Shareholder activists, as the phrase implies, are strategically and operationally involved in the companies in which they have a vested financial interest. The management of large corporations are unable to hold a monopoly on short-term (and at times, day-to-day) operations when these activists enter the game.
An activist investor may only need to secure a 10-15% ownership stake in large companies in order to place a disproportionate amount of pressure on management. That is because these shareholders, especially if they are high-profile and successful investors, gain the ear of other investors.
Their campaigns can lead to new board members and a hard drive to execute the activist's agenda. In military terms, you might view this as a mutiny. (Find out why certain companies are targeted by these investors; see Could Your Company Be A Target For Activist Investors?)
Why the Pressure on Management?
In large institutions, executives and managers work with assigned budgets that use the investors' capital. They are not using their own money to run a business; therefore, there may be high amounts of wasteful spending. Oftentimes, there is a mindset of "spend it or lose it."
Let's look at some typical examples of luxury spending at many of the Fortune 1,000 companies:
- Six-figure Christmas parties
- Lavish recruiting dinners
- Multiple corporate jets and helicopters (with plenty of idle time)
- Excessive per diems on meal allowances
- First-class plane rides
- Non-business related expenditures such as gift purchasing and entertainment expenses
- Non-essential training or educational expenses
- Purchase of the latest computer hardware, software or high-end office furniture
Shareholder activists place pressure on management for the following reasons:
- To Make a Quick Buck
A corporate raider may be interested in extracting short-term returns from an investment in a company. In this case, the investor buys a large chunk of shares with the intent of dumping these shares within a few months after a price increase. With such motivation in place, the short-term investor - in an effort to prop up the stock price - forces management to execute a combination of initiatives, including issuing dividends, taking on more debt, reducing research and development, and/or reducing capital expenditures. While in certain circumstances these initiatives may be beneficial for the company, they can also be harmful in the long-term.
- To Create Long-Term Value
An investor may be motivated to seek returns in the long-term, and thus may hold a company's stock for several years. Given the long-range outlook, the shareholder activist can attempt to motivate management to increase the company's value for the long haul. In this case, the shareholder activist may not want dividend payouts or stock buybacks. Instead, he may want management to put cash in projects that yield returns for the long haul, such as research and development, capital expenditures and new marketing campaigns.
- To Change the Game
An experienced and well-connected shareholder activist may hold a different industry or market outlook than management. He may have a different view on the future or may simply have more experience than management, resulting in foresight on trends. If the shareholder has the support of other investors, he could force management to change the strategic direction of the company. The shareholder may force the organization to divest of unwanted business units, pursue new product or service offerings, enter new markets or alter the business model.
- To Run a Tighter Ship
Management and employees may have gotten complacent over the years, and become satisfied with receiving a predictable stream of paychecks, generous benefits and annual salary increases and bonuses. As an example, a public transportation company which has a virtual monopoly in providing accessible mass transit for a city or state may become privatized. Under this scenario, the for-profit motives of the incoming shareholders behoove management to improve efficiencies and effectiveness, cater to customers, increase profitability and execute the business model as best they can. Thus, with underperforming companies, shareholder activists will prod management to manifest a leaner and more efficient organization.
- To Improve Performance
Key managers may want to pursue growth for the sake of growing. Investors, however, are motivated in getting returns for each dollar of cash they have invested in the business. Thus, the focus of management - from the view of shareholders - should be to balance and maximize the short and long-term return on invested capital. Activist shareholders can make this happen.
- To Spice Things Up
Shareholder activists often bring with them personal tastes and preferences. Because they are owners in company, management can often be pressured to align the organization's policies with the predilections of its investors. For example, an investor may be a philanthropist, thus management may feel compelled to reward employees who volunteer in their communities or who make charitable donations. A majority shareholder may also be a politician and have a motivation to maintain a clean image and reputation. Thus management may be pressured to get rid of perceived unsavory business units such as a tobacco division or a risqué publication business.
Let's take a look at a few examples of shareholder activist battles with company management.
Carl Icahn vs. Time Warner Management
Time Warner (NYSE:TWX) made the infamous business combination with AOL, a merger and acquisition (M&A) transaction considered one of the worst in modern history, and ultimately cost shareholders billions of dollars in lost equity value. In 2006, Carl Icahn led a group that called for (1) the breakup of Time Warner into four different companies, (2) cost-cutting efforts at the company, and (3) stock buyback worth $20 billion.
The Icahn-led group disagreed with management's stewardship of the company, including poor execution of its broadband offering, the sale of Comedy Central and Warner Music (which were successful up-and-coming divisions) and a failure to make strategic acquisitions (including the MGM film library and AT&T's cable business) that were thus gobbled up by competitors.
The group won concessions, including the $20 billion stock buyback, $1 billion in cost-cutting measures and the appointment of new board directors. (Buying up failing investments and turning them around helped to create the "Icahn lift" phenomenon, check out Can You Invest Like Carl Icahn?)
Roy Disney and Stanley Gold vs. Michael Eisner and Disney Management
In 2003, Roy Disney and Stanley Gold resigned as Disney (NYSE:DIS) board members in protest that Michael Eisner (Disney's CEO) had filled the company's board with directors that were too aligned with Eisner. As nephews of the company's founder, they wanted a board composed of directors who were accountable to investors, not the CEO.
In 2004, both Disney and Gold attempted to oust Michael Eisner. In 2002, Disney's stock had hit an eight-year low and 2004's earnings expectations fell far below Wall Street's expectations. Additionally, Eisner had created rifts with Pixar Animation Studios (led by CEO Steve Jobs) of which the Disney Company was the largest shareholder. Roy Disney wanted to normalize relations with Pixar and (rightfully) viewed the movie studio as a critical strategic ally.
In the spring of 2004, Eisner was stripped of his chairman title after a vote of no-confidence at the annual shareholder's meeting. Eisner's position became more tenuous and he eventually decided to step down as CEO in March 2005. Roy Disney soon rejoined the board (with 1% ownership stake of Disney, he was the third largest owner of the company) and successfully pushed for the appointment of a friendly CEO in Bob Iger. (Excess compensation, golden parachutes, tunneling and IPO spinning make bad executives even worse; read more in Pages From The Bad CEO Playbook.)
Kirk Kerkorian vs. Chrysler Management
Throughout the 1980s and 1990s, Chrysler had been steadily losing to international car makers such as Toyota (NYSE:TM), Nissan (Nasdaq:NSANY) and Honda (NYSE:HMC). Gone were the glory days when the giant car manufacturer was run by its former boss and business legend, Lee Iacocca.
Starting in 1990, Kerkorian started buying shares of the struggling Chrysler. With the help of Iacocca, Kerkorian's efforts culminated in 1995 with an attempted takeover bid over Chrysler. This was a classic case of a high-profile investor attempting to buy an underperforming company, replace its management, alter its competitive posture, improve execution and hold the equity for an eventual sale (and a large profit).
Chrysler's existing management viewed Kerkorian's efforts as a hostile bid, successfully thwarted the takeover efforts and the executive team preserved their jobs. In exchange for his co-operation, Kerkorian won a payoff in the form of stock buybacks and a seat on the board. Iacocca was slapped with a gag order preventing him from discussing Chrysler in public for a period of five years.
The Bottom Line
Management must often be reminded that its efforts should be aimed at increasing the value of the company's equity and make shareholders wealthier. When a company's board becomes less accountable to shareholders, shareholder activists often battle with management and get new directors on board, ones that are aligned with investor interests. This fresh composition leads to the appointment of new executives focused on creating shareholder wealth. If all goes well, this can mean better performance for the company involved. (To learn more about your power as a shareholder, read How Your Vote Can Change Corporate Policy.)
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