9.1 The Rise of Shareholder Activism

In the last 3 decades, individual and institutional shareholders found their voice. Today, they assert their power as a company’s owners in many ways—from selling their shares to private or public communication with management and the board, from press campaigns to blogging, from openly talking to other shareholders to putting forward shareholder resolutions, and from calling shareholder meetings to seeking to replace individual directors or the entire board.

Although shareholder proxy proposals typically are not binding or may not receive enough votes to pass, they draw public attention to companies’ practices and often force them to reconsider their policies. As a result, a growing number of companies meet with their institutional shareholders during the planning stages of a proposal rather than wait until the implementation stage. And an increasing number of companies are submitting all-equity compensation plans for shareholder approval.

In the United States, the birth of the shareholder rights movement can be traced back to the stock market crash of the late 1920s—investors and policy makers believed this disaster was caused in significant part by companies’ lack of transparency. In its aftermath, the Securities and Exchange Commission (SEC) was formed and charged with creating public disclosure and enforcement mechanisms to protect investors and promote the dissemination of reliable corporate information to the marketplace.The SEC regulates and promulgates rules governing shareholder resolutions.

In the 1970s, activists’ agendas began to include socially oriented shareholder activism; religious investors formed a shareholder coalition called the Interfaith Center for Corporate Responsibility (ICCR) and started using the shareholder proposal process as a way of working for peace and social justice. They began organizing and filing resolutions on South African apartheid and community economic development and global finance, environment, equality, international issues, health, and militarism. Today, shareholder resolutions cover a similar range of issues and are used by public interest–minded shareholders and their allies to affect social change on a company level.

Corporate governance activism emerged in the 1980s. This brand of shareholder activism focuses on corporate governance, primarily on how a company structures and compensates its leadership. In 1985, the Council for Institutional Investors (CII) was formed to protect the financial interests of its member investors and pension funds. The CII and its member groups are actively involved in studying and promoting good corporate governance.

One of the most popular shareholder proposals today demands that shareholders be allowed to directly nominate and elect directors rather than work with the slate recommended by the board’s nominating committee. Another proposal asks that shareholder resolutions receiving majority support become binding on boards, and that shareholder votes on merger proposals be made mandatory. Support for these further proposals has been lukewarm, however, because they tend to undermine rather than strengthen the role of the board.

In 1989, following the Exxon Valdez disaster, investors and environmentalists banded together to form the Coalition for Environmentally Responsible Economies (CERES), which was built around elements of environmental disclosure. This investor-environmentalist alliance uses the power of share ownership to persuade companies to adopt a set of environmental principles and produce public, standardized, annual, environmental reports.

Today, shareholder resolutions are used more than ever as a way of influencing corporate behavior and concern issues ranging from corporate political contributions to health care, from executive compensation to board leadership, and from the environment to animal welfare. Institutional shareholders, especially hedge funds, are a major force behind these developments. Using the power of activism to influence policies at companies in which they have significant holdings, they have begun to scrutinize stock plan dilution, compensation practices, and merger proposals. Mutual fund firms, which have traditionally not been vocal on behalf of shareholder rights, are getting more involved. And more institutions are turning to their most powerful form of activism and voting “no” on key items.

A contributing factor is the short-term boost such efforts can have on stock prices. Thomson Financial studied the performance of stock in 75 companies targeted by activist investors—whether hedge funds, public pension funds, or other entities—between 2001 and 2006. Within the first 3 months of being publicly targeted, the companies on average saw their shares rise nearly 12%, well above the rise of less than 1.5% for a control group of stocks. After one year, the 75 companies posted gains of 17%, compared to a rise of 7.2% in the control group.Thompson Financial (2007).

Not surprisingly, shareholder activism is controversial. Proponents argue that companies with active and engaged shareholders are more likely to be successful in the long term than those that largely function on their own. In their view, vigilant shareholders act as fire alarms, and their mere presence helps alleviate managerial or boardroom complacency. Opponents say that “shareholder activism” is a form of disruptive, uninformed, populist meddling that encourages short-term behavior and diverts a board from a focus on value creation. Some particularly worry about the rise of hedge-fund activism. They note that although hedge funds hold great promise as active shareholders, their intense involvement in corporate governance and control also potentially raises a major problem, namely, that the interests of hedge funds sometimes diverge from those of their fellow shareholders. These polar opposites reflect the broader societal disagreement about how much power shareholders should delegate to corporate boards and when direct shareholder action becomes necessary and on what terms.