by Nina Margariti, Member of the Interviews Team
Corporate activism is a phenomenon which started in the US and the UK but over time has gained international interest. This is why we asked an expert on corporate activism to give us answers on questions that this phenomenon raises. Our interviewee, Frank Partnoy, has been a law professor since 1997. He started his career as a law professor at the University of San Diego and currently teaches at UC Berkeley. Prior to that, he was a lawyer and an investment banker. He worked at Morgan Stanley and CS First Boston in New York, after he graduated from Yale Law School and then clerked. He also worked on Wall Street, as a lawyer at Covington and Burling.
What is corporate activism and how does it work?
Corporate activism involves shareholders who decide to be active. Many shareholders are passive. I own shares and I am usually very passive. The idea of shareholder activism is that typically a hedge fund, an investment vehicle, an institution will buy a block of shares, and then try to agitate for change at the company. The typical size of an activist position is in the range of 5-10%. So, activists are not controlling the company, but they are not a tiny shareholder in the company, either. One of the things that defines shareholder activism is crossing the 5% threshold. In the US, there is a regulation that requires shareholders to disclose when they have more than 5% of the stock. So, they do that, and then they will try to influence the company in some way to change operations. They might write things about the company’s governance or its CEO, they might also try to get on the board, to run a proxy fight to get what is called a short slate of directors, a couple or three directors on the board. The extreme version that happens in about 1/5 cases of activism is that the targeted company actually is taken over. So, they will merge, or they will find an acquirer, or an acquirer will find them, and this will result in the company being taken over. There is a wide range of activist interventions where people are shareholders, are acquiring stakes in companies and then rather than just sitting there and letting the managers do whatever they would like, they become active in some way.
When did the phenomenon of corporate activism first appear and where in the world?
Corporate activism of various kinds has been around for a long time. Some scholars trace it back more than 100 years. There were certainly incidents of activism in the middle part of the 20th century when hedge funds first developed. Much of the impetus for activism has been in the US, some of it in the UK, as well. Now activism is a global phenomenon. Historically activism did not always involve the same kinds of efforts. In the 1980’s takeover wave, there were investors, shareholders who took large stakes in companies and became active. That was one category of activism. In terms of social activism, there have been investors that have much smaller stakes, that might own even just a few shares, who try to agitate for a political or social change. Those activists have been around for many decades as well. The recent move to shareholder focused activism that is focused on value, has been since the early 2000’s, 2003-4. In 2005 was when it started picking up and when I first decided to study it as an academic.
Positive and negative activism: What should we keep in mind about these two forms of activism?
Positive activism is what we typically think of as being shareholder activism. The positive idea is that shareholders own shares in the company, they want the stock to go up and they feel happy about the company when it does well. Most of shareholder activism that has been studied up until a few years ago, was positive activism. These are the investors who are in the news for agitating the big-name hedge funds, like Elliott and Pershing Square, Starboard and ValueX. Those are all positive activists. One of the things that I wanted to do with my co-authors, Barbara Bliss at the University of San Diego, and Peter Molk at the University of Florida, was to study the opposite of positive activism, which we call negative activism. The idea in negative activism is that this investor, this institution, or this individual, will bet against the company. They have a negative view of the company, they want all the people in the boardroom, the managers and the shareholders to be sad, they want the stock to go down. What they do is they sell short shares, they borrow shares and sell them, hoping to buy them back for less in the future. They are short selling activists, and they take these positions based on companies that they think are overvalued. One of the interesting things we found in our research is that when positive activism is announced, when these investors cross over that 5% threshold that I mentioned before, the stock goes up on average by about 7%. Compared to everything else in the market, when you adjust on an abnormal return basis, as finance people call it, a cumulative abnormal return around the announcement, positive activists get a positive bump of 7%. Negative activists, interestingly, have exactly the opposite. When negative activism is announced, this is when some short seller goes out, researches the company and finds that the company is overvalued or has some problems (maybe there is even fraud at the company), and puts out a report with all these problems of the company, on average the stock goes down by 7%. This is the interesting mirror image of positive and negative activism. Both of them have very different aims. The positive activists are trying to really improve companies and help governance and operations get better. The negative activists are for the most part trying to focus on getting out information about the company, to make sure that the markets are accurately reflecting the value of the shares. All activists are vilified in various ways. People do not like activists. Often managers, when they hear positive activists “knocking at the door,” they do not necessarily like this because they might lose their jobs. Negative activists and short sellers are also vilified because they make money when the company goes down, when the stock goes down. Many people are critical of negative activism, but it also serves an important purpose of helping us accurately value shares. It ensures that negative information makes its way into the market.
Could you give us an example of both positive and negative activism from real life corporations?
There are lots of high-profile ones. One example that involves both positive and negative activism was Herbalife. There are lots of questions about Herbalife’s pyramid, where they get people to buy the products and then be representatives and sell downline. Bill Ackman of Pershing Square made a whole series of very critical arguments and presentations about Herbalife being overvalued and took a short position in Herbalife. There were all kinds of investigations. Then Carl Icahn, who was a prominent shareholder activist and actually was a very active person in the takeover market in the 1980’s, he took a positive shareholder activist position in Herbalife. As a result, you had these two people battling back and forth about whether Herbalife was properly valued. That was a billionaire battle which I found really interesting and wrote an article called Wall Street’s $6 billion mystery because we had activists on both sides, and people really did not know if the company is worthless, as Bill Ackman was arguing, or if it is extremely undervalued and a great bet, as Carl Icahn was arguing. It is still a bit of a mystery with Herbalife continuing to thrive, and questions about what really its business should be worth. Maybe my favorite example of shareholder activism is one that I did with my colleague at Berkeley Law School, Steven Solomon. We had been studying activism for a while and we decided to try being activists. We bought shares of Tejon Ranch Corporation that we thought was undervalued and that owns the largest contiguous plot of land in Southern California, just north of Los Angeles. It was not worth all that much based on what we thought. We bought some shares, not a huge stake. We are professors, and not billionaire hedge fund managers, but we bought enough to make us feel like we were investing. Then we started agitating. We sent them books and records requests, we went to the annual meeting and yelled, stood up and tried to influence the CEO and the CFO, we actually got meetings with them and I think we were effective and influential, at least a bit. So that is my favorite example and for people who want to have a feel for what a real person as opposed to a billionaire would do as an activist, my article on The Atlantic might be of interest to them.
What is the profile of people typically involved in corporate activism?
It is highly varied. There are very large hedge funds that have billions of dollars under management. Some of them are a little bit smaller, but many of them are quite large. They have investors of their own, which are typically pension funds or wealthy individuals or large institutions that give them money. This is one category of activist. The social and political activists are often much smaller. There are some corporate gadflies, who will just buy a handful of shares and try to agitate for change at companies. There are also pension funds that will have relatively small stakes, not as big as a large hedge fund would have. They will try to get shareholder proposals or other forms of activism going at companies. It is a pretty wide range but basically, they are clustered into those two categories, large hedge funds and then pension funds and some individuals engaging in social activism. To some extent they have worked together as these ESG -environmental, social and governance- factors are becoming more and more important. There have been some partnerships between the large and maybe a little bit smaller. It is a big umbrella for lots of activists to be involved in various ways.
What are the moral implications of corporate activism?
There are lots of controversial arguments about corporate activism and ethics. It is a little bit of a temperature gauge for people to take out how they feel about the markets. We know from empirical studies that activism is associated with significant increases in shareholder returns in the short run, and that those increases are not reversed in the long run. We know that -at least historically- the targets of activism have done well. On the other hand, there is a strong argument from law firms and some stakeholder groups that activism has been very damaging to their interests, to the interests of employees, maybe some social interests. There is a group of people led by Martin Lipton of the Wachtell Lipton firm, who argue that activism is ethically very problematic because it destroys long term value. There is this debate about short-termism versus long-termism. He and people who are opposed to shareholder activism, say that it is too focused on the short-term. Probably the biggest ethical debate is not necessarily about whether activism is generating value, but about whether the value is too short-term focused versus long-term focused. Short-term people say that insulating companies from activism, is letting managers run companies in ways that do not help shareholders or maybe even hurt shareholders. The activists say, if it is in the long run interests of the company, that’s going to be reflected in today’s stock price. In some ways, the ethical implications, in addition to being a gauge for people to think about markets, it is also just a good way to reflect on how you think about markets as processing information. Are the prices of stocks today really incorporating long term positives and negatives in a meaningful way? There is no simple answer to any of these questions but those are some of the issues that are raised in terms of ethics, and what people think normatively about these markets.
Do you think that at this moment the phenomenon of corporate activism is equally seen in the USA, Europe and Asia? And if not, where should the difference be attributed to?
Activism has been increasing globally. Last year was a little bit of a low. Activism has become much more significant in Europe and Asia, in a wide variety of markets over time. Some of the differences between how activism is used in different markets relate to both culture and regulation. It is a little bit more frowned on in some jurisdictions to do something like Dan Lowe writing these nasty letters about CEOs. In some countries that just really does not happen. Moreover, the regulatory structure is very different globally. In terms of negative activism, many companies and in Europe many countries implemented restrictions on shorting, some bans on short selling during the pandemic, and that is a big difference for negative activism, which involves short selling shares. If there is a restriction on short selling, that is going to be much less prevalent in the market. Another difference is that one of the top things that positive activists do is trying to replace the board. They try to run a proxy fight to elect new directors, and that’ s much more difficult in some countries than it is in the US or the UK. Another difference is just the nature of the shareholder base. For example, some countries have very significant bank shareholders or cross holdings by large institutional investors. Despite these differences, activism has been, until a year ago, been growing pretty significantly and expanding globally.
What about the impact of corporate activism on stakeholders other than shareholders? In other words, how does corporate activism affect the society in general?
As people are starting to think more about ESG, we know that activism has at least historically been good for shareholders, but that has been at the expense of other stakeholders. For example, there have been a few studies that have looked recently at employees who might be rationalized after activism starts. In other words, some employees might do better, and some might do worse. There are certainly lots of anecdotes about employees losing their jobs as a result of activism. There are some concerns that after companies have been subject to an activist attack, they will be less sensitive to thinking long term, maybe to incorporating some kinds of social or governance issues. This is a controversial one. I think that questions about how activism will affect society, were initially answered mostly focusing on shareholders. That was a big debate but now that debate is expanding to try to address in the most informed way that we can, how shareholder activism will affect society overall. Some people think that what activists are doing is extracting value for shareholders at the expense of society. Other people very strongly think that it’s great for society and that everyone wins as a result of the discipline that’s created from activism.
What could be done so that negative activism be addressed and eliminated? Is there anything that could be done at an international level?
There has been a lot done on an international level. In Europe, several governments have restricted or even banned short selling. European regulators imposed disclosure requirements. Those are ways to regulate negative activism and short selling. There are also rules like what’s called the “uptick rule” that restrict short selling depending on movements in the market. I am not sure that any of these is such a good idea, if you believe that negative activism is helping stock prices move to a more informed level. The empirical evidence supports that these things are not such a good idea. In the US, the previous administration resisted the calls for this kind of regulation of short selling and negative activism. It has been more popular in Europe. Those are the things that could be done internationally but again, I am not sure it’s such a good idea.
To what extent has corporate activism been affected from the covid-19 pandemic?
It is complicated. Initially the low stock prices, the decline in the markets through March made a lot of companies attractive to activists, stock prices looked low. On the other hand, it was hard to get enough capital then to dedicate capital to engaging in activism. Overall, there were fewer activist interventions in 2020 than in 2019. There was more of a focus on the ESG, these environmental, social and governance issues during the past year. Merger activity is down a little bit in part because of some of the complexities associated with the pandemic. It seems to have been a little bit of a dampening impact. There were some very large events during 2020 and people are looking very carefully at how business is changing because of the pandemic and how it might make sense for companies to reorient in various ways. Just as the pandemic has introduced uncertainty for all of us in our personal lives, it has introduced a lot of uncertainty for activism as well.
What is the foreseeable future of corporate activism?
Corporate activism is not going away. It has matured as an industry over the last 15 years, the price pop, this 7% increase associated with activism seems to continue to exist. Activists likely in the future will separate themselves out a little bit and start to specialize in different areas. Some will specialize in certain industries. That has already happened a little bit. Some will specialize more on ESG and social activism and some will get out of the business. There has been more of a bifurcation between positive and negative activism. There were some hedge fund activists that would do some negative activism on the side, have some big short positions, and there were some negative activists that would switch their positions and would be investors as well. The future is still bright. Lawyers are very much attuned to the threat of corporate activism and many big law firms have activism practices. I do not see those going anywhere. It is maturing and becoming more specialized. I would expect that activism five years from now will be a much more fractured field with specialists for different industries, different kinds of circumstances as well.
What is your overall impression on the phenomenon? And what is your advice to students and young professionals aspiring to get involved in corporate activism?
Corporate activism raises many fundamental questions about business and business law, for those of us who study it, and for students and for lawyers practicing in the area. So, I think it is a fascinating area that raises all these issues and requires students and practitioners to really be a Jack of all trades, to be able to understand M&A and tax, to know the securities laws and to understand business, to think about financial markets in a sophisticated way. What I hope that my students and other students will do, is to gather a sufficiently broad skill set to be able to advise either the targets of activism, or the proponents of activism, people who are engaging in it. Not everyone will have a practice that involves activism but it is something that I hope that people will become more informed about, because it is a core interesting topic for anyone who cares about business and business law. What students are training to do among others is to be sophisticated at cocktail parties and one of the topics that people like to talk about is stock purchase in big companies. To some extent, my advice for students is to just become conversant about activism because it is one of those big topics that is just not going away.
Prominent professor Frank Partnoy made clear in all ways that corporate activism is growing and expanding globally. In this regard, all of us and especially those interested in business and capital markets should be aware of that phenomenon and its implications. Interviewing Frank Partnoy was a great experience and SAFIA would like to deeply thank him for all his insightful answers.