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Are Activist Shareholders Eating Away at Your Investing Potential?

Traditionally large investors have been either activist or passive; either taking an aggressive role in financial engineering; or simply taking a large equity stake and deferring to existing management for decisions on the company’s strategy. Studies show that activist boards are largely composed of older white males, and are about 65 percent less diverse than S&P 1500 boards.

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A disturbingly common activist model of shareholder engagement often results in a precarious and potentially destructive short-term focus, often resulting in those activist shareholders bringing in board members and CEOs who are more financial engineers than real leaders. The result can be short-term gains at the expense of long-term growth and success. Such a scenario may yield big gains for those activist shareholders, but their gains come at the expense of ordinary retail investors and may compromise the long-term prospects of the company itself.

This model of investment, however, is reaching a turning point and may soon be obsolete, especially in a post-COVID environment and a new era of racial reckoning, in which both customers and employees are demanding more from the businesses they work at and patronize. Companies and the people who lead them are being held accountable, and best practices will now mandate that companies move quickly down this new path.

Traditionally large investors have been either activist or passive; either taking an aggressive role in financial engineering; or simply taking a large equity stake and deferring to existing management for decisions on the company’s strategy. The latter approach may be taken for example, by an operator of an index fund, who merely wishes to reflect an industry segment rather than influencing the strategies of individual companies. Such investors seldom engage, nor take any role in improving the governance or operations of their portfolio companies.

Adversarial activist investing and long-term harm

An activist approach, on the other hand, takes an aggressive hand in board appointments, often influencing strategy so as to improve the bottom line quickly with draconian and potentially harmful cost-cutting as opposed to encouraging long-term growth, new product exploration, and entering into new markets. Such an approach often has resulted in changes at both the C-suite and in the board, frequently displacing high-performing and successful CEOs, and often placing directors with a limited ambition to create long-term shareholder value. More to the point, this type of adversarial activism reduces diversity at a time when diversity is at the forefront of every investor’s mind. Activist shareholders disproportionately displace female and minority CEOs. Studies show that activist boards are largely composed of older white males, and are about 65 percent less diverse than S&P 1500 boards. The average board is 15.7 percent less diverse after an activist engagement.

The problem this resulting lack of diversity creates is that the company will tend to lack vision. Boards made up exclusively of older white males will often miss out on opportunities for value creation simply because that board has a fundamental lack of experience and visibility in markets they could be exploiting.

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Not to speak ill of the “Old White Man” – your author is one himself – but the natural tendency of creating a board and C-suite in one’s own image sets a dangerous precedent and will often result in alienating the business from its consumer base and harming long-term prospects for meaningful growth in sales and new markets.

A case in point: Jamba Juice, under the tenure of CEO James White (one of the few African-American public company CEOs), restored its solvency under White’s tenure, created long- term shareholder value, improved diversity in the management team, and launched new growth initiatives and captured new markets. During White’s tenure, the company achieved profitability, exceeded market same-store sales, and enjoyed a 22.7 percent annualized return. After an adversarial activist engagement however, management was replaced, a severe cost-cutting strategy was put into place and long-term initiatives were cut in favor of a short-term focus. White retired, the board became less diverse and same-store sales went into negative territory, with EBITDA declining 70 percent from peak. The company went from a 22.7 percent pre-activist annualized return, to only a 3.8 percent annualized return, and share prices declined by half.

ESG principles, diversity and more: Are the hippies taking over Wall Street?

Assuredly not. White, now the Managing Director at Mill Road Capital, has crafted a new category of investing which the people at Mill Road refer to as the “Sponsoring Investor” strategy, a sort of Goldilocks approach to institutional investing which actively engages, but unlike conventional activists, seeks to build long-term value creation, seeks to influence without having control, and makes a commitment to enhancing diversity and driving cultural change.  

“We have a view that there are changes that need to happen in the boardroom and governance,” said White. “We think one of the ways to have that happen is to have investments that are more long-term in nature, and more thoughtful from a mission perspective.” White is betting on that Sponsoring Investor model driving Mill Road’s newly launched Progressive Governance Fund. “Business is being held accountable differently,” said White. “A diversity of experience and background in the boardroom leads to better governance, and ultimately better returns. Our goal is to use capital in a surgical way that is long-term, with partners that will bring a skill set that will serve as accelerators to the business.”

The Sponsoring Investor model may originate from Mill Road’s Progressive Governance Fund, but it will not end there – and is very likely to serve as a model in the broader private equity industry, especially as institutional investors look to elevate their attention to ESG and diversity initiatives. While passive managers lack the skills or interest in structuring governance in their portfolio companies, and conventional activist fund managers lack the toolkit or incentive to foster long- term value creation, the Sponsoring Investor model drives that long-term growth, improves governance and seeks to build a relationship with management while gaining board representation, while maintaining a commitment to enhancing diversity and driving cultural change.

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White may be just the one to lead the charge, having served on 17 separate boards in the past 20 years, and held senior positions at Jamba Juice, Safeway, and Gillette. Mill Road is also led by Managing Director Thomas Lynch, whose background includes founding Lazard Capital Partners, and serving as Managing Director responsible for making investments at two Blackstone funds.

White says that support for diversity, as illustrated in the Sponsoring Investor model, will ultimately help Mill Road – and other funds which follow suit – gain board representation with fewer confrontations and proxy fights. Such initiatives are also likely to gain support from traditionally passive fund managers who own large voting blocks, who may generally support the concept of diversity but need a more active partner to “sponsor” the change.

“Corporate boardrooms and C-suites have never been as diverse as they  need to be,” said White. “There is a lot of work that needs to be done, but our thesis is that more diverse experiences and more diverse backgrounds in the boardroom will be an accelerator.”



(Featured Image by Io Io via Unsplash)

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Dan Blacharski is a thought leader, advisor, industry observer, and editor-in-chief of USNewsAndReview.com. He has been widely published on subjects relating to customer-facing technology, fintech, cloud computing and Asian news and culture. He lives in South Bend, Indiana with his wife Charoenkwan, and their Boston Terrier, "Ling Ba."

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