Should we embrace the shareholder activists?

Shareholder activistshave been in the headlines frequently over the past few months as a result of a number of high-profile shareholder campaigns around the world. UK investment trust Alliance Trust, Japanese robotics firm Fanuc and Korean conglomerate Samsung are among those that have come under attack from predominantly American investors, such as Elliott Associates and Third Point.But what do activists do and are they a help or hindrance over the long run?

Activist investors are typically private-equity groups, hedge-fund managers and very wealthy individuals with the clout and connections. The best-known activist investors, such as billionaire Carl Icahn, are almost exclusively from America, reflecting the fact that the US market has traditionally been far more conducive to shareholder activism.

Activists are a broad group, but essentially they all seek to change a company's strategy by buying a significant shareholding then putting pressure on the management. For example, they may push for a large corporation with two or more separate divisions to sell or spin off those that are not part of the core business.

They may want firms with large cash reserves to return money to shareholders as dividends or share buybacks. Or they may focus on trying to identify ways that the company can increase profit margins and try to get management to adopt them (or attempt to have top executives replaced if they don't agree).

A heated debate

This has led to calls for short-term shareholders' rights to be restricted compared to those of longer-term investors an idea that been taken up in some European countries, such as France, where shares registered for more than two years automatically get double voting rights unless two-thirds of shareholders in the firm vote against this provision.

So which view is closer to the truth?While it's not hard to imagine that activists can sometimes do damage, a recent paper by Lucian Bebchuk,Alon Brav and Wei Jiang of Harvard University suggests that they probably do more good than harm. They looked at 2,000 investor interventions between 1994 and 2007 and analysed how the companies involved performed in the five years after the intervention. The results showed that the operating performance of the companies typically improved after activists began pushing for changes.

The same was true for share prices. Activists are often accused of "pump and dump" trading: after boosting shares with calls for change, they sell out as the price falls back. But the research found that while stocks tended to spike after the activists unveiled their stake, they did not subsequently underperform the market, even once the activists began selling. Hence long-term shareholders benefited from the activists' agitations, suggesting they play a useful role in making markets work better for all investors.

Why Europe leads the resistance

writes Cris Sholto Heaton

In America, activists may well be able to rally other investors to support their attacks on underpeforming companies, whereas European companies typically find it easier to persuade their institutional investors to fall in line behind them.

There are some signs that shareholders in the UK are becoming more aggressive about challenging complacent companies. This helped Elliott Associates, one of the most combative US activist hedge funds, win a convincing victory by forcing the underperforming Alliance Trust investment trust to accept two Elliott-nominated directors onto its board earlier this year. But no activists have yet managed to force through major changes at any of Europe's largest companies.

If Europe remains tough, the rest of the world presents even slimmer pickings. Japanese companies, protected by extensive webs of cross-shareholdings between firms and relationships between management and local institutions, have successfully fought off countless assaults by optimistic US activists. However, this may be changing: earlier this year, robotics firm Fanuc bowed to pressure from hedge fund Third Point to return excess cash to shareholders and engage more with investors.

Korea presents an even tougher challenge: the family run conglomerates (known as chaebol) that dominate the economy are often happy to trample on minority shareholders. Last week, Elliott narrowly lost a battle to prevent Samsung from merging two listed subsidiaries (Samsung C&T and Cheil Industries) on terms that it said undervalued Samsung C&T while enabling the founding Lee family to strengthen their control over the group. Korea's National Pension Service apparently cast the deciding votes in favour of the deal.