Corporate Activism – Protecting Shareholder’s Money and Employee’s Health

Controversy starts with who’s an activist – a corporate raider, an advocate for shareholders, a change agent, a titan, a vulture capitalist, an adrenaline junkie?

The names Carl Icahn, Nelson Peltz, Paul Singer, Daniel Loeb, Bill Ackman ring a bell? Let’s see how they describe what they do:

?? Icahn says, “The idea of an activist investor is they buy a stake in a company with the plan and ambition to go to the company’s management and board and say, ‘You’re doing it wrong. Here’s how to do it.’”

?? Singer describes his business model as “a fight against charlatans who refuse to play by the market’s rules,” addressing his strategy on “distressed assets/debts.”

?? Ackman defends it by saying, “Shareholder activism means more accountability and motivation for directors to act in the best interest of the company, shareholders, and all stakeholders.”

As it’s obvious, there is no accepted definition of activist investor or shareholder activism; the agreement is on the need to rejuvenate corporate governance, more specifically the board and non-performing management of established companies. Before diving into the controversy and the drama, let’s try to understand the journey of activism.

Fundamentally, it’s rooted in “value investing” – an investing approach that tries to identify undervalued companies based on their stock price, asset value, and/or earnings power value without considering their growth or management forecast. It’s an approach where investors believe the company as-is is worth more than its market valuation. Hedge funds took this approach to the next level by simply identifying undervalued companies, secretly building a position through stock purchases, revealing shareholdings once the position gets large enough, building the narrative on why the company needs a strategic pivot, or just publicizing the mismanagement of the company, putting pressure on the board or executive team to make changes, and launching a proxy fight if the board/management is reluctant to force changes. And in most cases, over the years, the board and management will end up following the strategic pivot, the stock price will go up, and the hedge fund will make money by selling its holdings. More than it sounds, this approach has resulted in a ton of negative publicity, massive wealth for successful investors, and unspoken fear over the boards/managements of companies. It’s probably the hardest and most controversial invention of the new world order – aka Wall Street.

Activism has risen to enormous levels in recent years, with numerous high-profile activist campaigns capturing headlines. According to recent reports, the number of activist campaigns has steadily increased from 50 campaigns in 2015 to 120 campaigns in 2023. In 2023, activist campaigns saw a significant distribution across various types, with financial and operational campaigns accounting for 60%, board composition changes for 20%, strategic changes (such as mergers, acquisitions, and divestitures) for 15%, and Environmental, Social, and Governance (ESG) initiatives for 5%. The overall success rate of these campaigns was 65%, with financial and operational campaigns having a higher success rate of 70%, followed by board composition changes at 60%, strategic changes at 55%, and ESG initiatives at 50%. Management response to these campaigns varied, with 30% of companies fully cooperating, 40% showing partial cooperation, 20% resisting initially but eventually compromising, and 10% completely resisting the activists’ demands. During this period, the total assets under management by activist investors grew from $200 billion to $360 billion. For instance:

?? Elliott Management’s campaign against AT&T: Pushing for asset divestitures and strategic shifts.

?? Third Point’s intervention with Intel: Demanding changes in strategy and leadership.

?? Trian Partners’ engagement with Procter & Gamble: Advocating for board changes, strategic pivots and operational improvements.

?? Icahn’s campaign against Xerox: Resulting in leadership changes and strategic pivots.

?? Pershing Square’s intervention with ADP: Calling for operational restructuring and board changes.

?? Trian Partners’ campaign against PepsiCo: Pushing for a strategic review and operational changes.

?? Nelson Peltz’s involvement with Mondelez: Demanding cost-cutting and strategic shifts.

?? Elliott Management’s campaign against Walt Disney: Advocating for changes in leadership and strategic direction.

Even one of my favorite tools, S&P CapitalIQ, has a separate section on investor activism and takeover defenses.?

While public perception and wealth creation parts are not on my interest radar, the unrest wave it created over the board/management and the prolonged impact on the company’s performance and health is. Here’s the reason: As Carl Icahn nicely puts it, “You’re doing it wrong.” Let’s zoom into a few examples to prove their point:

1.?? Excess Cash Sitting on Balance Sheet: A company with a huge cash pile sitting on the balance sheet is a strong signal of management not having any clue for growth through strategic investments. Activist investors manipulate this towards share buybacks and special dividends for financial gains. The same applies to undervalued or non-core assets. The bottom line is the same – management is incapable.

2.?? Poor AR / Collection practices: A strong indicator of management applying extensive credit terms for sales or having ineffective collection practices.

3.?? Inefficient capital structure: Suboptimal capital structures, such as excessive leverage or insufficient debt, and push for adjustments to improve shareholder returns. The same principle with excess cash applies here.

4.?? High Executive Compensation with poor performance: Sounds obvious, right? Becoming more common lately.

5.?? Operational inefficiencies: Addressing bloated cost structures, layers of management, or operational inefficiencies and pushing cost-cutting measures and process improvements.

6.?? Overpayment for Acquisitions, integration issues, strategic misalignment: Paying too much for an acquisition without any strategic rationale, failure to effectively integrate acquired companies can lead to operational inefficiencies.

Activist investors spot these issues, scrutinize these activities, and take various actions, including pushing for divestitures, demanding leadership changes, or proposing alternative strategies to correct the course and enhance shareholder value. However, corporate activism needs a scope much bigger than that. Arrogance, mistreating human capital, excessive executive compensation, sweeping all sorts of corporate bullying under the carpet, and building silos lacking diversity mostly goes unnoticed.

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Expanding the Scope of Corporate Activism: A Call for Internal Reform

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While traditional activist investors have focused on financial and operational inefficiencies, there is an increasing need to address overlooked areas that significantly impact a company’s long-term health and sustainability. These include arrogance in leadership, mistreatment of human capital, excessive executive compensation, corporate bullying, and lack of diversity. Addressing these issues is not only ethically imperative but also crucial for sustainable value creation.

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The Need for a Broader Activist Investor Base

Activist investors can play a pivotal role in identifying and rectifying these issues. By expanding their focus to include:

1.?? Human Capital Treatment: Evaluate and push for better working conditions, fair wages, and comprehensive benefits, making sure to hold management accountable for lay-offs, asking for lifetime career journey of each new joiner Companies that treat their employees well tend to have higher productivity and lower turnover rates.

2.?? Diversity and Inclusion: Advocate for diversity in leadership and throughout the organization. Diverse teams are proven to be more innovative and better at problem-solving, leading to improved business outcomes.

3.?? Corporate Governance: Push for transparency and accountability in executive compensation and decision-making processes. Excessive executive compensation without corresponding performance can be a red flag for governance issues.

4.?? Anti-Bullying Policies: Ensure that companies have strong policies against workplace bullying and harassment. A safe and respectful workplace is fundamental to maintaining employee morale and productivity.

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Recommendations for Internal Corporate Activism?

In addition to external activism, fostering an environment where internal corporate activism is encouraged can lead to significant improvements. Here are some recommendations with one caveat – all should be visible to shareholders and public in a synthesized anonymous way:

1.?? Establish Internal Whistleblower Programs: Create secure channels for employees to report unethical behavior or inefficiencies without fear of retaliation. This can help identify issues early and address them promptly.

2.?? Empower Employee Advocacy Groups: Form internal groups focused on advocating for employee rights, diversity, and inclusion. These groups can provide valuable insights and drive change from within.

3.?? Regular Audits and Transparency: Conduct regular audits of company practices related to human capital, diversity, and governance. Publish the results to maintain transparency and hold management accountable.

4.?? Leadership Development Programs: Invest in training and development programs that emphasize ethical leadership, diversity, and inclusion. Future leaders should be equipped to foster a positive and inclusive corporate culture.

5.?? Feedback Mechanisms: Implement robust feedback systems that allow employees to voice their concerns and suggestions. Regularly review and act on this feedback to demonstrate a commitment to continuous improvement.

6.?? Partnerships with Start-Ups: Companies could partner with start-ups like Blind to provide confidential, synthesized reports to shareholders. This ensures that internal issues are highlighted and addressed proactively.

Rationale

Enhanced Employee Engagement and Retention: When employees feel valued and heard, they are more engaged and less likely to leave. This reduces turnover costs and retains institutional knowledge.

Improved Public Perception: Companies that prioritize ethical practices and transparency are viewed more favorably by the public and investors. This can enhance the company’s brand and attract top talent.

Sustainable Growth: Addressing issues related to human capital, diversity, and governance contributes to the long-term sustainability of the company. It ensures that the company is not only profitable but also resilient and adaptable.

Risk Mitigation: Proactively addressing potential issues reduces the risk of scandals and legal troubles, which can have significant financial and reputational costs.

By embracing a broader scope of corporate activism and fostering internal reforms, companies can create a more ethical, inclusive, and sustainable environment that benefits all stakeholders and communities.