Week 7: Shareholder Activism Flashcards
What is the shareholder-manager principal-agent problem?
Separation of ownership of shareholders (principals) & control of managers (agents hired by shareholders) –> info asymmetry between managers & shareholders –> managers may have inadequate incentives to max. shareholder value over their own personal interests e.g. exerting insufficient effort, engaging in wasteful investment/value-destroying acquisitions (empire-building) or extracting excessive salaries/bonuses/company perks.
What is the main source of shareholder-manager principal-agency problems & how is it affected by shareholder size?
1) MONITORING MANAGEMENT IS COSTLY –> monitoring managerial decision making involves time, money & effort to ensure managers serving best interests of shareholders.
2) SMALL SHAREHOLDERS INCUR HIGHER COST OF MONITORING MANAGEMENT –> i.e. have tendency to free-ride & disincentivised to monitor management & incur associated cost as benefit limited by their small stake in firm –> however large shareholders (BLOCKHOLDERS) have major stakes in company so are incentivised to bear cost of monitoring managers & play key role in corporate governance.
What are the 2 ways in which blockholders can exert governance i.e. solve agency problems?
1) DIRECT INTERVENTION: VOICE MECHANISM –> i.e. direct engagement w company’s management & board of directors to suggest strategic changes or changes to corporate policies –> e.g. via public shareholder proposal, private letter to management, or voting against directors.
2) EXIT MECHANISM: TRADING SHARES –> if large shareholder starts selling shares, stock price likely to decline –> likely to be interpreted by other market participants as a sign of firm underperformance –> puts pressure on management to act according to shareholders’ interests & maintain investor confidence (i.e. disciplinary effect), esp because publicly traded stocks are highly info sensitive.
What are the 2 ways in which blockholders may exacerbate agency problems?
1) REDUCED LIQUIDITY IN COMPANY’S SHARES –> blockholder intervention may max. firm value in short-term but risks reducing firm value in long-term –> threat of blockholder intervention may discourage managerial initiative & risk-taking if managers overly cautious or focus on short-term gains to avoid potential blockholder conflicts –> may reduce long-term growth & innovation –> investors may be reluctant to invest in companies w significant blockholder ownership.
2) EXTRACTION OF PRIVATE BENEFITS AT EXPENSE OF SMALL SHAREHOLDERS –> e.g. conflicts of interest where blockholders seek to extract private benefits at expense of company & its other shareholders –> e.g. using their influence to push company into related-party transactions primarily benefitting themselves where products purchased at inflated prices from companies owned by blockholders –> wealth transfers from minority shareholders to blockholders, reducing overall firm value & undermining principle of shareholder wealth max.
What are activist investors & what 6 actions might they do?
Individuals or groups that purchase large no. of public company’s shares &/or tries to obtain seats on company’s board –> goal of effecting major change in company to increase shareholder value via:
1) Spin-offs –> i.e. separating certain business segments from firm to increase value by separating underperforming or non-core assets from core business for each entity to focus on its strategic priorities).
2) Sale of entire company –> e.g. strategic acquisition by another company or through private equity buyout if activists believe firm value not fully reflected in stock price & that sale would generate greater shareholder returns.
3) Management shake-up –> i.e. if current CEO/key executives believed to not max. shareholder value.
4) Board seats –> i.e. activist representation on company’s board of directors to gain direct influence over corporate decision-making to ensure shareholder interests max.
5) Share buybacks.
6) Restructuring –> i.e. improving company’s operational efficiency via asset sales, cost-cutting measures, or strategic investments in new business lines.
How may activist investors exacerbate agency problems?
BY PRESSURING COMPANY MANAGEMENT TO ENHANCE SHORT-TERM SHAREHOLDER VALUE AT EXPENSE OF LONG-TERM VIA SHARE BUYBACKS (REPURCHASE) –> company repurchases its own shares from mkt to appease activist investors (‘greenmail’), effectively reducing no. of outstanding shares –> can boost earnings per share (EPS) by distributing same earnings over smaller no. of shares, potentially increasing short-term stock price as it signals confidence of investors & company in firm’s future growth prospects –> HOWEVER prioritising buybacks over investments in growth initiatives may lead to long-term stock price decline
–> e.g. ADT’s share buybacks where cash reserves used to repurchase shares instead of investing in marketing or competitive initiatives leading to company’s profit warning + LPL Financial’s debt-financed share buybacks led to concerns about company’s financial health & its ability to service debt obligations.
