03 Jan Wake up call for boards as activists doubt their capability
Source: The Australian Financial Review.
By: Tony Featherstone.
The forces behind the uptick in shareholder activism have been building for a decade.
Shareholder activism hit new heights last year as institutional investors flexed their muscles, forcing executive and director resignations and putting Corporate Australia on notice.
More than a dozen ASX 200 companies received a strike over pay in the latest AGM season and there was a spike in protest votes for director re-elections, as proxy advisers and institutions hammered corporate underperformers and governance laggards.
Separately, an investor revolt towards Westpac Banking Corporation after its money-laundering scandal led to the resignation in November of CEO Brian Hartzer and the forthcoming retirement of chairman Lindsay Maxsted.
Elsewhere, proxy adviser Ownership Matters controversially advised in November against the reappointment of Harvey Norman CEO Katie Page to the board. In retaliation, business leaders argued proxy advisory firms need urgent regulation.
These and other activist spot fires raged across Corporate Australia in 2019 as institutional investors made their grievances about companies public. For a governance community used to engaging with institutional investors behind closed doors, it was a watershed year.
However, suggestions that shareholder activism in Australia is new are misguided. Growth in activism is the result of tectonic forces that have been building for a decade, much of them to do with capital flows, index investing and changing communication expectations.
Dirt reports and reactive boards
Equally wrong are suggestions that shareholder activism here is rife. Australia has barely started with activism compared to larger developed markets and is yet to see the emergence of large domestic funds that specialise in deep-value activist investing.
In Australia, 78 companies were activist targets in 2018, according to researcher Activist Insight. The figure is likely to be higher because many activist campaigns are settled privately, but still small in the overall market.
About three-quarters of local activism campaigns were board related, found Activist Insight. Less than 10 per cent of campaigns related to business strategy, balance sheets, and mergers and acquisitions. Most were protests against board handling of performance and pay.
“The coverage of shareholder activism in Australia is vastly more extensive than the practice of it,” says Gabriel Radzyminski, founder of Sandon Capital, one of this market’s few specialist activist investment funds. “Activism has been around in Australia for decades. It’s just that in the 1980s and 1990s we referred to shareholder activists as corporate raiders.”
Definitions of activism are important. Short-sellers that profit when stocks fall are sometimes described as activists, particularly those that uncover accounting or governance scandals within companies and expose their findings by releasing “dirt reports” to the media.
“In some ways, short-sellers have hijacked the term activism,” says Radzyminski. “Short-sellers have a role to play in price discovery in markets but we do not see them as activists. True activism should be a force for good that creates, rather than destroys, value. We are using activism to unlock long-term value in companies, not drive the price sharply lower and make quick gains.”
Radzyminski says much of the recent governance tirade against ASX 200 companies is “active investing” rather than activism. That is, institutional investors doing their job and holding companies and boards to account on governance and performance issues – and making their own voting decisions rather than mostly outsourcing them to proxy advisers.
“True shareholder activism is proactive rather than reactive,” Radzyminski says. “That is, specialist activist funds developing an alternative strategy to unlock value in a company, communicating that strategy to management and the board, and being prepared to engage support from other shareholders if the company is unwilling to act on good ideas.”
Institutions, says Radzyminski, are mostly always reactive on activism. “They jump up and down and lodge a protest vote after something goes wrong in a company. Where were the institutions before AMP, for example, had all its problems? Not a single resolution was voted down at an AMP AGM before its [fees-for-no-service] scandal broke in 2018.
“Institutional shareholders never publicly said that AMP lacked a coherent strategy at the time or attempted to bring other investors together to force AMP to change. They sought board and management change after the damage was done.”
Radzyminski adds: “The reality is most institutions in Australia do not want to be associated with true activism around corporate strategy; it’s too confronting for them. They will protest publicly about executive pay or board performance after the event, but they have eschewed the proactive activism around ensuring companies develop and implement strong strategy – the activism that adds real value for shareholders.”
Arnold Bloch Leibler partner Jeremy Leibler, a legal adviser on activist campaigns, says activism in Australia has not played out as expected.
“There was a view that the big US activist hedge funds would set up here and target ASX 100 companies. And that several locally owned activist funds would emerge and grow quickly. But that has not happened.”
Leibler says the willingness of Australian institutional investors to engage in active investing partly explains the lack of specialist activist funds here.
“A big part of the market that previously stayed out of activist campaigns got a lot more interested in them this decade,” he says. “There was far less tolerance for boards that disregarded the views of a major shareholder or for company underperformance. Institutions were prepared to go public to force corporate change. That’s a good thing.”
Leibler says the growth in proxy advisory firms, which analyse corporate governance and advise clients on how to vote in company resolutions, has fuelled and challenged activism.
“The reality is that most super funds and fund managers outsource their voting decisions to a small group of proxy advisers who now wield enormous power over listed companies and in some instances have made reckless or careless recommendations. I have long argued that proxy advisory firms need to be better scrutinised and regulated in Australia.”
Ownership Matters rejected renewed industry calls for regulation of proxy advisers in December, describing demands for immediate government action on the issue as “febrile” and “shameless” in an opinion piece in The Australian Financial Review.
Looking for weakness
Leibler says activism, provided it is sufficiently regulated, is positive for investors. “The narrative that activists are barbarians at the gate is false. The vast majority of activists are deep-value investors rather than traders or short-sellers. Activist campaigns globally have mostly improved corporate performance and governance, and there have been relatively few destructive examples. I expect to see continued, steady growth in activism in Australia.”
Activism here is a long way from becoming an “asset class” as it has in the United States and Europe, where specialist activist hedge funds control billions of dollars in assets under management and aggressively target underperforming companies.
Globally, almost 1000 companies faced activist campaigns in 2018, from 611 five years earlier, according to Activist Insight. There were 712 campaigns in the first three quarters of 2019.
About a quarter of activist campaigns in the United Sates in 2019 came from first-time activists, found law firm Sullivan & Cromwell in its latest review of shareholder activism. It found active investment managers were increasingly adopting activist tactics, and activists were focusing on mergers and acquisitions issues in record numbers.
Professor David Beatty, of the University of Toronto’s Rotman School of Management, says global shareholder activism as an industry has “exploded in activity”. He says: “Every Fortune 500 company in the United States now has at least two or three activist investors running their ruler over it, looking for weaknesses. The trend is spreading to other developed markets.”
Beatty, a prominent observer of activism and governance in North America, believes boards are unprepared for what is ahead. “Investors want more say in strategy because they lack confidence in the ability of boards to govern corporate strategy and to hold management accountable for its implementation,” he says. “Activism is a way for investors to take ownership of corporate strategy where it has been ineffective.”
Drop-ins and amateurs
The veteran director and senior adviser to McKinsey & Co believes a breakdown in the traditional governance model is fuelling the activism boom and likens the gap between directors and executives in companies to the Grand Canyon.
“On one side are non-executive directors who are drop-ins and amateurs,” Beatty says. “They might not have deep experience in the organisation’s industry and on average only spend 250 hours a year on their role. They have other board roles and busy personal lives, yet are expected to govern large organisations on a part-time basis and be responsible for anything bad that happens.
“On the other side, you have professional executives who spend at least 3000 hours a year in their role and live and breathe their organisation and industry. The traditional governance model cannot keep up as organisations become larger and more complex. That is why shareholder activists are demanding greater say in corporate strategy and getting it.”
Beatty says the big change in activism this decade has been the willingness of institutional investors to team up with activists, forming “wolf packs” to force corporate change. “Activists have been able to mobilise billions of dollars of institutional capital because the big pension funds have become much more willing to work with them, to unlock corporate value.”
The rise of global index funds – the new king-makers in investment markets – is also fuelling shareholder activism. Index funds have more than $US4 trillion in assets managed, giving them enormous power to influence governance decisions and demand better corporate performance.
Globally, BlackRock, Vanguard and State Street have become vocal proponents of governance change – and active investing – this decade.
Forcing companies private
In theory, the governance influence of exchange-traded funds (ETFs) is limited: whether a company has good or bad governance, an ETF issuer has to hold its stock to replicate the index in which it sits. But the sheer weight of capital flowing into index funds has made them a powerful force in shaping governance and activism.
An inevitable outcome of activism, says Beatty, is more companies choosing to remain privately owned for longer and fewer listings on global stock exchanges.
The number of US listed companies has halved since 1996, according to the University of Chicago’s Booth School of Business. UK listings have halved since the late 1990s. And initial public offerings (IPOs) volumes in the US for companies capitalised above $US50 million have more than halved since the 1999 peak.
Context is needed with global listing trends: fewer listings is partly the result of mergers and acquisitions as big companies swallow smaller rivals. But high-performing companies have less reason to list as early on stock exchanges than in years past.
“The boom in private equity has meant companies have greater access to capital than ever in private markets,” says Beatty. “And being privately owned means their management and board have better control and get on with the job of creating value, rather than wasting so much time on investor relations and compliance. They do not have to be dictated to by a 25-year-old stockbroking analyst on Wall Street or worry about being hounded by activists.”
Beatty believes global financial markets are creating the solution to the breakdown in the traditional governance model and the shareholder activism it has sparked. “Capital is pouring into privately owned companies for a reason,” he says. “Investors realise that the costs of new companies listing on stock exchanges – from compliance, to investor relations and activism – is starting to outweigh the benefits.”
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