Liquidity and Shareholder Activism

Oyvind Norli

BI Norwegian Business School – Department of Financial Economics

Charlotte Ostergaard

BI Norwegian Business School

Ibolya Schindele

BI Norwegian Business School; Central Bank of Hungary

Forthcoming The Review of Financial Studies


Blockholders’ incentives to intervene in corporate governance are weakened by free-rider problems and high costs of activism. Theory suggests activists may recoup expenses through informed trading of target firms’ stock when stocks are liquid. We show that stock liquidity increases the probability of activism, but less so for potentially overvalued firms where privately informed blockholders may have greater incentives to sell their stake than to intervene. We also document that activists accumulate more stocks in targets the more liquid is the stock. We conclude that liquidity helps overcome the free-rider problem and induces activism via pre-activism accumulation of target firms’ shares.

Liquidity and Shareholder Activism – introduction

Through their voting rights, shareholders have the formal power to affect the governance of public companies. But shareholder activism is a rare event, a fact often attributed to its considerable costs.1 Election contests demonstrate how costs can be substantial. A shareholder seeking to replace existing board members in a proxy contest must run a public campaign, hire legal expertise, and pay for producing and distributing his own slate of directors to the company’s other shareholders.2 Even if the overall value added exceeds the costs, a large shareholder’s incentives to monitor and intervene are hampered by free-riding minority shareholders who reap the benefit of increased value, but do not bear any of the costs.

Theory suggests that liquidity may help to overcome the free-rider problem and strengthen the incentive of large shareholders to engage in costly activism (voice). If a firm’s stock is liquid enough, a shareholder planning an intervention can profit from informed trading and recoup the cost of activism by purchasing shares at a price that does not yet reflect the future increase in company value created by his privately known actions (Maug, 1998; Kahn and Winton, 1998; Winton and Li, 2006).3 In contrast, Coffee (1991) and Bhide (1993) view liquidity as an impediment to intervention because it allows blockholders to sell their shares without incurring large trading costs. Liquidity, in this case, makes exit more attractive than voice.

In this paper, we investigate empirically whether liquidity induces shareholder activism in the form of voice through informed trading as proposed by Maug (1998), Kahn and Winton (1998), and Winton and Li (2006). For brevity, henceforth we will refer to this hypothesis as \voice” or \the voice mechanism”. The mechanism of voice rests on the assumption that voice is costly. We therefore hand-collect data on contested proxy solicitations in connection with shareholder meetings. These are activist events that involve considerable costs as documented by Gantchev (2013).

Our analysis is based on a sample of firms listed on the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and Nasdaq. Activist events are collected from the Electronic Data Gathering, Analysis, and Retrieval system (EDGAR) of the U.S. Securities and Exchange Commission (SEC). We record information from all filings made by non-management and fillings relating to contested proxy solicitations during the years 1994 through 2007. We identify 385 shareholder activist events, for which the majority (87 percent) are fiings concerning proxy contests and the rest are related to shareholder proposals or other types of disputes.

We start by documenting that at the time their intervention becomes publicly known, activists own sizeable blocks of equity in the target firms, on average 9%. Activist shareholders therefore tend to be blockholders and the free-rider problem is likely to be relevant in our sample, leaving a role for liquidity. Our paper contributes by providing four pieces of evidence on the role of liquidity that all are consistent with the mechanism in the theories of Maug (1998), Kahn and Winton (1998), and Winton and Li (2006).

Shareholder Activism

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