Research published by academics at the BI Norwegian Business School in April of last year focuses of the targets of shareholder activists. The study, discussed in a recent blog post on the Harvard Business School Forum, discovered shareholder activists don’t just focus on “hidden value” they can unlock when choosing targets, and that liquidity is a significant factor in activist’s decision-making when selecting targets for their campaigns.
The first point that authors Oyvind Norli, Charlotte Ostergaard and Ibolya Schindele make is that shareholder activism is not free. They note that shareholder activism is actually a relatively rare event, probably because of the considerable costs.
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An activist shareholder who wants to replace board members in a proxy contest must run a public campaign, hire lawyers and PR staff, and also pay the costs of introducing his own slate of directors to the company’s other shareholders. Large European pension funds have been lobbying for proxy access with U.S. companies, and have frequently note the high costs of nominating individuals for election to BoDs as a factor in their increasing focus on non-U.S. stocks. Moreover, even if the hidden value unlocked is greater than the costs, a large shareholder’s incentives to intervene are lessened by “free-riding” minority shareholders who enjoy the benefit of the increased value, but do not share any of the costs.
Liquidity enables trading to cover costs of activism
The authors make the argument that liquidity assists in overcoming the free-rider problem and increases the incentive for large shareholders to undertake costly activism. If a company’s stock is liquid enough, a shareholder planning an intervention can easily profit from “informed trading” and make back the activism-related costs by purchasing shares cheap as the price does not yet reflect the increase in company value that will result from his actions.
Norli et al. noted they found a “statistically and economically significant positive effect of stock liquidity on the probability of activism.” They further note the results “imply that a discrete increase in liquidity from the 10th to the 90th percentile more than doubles the likelihood of activism.”
In addition, the authors hand-collected transaction data from activists’ 13D SEC filings and noted transactions up to one year before the activism began. The results show that activists trade actively before commencing activism: 76% of activists trade, and 95% of trades are purchases. Activists that trade on average accumulate 54% of their stock holdings during the year preceding the announcement of the activism. The activists typically made very trading profits; on average, they earned an 8.5% annual return on the capital invested.
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