Shareholder Activism And Voluntary Disclosure

Thomas Bourveau

Hong Kong University of Science & Technology (HKUST)

Jordan Schoenfeld

University of Utah

October 1, 2015

Abstract:

This paper studies the relation between voluntary disclosure and shareholder activism. We use a unique data set of 1,130 activism events from 2005 to 2011 to construct an empirical model of activism and disclosure. Our findings indicate that when the threat of activism increases, managers respond by increasing disclosure, and these additional disclosures reduce the probability of being targeted by an activist. We interpret these results as evidence that managers strategically influence their firms’ information environments through disclosure to deter activist intervention. This evidence stands in contrast to theoretical governance models that assume that a firm’s information environment is an exogenous force in activism settings.

Shareholder Activism And Voluntary Disclosure – Introduction

“Companies that can articulate their strategy and demonstrate that it is grounded in a well-considered assessment of both their asset portfolios and their capabilities may be more likely to minimize the risk of becoming an activist’s target.”  – Mary Ann Cloyd, PricewaterhouseCoopers LLP, May 2015

Information is the foundation on which traders form their beliefs about a company and ultimately their investment decisions. In empirical settings, information often arrives in the form of a company disclosure. Since managers have significant discretion over disclosure, researchers have extensively studied the relation between disclosure and trading via the price system. The general consensus in this literature is that company disclosures have significant pricing implications, which is in turn construed as evidence that disclosure affects traders’ beliefs. In this paper, we study the relation between disclosure and a specific class of traders, shareholder activists. Assets under management at activist funds have increased ten-fold over the last decade to $120 billion (J.P. Morgan, 2015), and many studies therefore focus on the economic consequences of activism. For example, it has been shown that targeted companies subsequently have higher CEO turnover (Brav, Jiang, Partnoy, and Thomas, 2008), lower CEO pay (Ertimur, Ferri, and Muslu, 2011), more independent board members (Fos and Tsoutsoura, 2014), and higher plant-level productivity (Brav, Jiang, and Kim, 2015). But this literature only indirectly explores the link between activism and disclosure. We extend this literature by looking at disclosure explicitly.

Any structural model of the relation between activism and disclosure must account for all the strategic reporting preferences of both managers and activists. Finding reasonable empirical proxies for all of these preferences would prove difficult (e.g., Leuz and Verrecchia, 2000; Joos, 2000). We therefore exploit activism peer firm settings and construct reduced form empirical models for the relation between activism and disclosure. Gantchev, Gredil, and Jotikasthira (2015) empirically show that activism in one firm is a valid instrument for an increase in the likelihood of activism at a closely matched industry peer firm.1 In contrast to Chen and Jung (2015), who study disclosure conditional on activism, we do not focus the analysis on companies already engaged by an activist because we expect these companies to pursue costlier strategic mechanisms such as activating poison pills or engaging in direct negotiation.

The peer firm settings are precisely where we expect managers to use the disclosure mechanism in connection with activism. Our intuition unfolds as follows: Managers have significant motivation to avoid activism at their firms because activism is associated with a drop in CEO compensation, an increase in CEO turnover, and an increase in director turnover. Disclosure has several properties that make it suitable for deterring activist intervention: (1) It reduces information asymmetries between shareholders, including management and the board; (2) it signals managerial credibility to the board and existing shareholders; (3) it erodes activists’ private information advantage; (4) it corrects mispricings; and (5) it in- creases stock liquidity. Establishing credibility with the board and existing shareholder base is critical for managers in preparation for activist negotiation settings because low credibility makes it easier for activists to effect their agenda (Levit, 2014). For example, passive shareholders with large voting blocs have a strong preference for high disclosure and can vote against management in a proxy contest if they are dissatisfied with the firm’s disclosure regime (Bushee and Noe, 2000; Boone and White, 2015). Balakrishnan, Billings, Kelly, and Ljungqvist (2014, Section 5) find that disclosure significantly increases firm value, which lowers the likelihood that activists will target a company for valuation purposes. It has also been shown that disclosure increases stock liquidity (Welker, 1995; Healy et al., 1999; Balakrishnan et al., 2014), and higher liquidity is associated with a reduced probability of activism (Edmans, Fang, and Zur, 2013).

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