Standing On The Shoulders Of Giants: The Effect Of Passive Investors On Activism

Ian Appel
Boston College – Carroll School of Management

Todd A. Gormley
University of Pennsylvania – The Wharton School

Donald B. Keim
University of Pennsylvania – Wharton School

March 15, 2016


We analyze whether the growing importance of passive investors has influenced the campaigns, tactics, and successes of activists. We find activists are more likely to pursue changes to corporate control or influence (e.g., via board representation) and to forego more incremental changes to corporate policies (e.g., via shareholder proposals) when a larger share of the target company’s stock is held by passively managed mutual funds. Furthermore, higher passive ownership is associated with increased use of hostile, expensive tactics (e.g., proxy fights) and a higher likelihood the activist obtains board representation or the sale of the targeted company. Overall, our findings suggest that the increasingly large ownership stakes of passive institutional investors mitigate free-rider problems associated with certain forms of intervention and ultimately increase the likelihood of success by activists.

“This is the biggest shift in the battle for corporate control since private equity was invented in the 1980s…activists realize they can influence [the] concentrated shareholder base at many companies, and they’re tapping into the desires of shareholders to see change take place.” — James Rossman, head of corporate preparedness at Lazard, The New York Times, March 18, 2014

Standing On The Shoulders Of Giants: The Effect Of Passive Investors On Activism – Introduction

The willingness of investors to engage in activism has grown rapidly in recent years. About 400 U.S. activist campaigns are launched per year, and as noted by The Economist, the current “scale of their insurrection in America is unprecedented… one in seven [companies in the S&P 500 index] has been on the receiving end of an activist attack” over the past five years.1 The goals of activists have also become more ambitious, and the success rate of activist campaigns has improved. Activists increasingly wage proxy fights to obtain board representation, and more than 70% of these campaigns were successful in 2014.2 As noted by The Wall Street Journal, “Activists are on a roll” and have “cemented their position as a force in U.S. markets and boardrooms.”3 Consistent with the growing influence of activist investors, managers and boards are increasingly concerned about being targeted by an activist, and there is no shortage of advice from consultancy firms on how managers and boards should prepare for an activist campaign.4 The determinants of this shift in activist tactics and success rates, however, are not well understood. For example, why do activists seem more willing in recent years to engage in hostile and costly tactics, like initiating a proxy fight? And, what factors affect their likelihood of success?

Passive Investors Activism

One potential contributor to the rise of activism is the growing presence of large, passive investors. Passively managed mutual funds, which seek to deliver the returns of a market index (e.g., S&P 500) or particular investment style (e.g., large-cap value) have quadrupled their ownership share of the U.S. stock market over the last 15 years and now account for more than a third of all mutual fund assets (see Fig. 1). Furthermore, the institutions that offer these funds, like Vanguard, State Street, and Blackrock, are now often the largest shareholders of U.S. companies. While these large, passive institutions do not generally initiate activist campaigns, the expanding size and concentration of their ownership stakes might facilitate activist investors’ ability to rally support for their demands (Brav et al., 2008; Bradley et al., 2010), which can affect both the type of demands activists make and the likelihood that managers heed these demands. In this paper, we examine whether the increased presence of passive institutional investors influences the types of campaigns undertaken by activists, the tactics they employ, and their eventual outcomes.

Activist investors face a classic free-rider problem (Grossman and Hart, 1980) when considering intervention in a firm. While the activist bears all costs associated with intervention, the benefits accrue across all shareholders. However, passive institutions (along with their large ownership stakes) may help to partially overcome this problem. Specifically, passive investors might either decrease the costs or increase the expected payoff of intervention. Lower costs may come in the form of easier coordination (e.g., during the proxy solicitation process) when the shareholder base contains multiple blockholders.5 Higher expected payoffs may result if bringing a few reputed passive institutions on board lends creditability to a campaign and increase activists’ likelihood of success. For example, the activist hedge fund ValueAct was successful in obtaining a board seat on Microsoft with less than 1% of stock because Microsoft recognized that other large institutional investors backed the fund’s demand. Consistent with the potential decisive role these large passive investors can play, anecdotal evidence also suggests activists attempt to gauge the support of a firm’s largest institutional investors before making demands of management. For example, in its fight against Agrium, the activist hedge fund Jana Partners gauged potential support from large institutional investors before going public with its demands.

Passive Investors Activism

Identifying the impact of passive investors on activists’ choices and success rates poses an empirical challenge. Actions by activists are an equilibrium outcome that reflect both the costs and benefits of different forms of intervention. Thus, correlations between passive investors and activism outcomes might not reflect a causal relation because ownership by passive investors might be correlated with factors—such as firms’ past performance or level of stock liquidity—that directly affect activists’ tactics and success rates.

Passive Investors Activism

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