Unlike private equity firms that buy and restructure companies in order to profit when they are resold, activist investors seldom acquire full or majority stakes. Instead, they use public communications and private discussions to win over other shareholders and company insiders. When such efforts fail, an activist investor may pursue a proxy contest to elect new directors in order to force the company to meet their demands.
- Activist investors buy minority stakes in public companies to change how they are run.
- If they fail to persuade company managers, they may wage a proxy fight for board seats.
- Some hedge funds specialize in activist investing while institutional investors may engage in it from time to time.
- Investor activism may focus on maximizing shareholder value or on the company's social responsibilities.
- The SEC has proposed tougher disclosure rules for activist investors that critics contend may make activism unprofitable.
Understanding Activist Investors
Activist investors are sometimes called shareholder activists, a term also used to describe those lobbying companies to improve working conditions for the overseas employees of their contractors, or backers of a dissident board slate elected to fight climate change.
However, many activist investor campaigns seek only to maximize shareholder value, and most of those are the work of hedge funds specializing in the unique mix of public pressure, behind-the-scenes lobbying, and business expertise required.
Unlike the public pension funds and mutual funds that also engage in activism at times, activist hedge funds may hold highly concentrated stakes and supplement them with additional leverage from derivatives like stock options to offset the considerable cost of such campaigns. In contrast with institutional investors that sometimes turn to activism after owning a disappointing investment for years, activist hedge funds typically buy a stake in an underperforming company shortly before calling for change, and hope to profit from the resulting turnaround and price appreciation.
In contrast to institutional investors, activist hedge funds are also more willing to use confrontational tactics, from poison-pen letters to management and unflattering public reports to proxy fights seeking to oust incumbent directors.
The rise of activist investors has been described as an effective market response to the agency problem, which arises when agents (in this case company managements) have the opportunity and the means to enrich themselves at the expense of clients (in this case shareholders—a diffuse group with limited powers to safeguard its ownership interests.)
How Activist Investors Make Their Case
Investor activists often announce their campaigns by filing a Schedule 13D form with the U.S. Securities and Exchange Commission (SEC). An investor or group of investors must file a Schedule 13D within 10 calendar days of acquiring 5% or more of a company's voting class shares.
Qualified institutional investors and passive investors, meaning those not trying to acquire or influence control of the company, may instead file a simplified Schedule 13G with less stringent disclosure requirements and thresholds.
Schedule 13D filers must disclose, among other facts, their reasons for acquiring the stake and any plans they may have for the company in terms of mergers and acquisitions, asset disposals, capitalization or dividends, or other policies.
The initial 13D filing gives the activist investor a golden opportunity to publicize their case for change at the targeted company. At the same time, the filing curtails the activist's ability to alter their stake in, and plans for, the company out of the public eye. Any changes to the facts disclosed on a Schedule 13D must be reported in an amended filing "promptly," under current SEC rules.
Activist investors may use amended Schedule 13D filings to comment on a company's response to their proposals. For example, when Netflix, Inc. (NFLX) adopted a poison pill after funds affiliated with Carl Icahn reported a stake of nearly 10% in the video streaming company, the funds filed an amended disclosure calling the poison pill "an example of poor corporate governance."
Activist investors may also write sharply worded letters to incumbent managers, issue press releases arguing their case to other shareholders, or privately lobby institutional investors to side with them.
Whatever tactics they use must be persuasive, since the only way to overcome opposition from entrenched company management short of a hostile takeover is to persuade a sufficient number of other shareholders to replace the board in a proxy fight, or at least to be able to credibly threaten to do so.
The End of Shareholder Activism?
"Activism is dying," The Economist quoted Icahn as saying in May 2022, contrasting the legendary investor's few-holds-barred approach with the softer tone prevailing more recently. Some have argued the changes to the Schedule 13D disclosure requirements proposed by the SEC in 2022 constituted a more pressing threat, with Elliott Investment Management saying in a public comment letter the proposed rules "will virtually shut down activism."
In February 2022 the SEC proposed shortening the initial Schedule 13 filing deadline from 10 calendar days to 5, with amendments due within a day of a material change rather than "promptly" as currently. The proposal would also force activist investors filing a 13D to specify holdings of derivatives such as options providing an economic interest in the company without the shareholder rights associated with an equity position. Perhaps most controversially, the proposed rules would no longer require investors to agree to act in concert to be designated a group by the SEC for Schedule 13D reporting purposes.
SEC Chair Gary Gensler argued the stepped up requirements proposed would address "an information asymmetry" between activist investors and other shareholders. Critics countered the proposed rules would make activism unprofitable by making it more difficult and costly for activist investors to accumulate significant stakes, while inhibiting communication among shareholders.
Do Activist Investors Ever Settle With Companies?
Yes, because activist investing is not a zero-sum game. Since activist investors and incumbent managers share an interest in the company's success, they may sometimes agree to a mutually acceptable compromise. Such agreements typically grant the activist investor representation on the company board in exchange for a pledge to support management and the company's director nominees for a specified time. The agreements may also specify steps management will take at activist investors' behest, while including standstill provisions preventing the activist from increasing their stake in the company or requiring them to maintain a specified minimum stake.
Is Shareholder Activism Dying?
Not if you judge by the 73 activist campaigns initiated in Q1 2022, a quarterly record. The 126 activist investor engagements initiated in H1 2022 were up 34% year-over-year to the highest first-half total in four years.
Do Activist Investors Create Value?
Activist investors have been effective at times in addressing the agency problem faced by shareholders whose interests don't always coincide with those of entrenched management teams. They've certainly created value for themselves and other shareholders. Activist investing can't easily be pigeonholed as good or bad, however. Activist investors look out for themselves and realize the lion's share of the value they unlock. Their relatively short-term focus on strategies likely to lift the share price, such as return of capital to shareholders in the form of dividends or share buybacks, can prevent companies from making needed long-term investments.
Which Activist Investor Generates the Largest Share-Price Gains at the Outset?
According to Elliott Investment Management, among activist investors with more than a single activist campaign between 2017 and 2021, it's Elliott with an average pop of 8% for shares of the target company on the day the firm made its stake public. According to the firm, its 47 activist engagements during that five-year span increased the market value of the targeted companies by an aggregate of nearly $30 billion on the day they were announced.
The Bottom Line
When activist investors use their significant but still relatively small minority stakes to push for change at publicly listed companies, they must often exercise their rights as shareholders to the fullest to get the attention of incumbent management and persuade other shareholders. The discipline they impose promotes shareholder-friendly policies at other companies as well. But they are not always right, and any public benefit they provide is incidental to their pursuit of profits for themselves and their clients.