In praise of activist investors
Agitators are far from perfect, but they can play key role in spurring long-term thinking.
Unstructured Learning Time
This month the Dutch government debated a proposal to suspend all shareholder rights for a year in the event of an unsolicited takeover bid.
This move, which we view as a “backwards step”, is the latest in a salvo of proposals to curb engaged investors. But it is also part of a broader debate about the perceived short-termism in markets, the weaknesses in corporate governance and the role of activists which policymakers, boardrooms and investors wrestle with.
That’s why we organised a summit this week to debate the merits and demerits of taking a long-term perspective and market-based solutions. I for one will be looking to praise, not bury, activist investors.
The history of short-termism is a long one. Keynes in the 1930s called short-termism a “contemporary evil”. From the pioneering “proxyteers” of the 1950s through the Barbarians at the Gate in the 1980s, to today’s activists, companies have often bemoaned engaged shareholders who have agitated for change. It remains true today.
However, bosses perceive that short-termism is more acute than ever. A recent study commissioned by think-tank Focusing Capital on the Long Term suggested 87% of executives felt pressure to deliver results within two years or less.
The pressure on executive teams is indeed high. But in our experience it is the disruptive impact of technology and its intersection with the big macro challenges of globalisation, political uncertainty and the scars of the financial crisis, which are often the root cause.
The second concern is that a large proportion of investors are focused on short-term returns. But it is hard to find systematic evidence of short-termism in markets. While plenty of investors are looking to trade small movements or focus on merger arbitrage, the vast weight of money is looking for long-term value. The valuations of tech giants or biotech stocks affirms that markets do value long-term earnings power and try to value the optionality inherent in such innovative sectors.
The next complaint is that companies are underinvesting to boost short-term profits. The normal statistic trotted out is that buy backs and dividends are now higher than earnings or research & development (R&D) in the US. But when you look more closely you see that R&D has stayed fairly constant as a percentage of GDP and percentage of sales.
Rather, companies are returning cash as the windfall gains of incredibly cheap borrowing costs due to quantitative easing is being handed back to shareholders.
Put another way, QE has not been as effective as the central bankers’ fair weather models suggested. Companies are simply not seeing a wide range of new investment opportunities just because of cheap money. Moreover, QE also means investors are yield hungry and so nudge companies to up their payouts.
A more compelling concern is that the rising share of passive investing risks creating a swath of absentee landlords with less check on poor management teams. Given passive investing is likely to breach half of US equities fund investments in the next 12 months and well over one quarter in Europe, some are becoming more apprehensive.
While there are many tensions and stakeholders running a public company, some management teams are too focused on gilding their cage. Others underemphasise the long-term sustainability of their firms beyond their tenure, get stuck on the treadmill of quarterly reporting or simply chase poorly designed incentive schemes.
So who is going to solve this? Rather than passing new laws, we should welcome activist and engaged investors which can be an important catalyst for change. The best academic study on activism suggests activists are not myopic. Harvard’s Lucian Bebchuk and colleagues looked at 2000 interventions by activists which showed that five years after activist intervention, their operating performance was materially improved.
That is not to say there aren’t short-term activists, or that all engaged investors proposals are good. There are virtues and vices in short and long-termism. Rather the devil is in the detail and idealism needs to be married with deep pragmatism. A keen focus on appropriate incentives and corporate governance is a critical ingredient. But so too is a pluralistic market for financing the economy: private and public markets; passive and activist investors.
I often suspect companies get the shareholders they deserve. Those who are not sufficiently focused on driving long-term value and the sustainability of their business ironically make themselves more vulnerable to the activists they fear.
The author is Global Head of Strategy at Schroders and member of the World Economic Forum Disruptive Innovation in Financial Services group. Jessica Ground, Global Head of Stewardship and Nick Kirrage, Fund Manager, Equity Value, also contributed to this piece.