of other institutional shareholders on activists’ campaigns. The research documents, as one of the first, the impact of institutional shareholders on likelihood of and value creation from hedge fund activism. The key finding is that friendly institutional shareholders are associated with higher stock returns in the short- and long-term as well as higher operating performance of target firms. The research paper does not differentiate institutions by considering their investment horizon or size of stake, but instead use the likelihood of supporting activism. Therefore, shareholders are categorized in activism-friendly and activism-unfriendly, which allows covering all shareholder types and considers shareholders who change from one type to another over time. The key conclusion is, that “support from institutional shareholders appears to be crucial to unlock firm value through activism“.²² Further research by Foroughi found that connections and information flows between activists and other institutional shareholders have positive impact on both short-term and long-term success of activists’ campaigns. As two likely mechanisms beneficial for activism, Foroughi names the “information- gathering channel” and the “support channel”. The information-gathering channel includes an already common strategy which is to receive information from other institutional shareholders before selecting a target that allows investors to find targets with high improvement potential. Also, disappointed shareholders invite activists to run campaigns against the management. The support channel includes the easier distribution of information to other institutional shareholders with already existing connections, which attracts more shareholders and obtains higher support rates for campaigns. Furthermore, being well-connected to other institutional shareholders implies more influence while negotiating with management. Foroughi’s findings are coming from a network of investors which is built on past investment behavior and a grouping of shareholders in activists and non-activists. He relates the network information to share price developments and observes abnormal returns around the announcement date. The results emphasize a positive effect both, in the shortterm and long-term on targets’ performance.²³

5. Analysis of institutional shareholders’ support in activist-initiated proxy fights

After having collected a total of 1,065 campaigns initiated by activist shareholder targeting US-based and German companies in the period between 2015 and the first half year of 2018, 28 campaigns resulting in proxy fights were reviewed. Therefrom, 2 US and 4 German campaigns were excluded due to missing voting result information. From the remaining 22 campaigns, a total of 87 voting results represent the sample for the analysis of the support of activists’ campaigns by institutional shareholders. In total, voting results for 273 voting items proposed by institutional shareholders during proxy fights were assessed.

The results show a support rate²⁴ of activists’ campaigns by institutional investors of 38%. The highest support rate, weighted by proxy results analyzed, is from Goldman Sachs with a support rate of 88% (of a total of 9 voting results), followed by The Vanguard Group with 67% (of a total of 6 voting results) and BNY Mellon Investment Management with 57% (of a total of 7 voting results). The least supportive institutional shareholder is State Street Global Advisors with a support rate of 0% (of a total of 4), followed by BlackRock, Capital Group and Norges Bank Investment Management with 25% each. The detailed support rate²⁵ analysis shows a support rate of 26%. Only 71 of the total of 273 items were voted as for, whereby 16 items were voted against the activist (6% of total proposed items) and 186 times the institutional shareholders did not vote (68% of total proposed items). On proposed item-based results, the highest support rate comes from The Vanguard Fund with a support rate of 67% (of a total of 19 votes on proposed items). The highest support rate by absolute votes on proposed items shows Amundi with 16 for votes on proposed items. The least supportive institutional shareholder item based is State Street Global Advisors with a support rate of 0% (of a total of 8 votes on proposed items), followed with a support rate of 14% by BlackRock (of a total of 43 votes on proposed items). The least supportive absolute item-based institutional shareholders besides State Street Global Advisors and BlackRock is Capital Group with 6 support votes.

Source: Own illustration

Source: Own illustration

Furthermore, the demands which were raised at the beginning/ during the activists’ campaigns with a total number of 403 as well as the demands outcome with a total number of 760 were collected and analyzed. The average duration of the campaigns was 1078 days, whereby the shortest campaign lasted 163 days and the longest 3832 days. Longer campaign durations increase the awareness of the institutional investors.²⁶ The difference between the numbers of changes demanded at the beginning/during activists’ campaigns and the demand outcomes derives from the variety of settlements and agreements. As shown in figure 2, at the beginning and during activists’ campaigns operational and tactical-related changes were demanded most often with 43%, followed by board- and management-related changes with 33% and capital-related changes with 13%. The least demanded changes were discussion- related changes with 5%. The analysis also shows that board- and management related changes are the major items voted on in proxy fights. As outcomes of activists’ campaigns, board and management-related demand outcomes were achieved most often with 41%, followed by operational- and tactical-related demand outcomes with 22% and capital-related changes with 15%. Discussion- and asset-related demand outcomes were achieved least of all with 11%.

Since the amount of campaigns resulting in proxy fights is relatively small (less than one-tenth of 13-D filers), this analysis does not represent results about certain activist shareholder who are more likely to initiate campaigns which do not end in proxy fights.²⁷ Furthermore, German companies are approached by activists less frequent than US-based companies, but with an increasing trend. This also reflects the fact that few proxy fights end in proxy voting in Germany: only 5 proxy voting took place during the assessed period. Besides the low number of proxy fights, missing ownership data of companies, no disclosure of votes of German funds and small ownership base of US-based mutual funds in German companies were responsible for missing information about voting results. Nevertheless, the campaigns driven in Germany increase and therefore could learn from the US market to be prepared for future campaigns.

6. Summary

Shareholder activism has been subject of academic research already for the last thirty years. During the last years, the topic gained also much more attention in practice due to the evolving tactics of activists but also a wider geographical reach beyond the US, where it originally started. Since institutional shareholder ownership in companies increased too, they also became a more powerful player in activists’ campaigns due to their voting power. Activists seek the institutional shareholders’ support during their campaigns, but also the institutional shareholders discovered activism as a new option of expressing their disagreement with management.

The research shows the support of activists by institutional shareholders in proxy fights by means of proxy voting results. The results show that institutional shareholders supported activists’ campaigns in 38% of the analyzed proxy voting results and 26% on a more detailed level. Furthermore, the most often demanded changes were operational- and tactical related with 43% at announcement and during campaigns, whereas measured by the outcomes board- and management related demands were highest with 41%.

In conclusion, companies increasingly face activism and discussions with activists. In Germany the number of campaigns also increased. Even though the absolute number of campaigns is still much lower than in the US, German companies should learn from the US campaigns and prepare accordingly ahead of a potential campaign. This analysis shows that institutional shareholders being increasingly supportive of activists rather than management and considering activism as a new option of expressing their disagreement, which will change the activism environment in the future to the advantage of the activists. Companies’ management should take this into account and explain their strategy continuously to their shareholders and listen to their concerns.