Shareholder Activism through Shareholder Proposal:A Dialogue

By Jeff Wongchoti

Defining Corporate Governance

Corporate Governance: “Rules under which corporations are governed so that outside investors can protect themselves against expropriation by insiders”

Shleifer and Vishny (1997):

“Corporate governance deals with the ways in which suppliers of finance to corporation assure themselves of getting a return on their investment”

Agency context:

“Set of rules/mechanisms through which firms operate when ownership is separated from management”

Rules/mechanisms can come from:

- The legal/judicial system- The financial markets- Society

Shleifer and Vishny (1997): “Corporate governance mechanisms are economic and legal institutions that can be altered through political process” (e.g. Both rules and institutions matter in CG process)

Examples of CG aspects

• How board of directors operate (e.g. independence, accountability, formulation, monitoring, and others)

• Executive compensation• Anti-takeover mechanisms• Minority rights protection• Creditor rights protection• Ability to sue insiders• Insider trading laws enforcement• Others (e.g. in a broader term today, CSR)

Potential benefits of good CG“the value of trust”

1. Lower cost of capital2. Improved liquidity and increase access to

external financing3. Improved operational performance4. Immunity to instability (e.g. financial crises)5. Better relationship with other stakeholders

(in the broader sense of CSR context)

Can investors sit and wait for good CG to come around by itself?

• Theoretically, a perfectly functioned capital markets will act as effective/reliable monitors of corporations. But there are lots of ‘absentee (inactive) owners’…..not to mention market noisiness and others……!!

• Rules and regulations are ever-changing, take time to materialize, and prone to political situations.

As a result, serious investors cannot afford to become passive about achieving good CG for themselves!!

Shareholder activism

Gillan and Starks (2007): “A response to the potential gains from addressing the agency conflict at the core of large publicly traded companies with absentee owners”

Shareholder activists: “Dissatisfied investors (with firms’ management) who try to bring about changes within a company without change in control (e.g just buy more shares to gain control and replace

management altogether) ”

Players through time- US• Early 1900’s: Financial institutions (banks, insurance companies, mutual funds) took this

in their own hands. • 1929 US market crash: Followed by regulatory reforms that generally raise costs to active

investors to participate in corporate affairs. (e.g. Glass Steagall Act prohibit banks from owning equity)

• 1942 changes that eventually leads to Rules 14a-8, allowing shareholders (with certain characteristics/quality) to submit proposals (that constitute a proper subject for action by the security holders) for inclusion in corporate ballots.

• 1940’s – mid 1980’s: Individual investors mainly (with a few prominent: Gadfly investors such as Evelyn Davis)

• Mid 1980’s: Institutional investors (e.g. pension funds) became active but there was also direct corporate control rallies through hostile takeovers at the same time.

• Council of Institutional Investors (CII) were formed in 1985 and are still influential until nowadays. They act as ‘a lobbying group for shareholder rights’. Other active player is ‘CalPERS’. These involve a lot in: 1) Repeal of anti-takeover amendments; 2) adoption of cumulative voting; 3) Increase board independence. Strategies: a) initiate dialogues with management directly first; b) If not working, submit proposals while getting others involved through media.

• Mid 1990’s: Labor Unions and still active• Latest key player: Hedge funds. Note that individual investors are still active!! And pension

funds/mutual funds are criticized for not being active due to their ties/dependence with corporate managers to supply them with corporate inside information.

Interesting aspects on shareholder proposals – US experience

• A major way/channel for shareholder activism• Ease: In the US, even small/individual investors (owning thousand$ worth of a

firm’s stock) are entitled to submit a proposal. It also costs next to nothing to these sponsors.

• Cycles: Proposals are voted for/against mostly at the annual meeting, regardless of when it is submitted (usually mailed to shareholders on firms’ expenses) during the year.

• Obstruction (of justice): Management has the right to exclude proposals (with permission of SEC). They can also submit management proposals (bundled as rather hidden agenda).

• (Non)Success in votes: Typically speaking, shareholder proposals do not receive majority votes. But the trend has been sharply turned around in most recent years.

• Not obliged: Corporations are not obliged to what is proposed, even when it received majority vote!!

• Increasing trend: Even though players changed, it has been increasingly active in the the recent years. AND even in ASIA (e.g Japan recently)

What kind of proposals are received and in-trend?

- Used to be mainly CG aspects, especially executive compensations, and board declassification (undo the staggered boards)

- CSR has been an increasing trend. - Political contribution also received more attention over the

years.

So, does it work?

Do shareholder proposals add value?

Short-term stock price reactions

Premise: “If stock market is efficient, AND investors perceive (and correctly evaluate) shareholder proposals as value-adding, there should be a positive reactions on stock prices around the event dates (e.g. proxy mailing dates)”

Results:1. Overall, insignificant effect on stock prices. 2. Cleaner studies (e.g. on CalPERS) suggest ‘negative’ stock price reactions.3. Perhaps, ‘negative’ reactions represent investors’ interpretation of

management’s unwillingness to adopt positive changes to its problematic practices (e.g proposals can be and could have been negotiated behind the scene with institutional investors or other influential groups…..the fact that proposals are submitted suggest that management ignore making positive changes)

Voting outcomesPremise: “If shareholder proposals receive positive (majority vote) outcomes, it is successful as an efficient way to get investors involved. ”Results:

Pre-2000, overall, not very successful. Now getting better

Certain factors lead to more success:1. Types of proposals (anti-takeover repealed, CG over CSR proposals)2. Identity/synchronization of sponsors (institutions, funds, coordinated groups,

labor unions THAN individual investors). Campaigns and media attention also helps.

3. Companies with fewer insiders/ Smaller companies4. Companies of which stocks had performed poorly in the stock market5. Existing of proxy voting advisory firms6. (Rules for) Public disclosure of mutual fund proxy votes7. Investors’ base: S/T investors with management while L/T investors against

management.

Long-term performance

Premise: “Perhaps a better test. Proposals deal with aspects that are mostly long-term. ”

Three aspects:1. Long-term stock performance2. Long-term operating performance3. Changes in other aspects of the target firms

Long-term stock performance

• Generally no significant positive performance in stock prices

• However, looking at a serious group such as CalPERS (2nd largest pension fund in US) as sponsor, companies that co-operated with their proposals/initiation experience positive changes in wealth.

• Note though that stock returns could be quite noisy.

Long-term operating performance

• Empirical studies reach a consensus of ‘NO’ evidence.

• But causality is a big issue• Explaining corporate finance variables such as

ROE and ROA also proves a bit illusive. • That is, one cannot make much statement

here.

Changes in other aspects of firms

Governance structure (most direct):

- Majority of companies targeted by serious groups (e.g. CalPERS) make changes afterwards.

- Poison pills are more likely to be removed or put on votes by shareholders.

- Target companies are associated with governances afterwards.

- The above is especially the case post-Enron. - One aspect does not improve: Executive compensation!!

Investment decisions :

- Improvement in general- More divestitures; Fewer acquisitions: More

joint ventures- And the above are received more positively

(than comparable firms) by investors

Management turnover :

- In general term, no significant effect on CEO but some on other senior managers

- But again, if focused on serious group of sponsors, there is higher turnover for CEO

What else can be studied?

What Jeff has:

• Shareholder proposal data (exclusive to Jeff’ co-authorship)

• Source: GMI rating, Not a ‘typical’ dataset• Thanks to: MURF fund• Coverage: US proposals, year: 2003 to 2010• About 4,800 proposals