Shareholder Activism: How It Helps & Hinders Corporate Governance

Introduction

Shareholders of large organizations have sought for greater influence over company behavior for some time now. Not surprisingly, shareholder activism has now become very prevalent throughout the business world, especially within the past decade. Indeed,

commentators note that since the implosion of Enron in 2001 and more recently, the 2008 financial crisis, activist shareholders are seeking to voice their concerns and press companies for change (The Shackled Boss, 2012). While critics are quick to argue that such activism hinders businesses, shareholders continue to push for greater rights in order to seek improvements in corporate governance. In fact, shareholders gained substantially more rights in 2010 when Congress passed the say-on-pay law that provides shareholders with a right to hold a vote as to executive pay (The Shackled Boss, 2012). With shareholders attaining greater roles within organizations, it is important to address whether the changes they seek actually increase corporate governance, and ultimately, corporate performance. Critics will argue, however, that there are several ways in which shareholders have decreased corporate performance. This paper will address both sides of the issue, while pointing out ways in which such activism both helps and hinders corporate governance.

Shareholders Find Their Voice, Speaking Louder than Ever The actions of shareholders in todays financial market have lead to an increase in some companies corporate governance and overall performance. Historically, the exposing of

inefficient management and board of directors went largely unrecognized prior to the financial crisis in 2008 (Squire, 2010). Indeed, shareholder activism in the past constituted demands such as companies buy back of shares and issuance of special dividends; however, corporate governance and operational concerns now make up the majority of activist initiatives (Squire,

2010). In addition, proponents of shareholder activism maintain that it boosts the board of directors accountability on key issues, such as acquisitions and executive pay (Lublin, 2011). Because of the strong emphasis on corporate and operational performance, shareholders have been able to improve the quality of the management and boards of directors of companies, which in turn leads to an increase in corporate governance. It is no coincidence that as shareholder rights have increased over the past decade, so too has the corporate performance of various companies. In fact, research has shown that

companies with strong shareholder rights have higher operating profits than those with weak rights (The Shackled Boss, 2012). And since shareholders now have more input on the individuals who serve on boards of directors, companies with stronger boards are now able to raise capital with less expense (The Shackled Boss, 2012). While research does tend to demonstrate that stronger shareholder rights ultimately leads to better corporate performance, there remains intense dissention among critics opposed to increasing these rights. For example, the Securities and Exchange Commission (SEC) is working to make it easier for shareholders to nominate members to boards of directors; however, efforts have been delayed as a result of a lawsuit brought by two prominent business groups (Ready, Set, Dough, 2010). Ultimately, shareholder activism places pressure on companies to become more efficient with their business practices and behavior. Since the financial crisis in 2008, shareholder activists have become more willing to expose company corruption and seemingly unfair policies (Ready, Set, Dough, 2010). Moreover, such activism helps eliminate the unethical business practices of corporate governance, which can in turn create an increase in overall corporate performance (Ready, Set, Dough, 2010). Such examples of unethical business practices range from the lavish bonuses for executives, to personal use of corporate aircraft, and the like

(Ready, Set, Dough, 2010; Delves, 2011). Because shareholders are voicing their concerns more loudly than before, corporations and their management are feeling the pressure to respond, and in effect, make their companies more efficient. Corporate governance can be increased and made more efficient as regulations and laws continue to develop. Indeed, regulation will help shareholder activism increase corporate

performance (Ready, Set, Dough, 2010). One step in this direction took place in 2010, with Congresss passing of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Delves, 2011). Under the Act, public companies are required to submit executive compensation programs for nonbinding shareholder votesthis provision is known as say on pay (Delves, 2011). The effects of the say on pay provision of the Act will more than likely lead to an increase in overall corporate governance. This is because directors will have a greater sense of accountability for designing compensation programs that are palatable to institutional shareholders (Delves, 2011). Furthermore, say on pay will serve as an effective tool in creating executive pay policies that are designed to encourage executives to maximize long-term shareholder value (Flannery, 2011; Delves, 2010). Whether its via an increase in shareholder rights, pressure on companies to become more efficient, or new regulations, one thing is for sure: all of these aspects of shareholder activism are forcing an increase in corporate governance and overall performance.

Critics Argue Shareholders Harm Corporate Performance Critics of shareholder activism assert that actions by the owners only complicate the overall goals of companies, thus leading to a decrease in corporate governance and performance. With several arguments under their belt, these critics essentially conclude that shareholders are

unfit to provide any insight into how to appoint directors, manage money, and ultimately influence the corporate governance. While points were made earlier as to how such activism leads to an increase in corporate performance, the counter arguments as to how shareholders lead to a decrease in corporate performance could indeed have some merit. Put bluntly, shareholder activism may lead to a decrease in corporate governance because shareholders are more concerned with their own self-interest. Given the nature of activism, a single individual shareholder has the power to transform the corporate dialogue altogether (Levick, 2011). While some commentators argue this is positive, others fear the repercussions that a shareholder, who may be more concerned about a companys commitment to rainforests than current share price, can have on the corporate culture of an entire organization (Levick, 2011). Indeed, shareholders agendas may be aimed at the promotion of their own self-interest more so than the promotion of corporate governance. It is the management and directors role to have a companys best interests in mind, after all, that is why these individuals were appointed to their positions in the first place. However, shareholders simply own shares; they are not elected, appointed, or hired. Therefore, the special-interest orientation of shareholders could erode the alignment of equity owners interests with share value, thus leading to a decrease in overall corporate performance (Copland, 2011). Similarly, shareholders lack of experience in making crucial decisions for the benefit of an entire organization can lead to a decrease in corporate governance. As one commentator notes, shareholders lack the experience to make decisions that are in-line with company needs (Tolley, 2012). Owning shares in a company does not automatically mean that shareholders are experts on managing the overall performance of the company. Furthermore, managers and directors have a scarce resource of time in terms of making decisions for their organizations.

Shareholder activism tends to consume managements scarce resource of time, when that time could be spent on increasing profits for the company, or working towards acquisitions, and the like (Copland, 2011). The lack of experience of shareholders is what could lead to behavior that consumes directors scarce resource of time, thus decreasing corporate governance in the long run. Perhaps the most often cited reason for why shareholder activism does not aid in the corporate governance of an organization is the short-term focus of the shareholders. As some critics put it, shareholders acting with short-term interests in mind can erode the quality of their companies, especially when they push for a corporate break-up or asset sale (King, et al., 2008). Along the same line of reasoning, shareholders tend to destroy value if they push for unsustainable increases in dividends, a more aggressive growth strategy or a more leveraged financial approach (King, et al., 2008). As such, the biggest problem with this short-term outlook is that it can lead to an increase in long-term debt, a threat that might harm a company in the long run (Ready, Set, Dough, 2010). This focus on short-term interests has been coined short-termism (Davidoff, 2011). Thus, shareholders encourage this practice, whereby

companies take short-term measures to bolster their share prices in response to activists, and activists themselves are only in it for the short-term lift, not the long-term health of the company (Davidoff, 2011). As several critics of activism make clear, shareholders decrease the corporate governance and overall performance of companies by putting their own self-interests above those of their own organization; through their lack of experience, wasting managements scarce resource of time; and focusing on short-term interests and increase in value without understanding the longterm effects of such decisions.

Shareholder Activism Is Here To Stay As evident, there are several ways in which shareholder activism both increases and decreases the corporate governance and overall performance of an organization. Whichever side the public chooses to take, a few things are for certain. Shareholder activists are poised to help companies improve corporate-governance practices for years to come (Squire, 2010; Levick, 2011). Given the recent say on pay provision, as well as a push for increased regulations, it is evident that directors must learn to work with shareholders and handle their concerns and influence in the proper way. As such, the best practice could be to communicate early and often enough to identify concerns even before they rise to the level of an activist agenda (Levick, 2011). Indeed, research has suggested that communication is the most effective strategy in achieving desired results (Levick, 2011). Just as there are two sides to any story, there will always be those who approve of shareholder activism and those who criticize it. As such, some commentators will maintain that such activism improves corporate performance by holding executives feet to the fire (Copland, 2011). Other commentators will continue to argue that shareholders lack the

experience and interests necessary to improve corporate governance. Whether shareholders believe that they are improving corporate governance, or critics are certain they are not, shareholder activism is absolutely here to stay.

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