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The Economist, May 31, 2007 article

American corporate governance

Hail, shareholder!

May 31st 2007 | NEW YORK
From The Economist print edition


David Simonds
David Simonds

Activist shareholders are getting tough with boards and managers

WHEN historians of American corporate governance pick up their pens, Home Depot's annual shareholder meeting in 2006 will be seen as a pivotal moment. Bob Nardelli, the retailer's boss, was the only director to show up. Large clocks were used to keep the utterances of talkative shareholders to a minimum. Mr Nardelli, whose combative style earned the firm the nickname “Home Despot”, did not take questions. The whole event was over in less than 40 minutes.

This year's meeting, which took place on May 24th, was altogether different. Mr Nardelli had gone, having been ousted in January, largely as the result of shareholder pressure. So had the clocks. The new boss, Frank Blake, apologised for the previous meeting and took questions. Almost every board member attended, new among them a founder of Relational Investors, an activist fund-manager which had been agitating for a greater say in the company's strategy. The message was clear: the board is accountable to shareholders.

The changes at Home Depot are more striking than most, but owners are flexing their muscles everywhere. Last month shareholders at Verizon and Blockbuster became the first in America to give majority backing to resolutions calling for an advisory shareholder vote on executive pay. Such “say on pay” resolutions were unknown in America before last year, but more than 60 have been filed this year and support is averaging more than 40% during this year's round of annual shareholder meetings. Take-up has been extraordinary, says Stephen Davis, a veteran corporate-governance watcher.

Shareholders have also shown support for proposals to give them a greater say on poison-pill defences (Hewlett-Packard, Disney) and to eliminate staggered boards, forcing every director to stand for election each year (Limited Brands, McGraw-Hill). And majority voting is fast displacing plurality voting, in which there is no way to vote against a nominee, in board elections.

This increased level of activism has deep roots. The rise of defined-contribution pension plans has been shifting power towards individual investors for years. WorldCom and other failures of oversight at the start of the decade did much to erode traditional deference towards management and boards. And the cost of transmitting information to and between shareholders has fallen, making it easier to launch and fight campaigns.

The emergence of a new type of activist investor—deep-pocketed hedge funds—has also had a galvanising effect. Motivated less by broad governance concerns and more by financial ones, activist funds build stakes in firms and use their clout to push for changes in strategy, from putting the company up for sale to putting their own people on the board. If persuasion fails, confrontation is rarely far behind. “These are ‘Type A’ individuals, traders not investors,” says Chris Young of Institutional Shareholder Services (ISS), a proxy-research firm.

Activists now sit on the boards of businesses such as Heinz, Wendy's and Applebee's, as well as Home Depot. Even failed campaigns, such as Carl Icahn's recent attempt to win a seat on the board of Motorola, a troubled telecoms-equipment firm, have the salutary effect of telling managers that they are being watched. And funds' appetites appear to be growing: on May 16th it emerged that Eddie Lampert, a famed activist, has acquired 15m shares in Citigroup, the world's largest financial-services firm.

Activist funds would not be effective without the support of other shareholders, chief among them big institutional investors. These investors are becoming more outspoken, too. Greater transparency is one reason. Since 2004 disclosure of how they vote on proxy resolutions has forced fund managers to think much harder about their stance on governance-related issues. Newer concerns that companies they invest in are being sold for a song to private-equity firms are also provoking funds into action. Opposition by Fidelity, a fund manager, to the proposed sale price for Clear Channel Communications, a media company, has led not just to higher offers from the suitors, but also the chance for shareholders to retain shares in the company once it has gone private. According to, a website that tracks takeover defences, public campaigns against merger transactions in 2006 led to better offers in a quarter of cases.

The outlines of the next big governance battle, over shareholders' rights to nominate directors, are already visible. Three shareholder resolutions have been introduced this year and America's stockmarket regulator, the Securities and Exchange Commission, held a public consultation on the issue in May.

Is all this activism good for corporate America? It is too early to say whether activist hedge funds can extract long-term value—some are keen simply to sell firms to private-equity buyers or to load company balance-sheets with debt. But investors lucky enough to hold a portfolio made up of firms that were involved in activist fights in 2005 would have enjoyed excess returns since then, says ISS. And a study published last year by Alon Brav, Wei Jiang, Frank Partnoy and Randall Thomas examined 374 interventions by 110 activist hedge-funds in 2004-05, around 40% of which were hostile, and found that shares in the target firms outperformed the market over various periods, particularly when the hedge fund tried to get the firm to change strategy or put itself up for sale.

Critics worry that as shareholders become more demanding and their clout increases, hamstrung managers and boards will be more inclined to sell out to private equity. “Activists seem to assume there is no alternative to the public markets, and increasingly there is,” says Paul Danos, dean of Tuck School of Business and a board director himself. But harried managers may conclude that the best approach is to adopt corporate-governance reforms that increase shareholder democracy and so give them a stronger mandate. If shareholders are able to elect directors and hold them properly accountable for their performance, then they should be more willing to let them get on with the job.


Copyright © 2007 The Economist Newspaper and The Economist Group. All rights reserved.




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