SHAREHOLDER ACTIVISM AND ITS IMPACT ON CORPORATE GOVERNANCE

This article is written by Waad Elmuftah of 4^th Year of University of Khartoum, an intern under Legal Vidhiya

ABSTRACT

Shareholder activism has gained significant importance in recent years as a key mechanism for influencing corporate governance. This research article examines the definition of shareholder activism, its various forms, and the reasons behind its growing prominence in modern corporate environments. By exploring different theoretical perspectives, the article highlights the connection between shareholder activism and corporate governance, focusing on how active shareholders seek to influence corporate decision-making, management accountability, and governance practices. Additionally, the study investigates the broader impact of shareholder activism on corporate governance structures, assessing its role in promoting transparency, improving board oversight, and shaping long-term corporate strategies. This research contributes to a deeper understanding of shareholder activism and its implications for the evolution of corporate governance.

KEYWORDS

Shareholder activism, corporate governance, transparency, corporate structure

INTRODUCTION

Shareholder activism has redefined the power dynamics between shareholders and corporate management, making it a pivotal issue in discussions of corporate governance. Traditionally, corporate decision-making was largely driven by boards of directors and executive management, with shareholders playing a more passive role. However, the rise of activist investors has disrupted this status quo, allowing shareholders to assert their influence over key decisions such as mergers, leadership changes, dividend policies, and even environmental and social policies.

The growing prominence of shareholder activism is driven by a variety of factors, including increased transparency, the rise of socially conscious investors, and technological advancements that facilitate coordination among shareholders. Activist investors typically seek to enhance shareholder value, often by advocating for operational improvements, cost-cutting measures, or better use of company assets. However, the movement has evolved beyond purely financial motives; activists are increasingly focusing on long-term sustainability, ethical governance, and social responsibility, particularly as global standards around ESG considerations grow more robust.

This article will explore the historical context of shareholder activism, analyze key case studies, and assess the tangible impact these movements have had on corporate governance structures. By examining both successful campaigns and controversies, it will provide a nuanced understanding of how shareholder activism continues to shape the governance landscape and what future trends might emerge in this evolving field.

UNDERSTANDING SHAREHOLDER ACTIVISM: DEFINITION, SIGNIFICANCE, AND RISE IN PERFORMANCE

Shareholder activism refers to the efforts of shareholders, particularly institutional investors, to influence a company’s behavior by exercising their rights as owners. These actions can range from engaging with management on corporate governance issues to more public campaigns aimed at changing business strategies, improving corporate governance practices, or even replacing board members. Activist shareholders typically seek to increase shareholder value, improve corporate responsibility, or address underperformance.

Shareholder activism has been identified as a promising new avenue for overcoming the problems of dispersed holdings and a lack of major shareholders. Activists often address issues such as board reforms, executive compensation, and performance deficiencies, using tools like shareholder proposals and direct engagement with management.[1]

Shareholder activism is a logical extension of corporate governance codes and principles, serving as a mechanism to press companies to implement best practices.[2]

FORMS OF SHAREHOLDER ACTIVISM

[3]Shareholder activism manifests in various forms, each aimed at influencing corporate behavior and governance. One prominent method is engaging in proxy battles, where shareholders seek to influence company decisions by voting on key issues such as board elections or significant policy changes. This often involves mobilizing other shareholders to support their proposals, which can lead to shifts in corporate leadership or strategy. Another form of activism is filing shareholder proposals, which allows shareholders to suggest changes to company policies or practices. These proposals are typically put to a vote at annual meetings and can address a range of issues, from environmental impact to executive compensation. Shareholders use this method to push for specific changes that they believe will enhance the company’s performance or governance. Public campaigns are another common approach. Activists use media, press releases, social media, and open letters to pressure companies into making desired changes. These campaigns aim to bring public attention to issues and sway both the company’s management and other stakeholders to support their cause. Direct negotiations involve shareholders engaging in private discussions with management to negotiate changes. These negotiations can result in significant reforms that may not be publicly disclosed but can lead to substantial improvements in corporate practices or policies. Litigation is a more adversarial approach where shareholders take legal action to address grievances. This can involve suing the company or its executives for breaches of fiduciary duty or other legal claims. Litigation can compel companies to make changes or provide remedies for shareholder concerns. Withholding support is a more passive form of activism, where shareholders may refuse to vote for certain proposals or participate in capital raises until their demands are met. This tactic exerts pressure on the company by leveraging the shareholder’s economic influence.

WHY SHAREHOLDER AVTIVISM HAS GAINED IMPORTANCE

The growing prominence of shareholder activism is due to several factors. Institutional investors, such as pension funds, have increasingly sought to ensure that the companies they invest in maximize long-term value[4]. Additionally, advancements in corporate transparency and communication technologies, along with a growing focus on ESG factors, have enabled shareholders to exert more influence[5]. Furthermore, regulatory changes have facilitated activism, allowing shareholders to engage more actively and hold companies accountable.[6]

THE FRAMEWORK OF CORPORATE GOVERNANCE: ROLES, RESPONSIBILITIES, AND KEY ELEMENTS

Corporate governance encompasses the systems, principles, and processes by which a company is directed and controlled. It ensures accountability, fairness, and transparency in a company’s relationships with its stakeholders, including shareholders, employees, and society. The primary goal is to protect stakeholder interests while achieving strategic goals in an ethical and sustainable manner.[7]

Corporate governance is concerned with reconciling conflicts of interest between various corporate claimants and resolving collective action problems among dispersed investors.

CORPORATE GOVERNANCE  IN THE BROADER CORPORATE STRUCTURE

Corporate governance operates within a broader corporate structure, consisting of shareholders, the board of directors, and executive management. Shareholders elect the board to oversee management and protect their interests, while the board appoints executives to manage day-to-day operations.

Key elements of corporate governance include board composition and responsibilities, accountability and transparency, stakeholder relations, and risk management.

THEORETICAL PERSPECTIVES ON SHAREHOLDER ACTIVISM  AND CORPORATE GOVERNANCE

Shareholder activism and corporate governance are analyzed through various theoretical lenses, including agency theory, stakeholder theory, and resource dependence theory.

• Agency Theory

Agency theory posits that the relationship between shareholders (principals) and corporate managers (agents) can lead to conflicts of interest, as managers may not always act in the best interest of shareholders. Activism serves as a corrective mechanism, reducing agency costs by aligning management actions with shareholder interests.[8]

• Stakeholder Theory

Stakeholder theory expands corporate governance’s focus beyond shareholders to include employees, customers, and society. Shareholder activists who emphasize ESG issues argue that companies should be accountable to the broader community.[9]

• Resource Dependence Theory

Resource dependence theory suggests that companies rely on external resources, including shareholders, to achieve objectives. Activists may demand governance changes to ensure effective resource utilization. This theory helps explain the influence of activists on corporate governance reforms and board composition.[10]

SHAREHOLDER ACTIVISM  AND ITS IMPACT ON CORPORATE GOVERNANCE

Shareholder activism has increasingly become a critical force in reshaping corporate governance. In recent years, activist investors have played a pivotal role in challenging traditional governance structures and advocating for significant changes within companies. Their influence extends across various aspects of corporate management, including corporate strategies, board composition, and transparency.[11]

Activist investors often seek to overhaul board structures by pushing for the appointment of new directors who they believe will better represent shareholder interests. This focus on board composition can lead to enhanced oversight and more effective governance, as new members may bring diverse skills and perspectives that align with shareholder priorities. Similarly, shareholder activists frequently advocate for changes in corporate strategies, such as restructuring, mergers, or shifts in business focus, aimed at maximizing shareholder value. These strategic adjustments can lead to more efficient capital allocation and improved financial performance.

Furthermore, transparency has become a major area of focus for shareholder activists. By demanding more detailed disclosures on executive compensation, corporate policies, and financial performance, activists work to reduce information asymmetry between management and shareholders. This push for greater transparency helps ensure that shareholders are well-informed about corporate decisions and can hold management accountable for their actions.[12]

While shareholder activism can drive positive changes and enhance corporate governance frameworks, it also introduces complexities. The tension between short-term activist demands and long-term strategic goals can sometimes create challenges for companies. Balancing these dynamics is crucial for leveraging the benefits of shareholder activism while mitigating potential drawbacks. As a result, shareholder activism has become a dynamic force that both enhances and complicates the landscape of corporate governance.

Historically, shareholders had limited avenues to affect corporate decisions, but this dynamic has changed with the rise of institutional investors and hedge funds. Lucian Bebchuk, Alon Brav, and Wei Jiang provide a comprehensive analysis of this shift, asserting that hedge fund activism has become one of the most influential forms of shareholder activism. Hedge funds, equipped with substantial resources and sophisticated strategies, often target companies to implement substantial changes in corporate strategy, governance structures, and capital allocation practices.[13]

Stuart Gillan and Laura Starks further contextualize this evolution by examining the regulatory and market changes that have facilitated shareholder activism. They argue that increased regulatory reforms and the growing presence of institutional investors have empowered shareholders to demand greater accountability and better governance practices. The sophistication of activist shareholders has significantly increased, allowing them to push for reforms that were previously unattainable.[14]

EXAMPLES

1. Delaware Court of Chancery Cases:

• Air Products and Chemicals, Inc. v. Airgas, Inc. (2011):[15]

This case involved a hostile takeover attempt by Air Products, where Airgas’s board resisted the offer based on their strategic vision. The court’s decision highlighted the board’s authority in resisting shareholder activism that conflicts with long-term strategies.

• Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc. (1986):[16]

This case established the Revlon duties, where the court ruled that when a company is up for sale, the board must prioritize shareholder value and respond to activist proposals.

2. Baxter International Inc:

Baxter International Inc. v. Shareholders (hypothetical case):

This can refer to real-life instances where shareholder proposals have significantly impacted corporate strategies and governance practices. For example, Baxter has faced shareholder activism relating to executive compensation and board structure in the past.

SHAREHOLDER ACTIVISM  AS CORPORATE GOVERNANCE TOOL

• Board Composition and Accountability

One of the primary areas where shareholder activism exerts significant influence is in the composition of a company’s board of directors. Bebchuk, Brav, and Jiang highlight that activist investors frequently campaign for the replacement of board members whom they believe are not serving shareholders’ best interests effectively. These campaigns often lead to changes in the board’s composition, which can result in enhanced oversight and accountability. New board members brought in through activist efforts are often more attuned to shareholder concerns and can drive more effective governance practices.[17]

Activist shareholders also frequently advocate for the separation of the CEO and board chairman roles. This practice enhances board independence and reduces potential conflicts of interest by preventing a single individual from wielding excessive control over both the company’s strategic direction and its oversight mechanisms. Evidence supports that such structural changes can lead to improved board performance and governance quality. For instance, separating these roles can enhance the board’s ability to provide objective oversight and foster a more balanced decision-making process. Research indicates that this separation often leads to a more robust governance structure, which can improve overall corporate performance and shareholder satisfaction.

• Improving Transparency and Disclosure

Shareholder activists play a crucial role in advocating for greater transparency and disclosure within companies. They frequently push for more detailed information regarding executive compensation, corporate strategies, and environmental practices. Goranova and Ryan emphasize that shareholder activism often leads to significant improvements in corporate transparency, which helps reduce information asymmetry between management and shareholders. By demanding more comprehensive disclosure, activists ensure that shareholders are better informed about corporate decisions and their implications.

Enhanced transparency can lead to more informed decision-making by shareholders and pressure management to adopt more responsible and accountable practices. For instance, activists may push for detailed reporting on how companies address environmental and social governance (ESG) issues, fostering a more sustainable and ethical approach to business operations. The drive for greater transparency often results in companies implementing more rigorous reporting standards and improving their corporate social responsibility practices, which can positively impact their reputation and long-term value.

• Aligning Corporate Strategy with Shareholder Interests

Activist shareholders frequently advocate for changes in corporate strategy, including restructuring, mergers, or divestitures aimed at enhancing shareholder value. Bebchuk, Brav, and Jiang argue that hedge fund activism has been instrumental in prompting companies to reassess their strategic directions. Such interventions can lead to increased shareholder value through improved capital allocation decisions, such as stock buybacks or special dividends. However, Gillan and Starks caution that not all activism leads to positive long-term outcomes. Some activist campaigns may focus on achieving short-term financial gains rather than fostering sustainable growth. This short-term orientation can create challenges for corporate governance, as management must navigate the immediate demands of activists while balancing the long-term strategic goals of the company. The pressure to deliver quick results can sometimes lead to decisions that undermine the company’s broader strategic objectives, potentially affecting its long-term stability and growth prospects. Consequently, while shareholder activism can drive significant short-term improvements, it also necessitates careful consideration of its long-term impact on corporate strategy and governance.

CONCLUSION

Shareholder activism has emerged as a formidable force in reshaping corporate governance by influencing board composition, improving transparency, and realigning corporate strategies. As demonstrated by Bebchuk, Brav, and Jiang, shareholder activism can drive significant improvements in governance structures, such as the replacement of ineffective board members and the separation of the CEO and chairman roles. These changes can lead to enhanced oversight, accountability, and a more independent board, which are crucial for effective corporate governance.

Moreover, activist investors play a vital role in pushing for greater transparency and disclosure. They demand detailed information on executive compensation, corporate strategies, and environmental practices, leading to improved corporate reporting standards and reduced information asymmetry. This push for transparency not only aids in better-informed shareholder decision-making but also compels management to adopt more responsible and accountable practices, thereby fostering a more ethical and sustainable approach to business operations. Activists’ influence extends to corporate strategy as well. By advocating for restructuring, mergers, or divestitures, they can prompt companies to reassess their strategic directions, often leading to enhanced shareholder value through improved capital allocation decisions. However, this influence comes with its own set of challenges. Gillan and Starks highlight the potential pitfalls of activist campaigns that focus on short-term financial gains at the expense of long-term growth and sustainability. The pressure to deliver immediate results can sometimes lead to decisions that undermine broader strategic objectives and long-term stability. Balancing these dynamics is crucial. While shareholder activism holds the potential to drive significant improvements in corporate governance and align corporate strategies with shareholder interests, it is essential to manage its impact carefully. Companies must navigate the immediate demands of activists while maintaining a focus on their long-term strategic goals to avoid compromising their overall stability and growth. By doing so, they can harness the positive aspects of shareholder activism to enhance governance practices and ensure sustainable value creation. Ultimately, the effectiveness of shareholder activism as a governance tool depends on the ability of companies to integrate activist insights while maintaining a balanced approach that considers both short-term pressures and long-term objectives. As the landscape of corporate governance continues to evolve, understanding and managing the complexities of shareholder activism will be key to corporate success.

shareholder activism has become a powerful force in modern corporate governance, significantly influencing board composition, transparency, and corporate strategies. By challenging traditional governance structures and advocating for reform, activist shareholders have prompted meaningful changes, such as enhanced board oversight and improved disclosure practices. These changes contribute to more responsible corporate governance, aligning management decisions with shareholder interests.

However, shareholder activism also presents challenges, particularly when short-term gains are prioritized over long-term stability. Companies must navigate the demands of activist shareholders while maintaining a focus on sustainable growth and value creation. Ultimately, the success of shareholder activism as a governance tool depends on balancing these short-term pressures with long-term strategic objectives, ensuring that corporate governance evolves in a way that fosters accountability, transparency, and sustained corporate success.

REFERENCES

1. Gillan, Stuart L. Empirical Evidence on the Effectiveness of Shareholder Activism,. Routledge, 2020.
2. Miller, Geoffrey P, Shareholder Activism: Corporate Governance and the Role of Institutional Investors*. Cambridge University Press, 2018.
3. Johnson, Steven S. “The Role of Shareholder Activism in Corporate Governance Reform.” Yale Law Journal, vol. 125, no. 3, 2016, pp. 778-828.
4. Klausner, Michael. “The Effects of Shareholder Activism on Corporate Governance: Evidence from Recent Studies.” Stanford Law Review, vol. 70, no. 4, 2018, pp. 1045-1100.
5. Harvard Law School Forum on Corporate Governance. “Shareholder Activism and Corporate Governance: Trends and Impacts.” HLS Forum Report, 2023, https://corpgov.law.harvard.edu/2023/01/01/shareholder-activism-and-corporate-governance-trends-and-impacts.
6. PWC. “Shareholder Activism: Its Impact on Corporate Governance.” PWC Report, 2022, https://www.pwc.com/gx/en/services/governance/shareholder-activism.html.

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[1] Kahan, M., Rock, E.B., Hedge Funds in Corporate Governance and Corporate Control, University of Pennsylvania Law Review, 2007

[2] Brav, A., Jiang, W., Partony, F., &Thomas, R., Hedge Fund activism, corporate governance and firm performance, 2008

[3] Bebchuk, L. A., The myth of shareholder franchise, Virginia law review, 2007

[4] Sjostrom, E., Shareholder activism for corporate social responsibility: What do we know?, Sustainable Development, 2008

[5] Goranova, M., & Ryan, L. V., Shareholder activism: A multidisciplinary review, Journal of Management, 2014

[6] Romano, R., Less is more: Making institutional investor activism a valuable mechanism of corporate governance, Yale Journal on Regulation, 2001

[7] Monks, R., A. G., & Minow, N., corporate governance, John Wiley& Sons, 2011

[8] Tricker, B., Corporate governance principles, policies, and practices, Oxford University Press, 2019

[9] Stout, L., The shareholder value myth: How putting shareholders first harms investors, corporations, and the public, San Francisco Berrett-Koehler publishers, 2012

[10] Stout, L., The shareholder value myth: How putting shareholders first harms investors, corporations, and the public, San Francisco Berrett-Koehler publishers, 2012

[11] Leo E. Strine Jr., Toward a true corporate republic: A traditionalist response to Lucian Bebuck’s solution for improving corporate America, Harvard’s Law Review Association, 2006

[12] Thomas W. Briggs, corporate governance and the new Hedge fund activism: An empirical analysis, University of Iowa, 2007

[13] Lucian Bebchuk, Alon Brav & Wei Jiang, The long-term effects of Hedge fund activism, 2015

[14]Stuart L. Gillan & Laura T. Starks, The evolution of shareholder activism in the United States, 2007

[15] https://law.justia.com/cases/delaware/court-of-chancery/2011/6467.html

[16] (https://law.justia.com/cases/delaware/supreme-court/1986/506-a-2d-173.html)

[17] Bratton, William W., Corporate governance and the board: What works best? Cambridge University Press, 2021

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