RIETI-ECGI-WBF Webinar Series

A New Concept of the Corporation [Part 3]
Ownership of the New Corporation: the Role of Activist Funds (Summary)


  • Time and Date: 4:00 pm - 5:30 pm (JST), 8:00 am - 9:30 am (BST), 9:00 am - 10:30 am (CEST), May 20, 2021
  • Language: English
  • Hosts: Research Institute of Economy, Trade and Industry (RIETI), European Corporate Governance Institute (ECGI), Waseda University Institute for Business and Finance (WBF)



Colin MAYER:
There is a parallel form of ownership that prevails in nearly all countries in some of the most significant listed companies. They are traded actively on liquid stock markets. In most countries, there are also significant holders of substantial blocks of shares that are the controlling shareholders in those large, listed companies.

On average, around the world, about 40% to 50% of the shareholdings of a company are controlled by the three largest shareholders. Families are the dominant owners of even the largest listed companies. There are significant blocks also in the hands of institutional investors, other companies, other financial institutions such as banks, and also the state in some countries.

In Japan, prior to WW2, ownership in some of the largest companies was predominantly in the hands of families, in the form of zaibatsu. In the post WW2 period, ownership was dispersed for a period, but during the 1960s, concentrated ownership returned, but ownership by banks and not in the hands of families. The period of the bank ownership of Japanese companies came to an end during the 1990s. From there, outside ownership began to grow during the 2000s, and then stabilized. Insider ownership also stabilized around 30% on average in the form of cross shareholdings of companies holding shares in each other.

The system that prevails today reflects both the presence of those cross shareholdings and outside shareholders, with an active debate going on in Japan about reform to promote the role of outsider, relative to insider, cross shareholdings. Alongside that, shareholder activism emerged from the early 2000s.

I will provide an explanation of these features of ownership around the world by distinguishing between a number of concepts: the notion of the purpose of a company as against its strategy; the shareholding of firms as against ownership of companies; the notion of agency as against trusteeship; and activism as against acquisition.

In relation to the first concept, the purpose of a company is fundamental. It is about the reason why a company exists, why it was created, and its reason for being. The strategy of a company is not the "why," but it is the "what." What does the company do, what does it intend to do, and how does it intend to do it? The way I have defined purpose is to produce profitable solutions to problems of people and planet, not profiting from producing problems for either. I argue that this needs to be the core of a business and is the overarching framework for its strategy. The way I have suggested that should link to the governance of companies is through defining that purpose, connecting it with the strategy of the business, ensuring that purpose is really owned by someone in the organization, and that it links to the measurement and reward structure in the reporting of the company to outside parties.

The key is the notion of ownership. The first point to notice is the notion of shareholding, which is about the holding of a share or the sharing of the holding in a company. Ownership, in contrast, is about the possession of something. Based on work by academics and professionals in the field, it has been shown that shareholders satisfy none of the conditions required for ownership, concluding that shareholders are not owners of companies at all. Then, who are the owners? It is important to distinguish between two concepts of agency and trusteeship. Within the context of the conventional view of a company, the directors of a company are regarded as the agents of the shareholders, managing the shareholders' assets on their behalf, and they owe a duty of fiduciary responsibility to the investors in the way they manage the shareholders' assets. In contrast, the trustee version of the directors of a company emphasizes the role that the directors perform in terms of managing the assets of the company as a whole, including its financial assets and material assets, but also the form of its human assets, the way in which it employs natural assets, and its dependency on, for example, its society. The directors then have responsibilities which are not just ones of agents or the shareholders, but as trustees of all of the contributing parties to the company, in relation to the way in which the company then impacts all of the parties to which it has relevance. That distinction is brought out quite well in the context of UK company law, and in particular, that which describes the directors' responsibilities.

According to the law, there are two ways of viewing those direct responsibilities. The first is the conventional way in which it is interpreted, which is sometimes described as being enlightened shareholder interest. This way, the director must promote the success of the company for its shareholders. However, in so doing, it should take account of the long term and the interest of other stakeholders, but only that which promote the interest of shareholders. However, there is an alternative that the law sets out, and it suggests that, as an alternative, a company can choose to adopt another description of the role of the director; the director should promote the purpose of the company. This approach is about the director of a company acting to promote profitable solutions for the problems of people and the planet, not profiting from producing problems for either. The importance is that the view of the directors as agents of shareholders means that, in the presence of dispersed shareholders, neither the directors nor the shareholders can be described as owners of the company in a conventional sense.

In contrast, the purpose approach suggests that the directors of the company are there to act as trustees of the company's purpose. As trustees, they have the types of ownership rights and responsibilities that are associated with the trustee role. In the traditional approach, by being accountable to shareholders for the success of the company, the shareholders have associated rights, and in particular, important rights in relation to the appointment and removal of the directors. In contrast, under the purpose approach, the directors are accountable to all of the parties contributing to the delivery of the company's purpose, and therefore, rights of appointment and removal of directors are not necessarily restricted to the shareholders, but could apply to any of the parties contributing to the purpose as specified in the company's constitution.

To give some examples of how this applies in practice, one can think about this role of the directors in relation to the company in the context of a supervisory board approach; a two-tier board in which a combination of shareholders and employees are involved in the ultimate oversight of the running of a company. One can also think about it in terms of a formal notion of ownership. In addition, one can think about it in terms of another trust arrangement where the company is actually owned by a foundation and where that foundation has a charitable purpose. However, its primary function is to oversee the running of the company.

That brings out a variety of different forms in which there are a variety of different owners who can play that role, and indeed the governance structure through, for example, the two-tier board, is another way in which that can happen. Also, it brings out another point that, while there may be some merits associated with broadening the scope of a purpose of a company beyond shareholder interest, there are also potential detrimental effects as well. This creates the notion of the potential benefit of not just having insider owners acting essentially as trustees, but the role of outside shareholders as well. The importance of that takes a number of different forms.

Activism is a critical element in a number of aspects, such as altering both the leadership and the strategy of companies where there has been a failure to promote corporate efficiency in firms, a focus on greater efficiency in shareholder value, and having engagement in the form of activism or private equity that has a shorter period of engagement. The question that has arisen in relation to both activism and private equity engagement is whether or not this is a form of wealth creation or wealth transfer.

The combination of a system of outside shareholding with the potential for engagement through activism and long-term ownership in the form of the blocks of shares offers the potential of doing both. Mainly, the ownership of purpose retains that focus on delivering benefits in the form of solving problems to parties beyond the shareholders, whereas activism encourages the focus on efficiency in terms of delivering greater returns to shareholders because the purpose of a company has the components of solving problems in ways which are profitable.

There is an important distinction in terms of blocks of shares being purchased by activists, and acquisitions of entire companies which involve a change of purpose as well as trying to restructure companies to deliver those purposes more efficiently. The importance of purpose, ownership, and trusteeship then emerges in terms of the long-term perspective on problem solving, of avoiding wealth transfers, and protection of interests of societal and environmental concerns, as well as those of shareholder concerns.

To conclude, I have emphasized the diverse forms of ownership around the world, that the dominance of block holders even in the largest listed companies is a feature of stock markets around the world, and that block holders are often in the form of families. One should not regard dispersed shareholders as owners. Ownership of purpose involves an accountability not just to outside shareholders, but to the parties involved in the delivery of the purpose, and by so doing, one retains a focus on the long-term as well as short-term benefits that can be derived, and avoidance of wealth transfers. Together, with activism that promotes a stronger emphasis on efficiency and performance, one can combine the benefits in terms of delivering purposes of profitably solving problems.

Is Shareholder Activism Good for Shareholders and Companies?

Julian FRANKS:
I think activism has gone mainstream, but the majority is outside the U.S. In every 2021 activist shareholder campaign in the U.S., the activist was trying to nominate new directors to the board of directors. Those directors sometimes come from the activists, and sometimes are nominated by the activists and are more independent directors. in contrast, here are some examples of non-U.S. engagements in Europe, the UK, France, Italy, etc., with not a single case in which the activist nominated a director of the board. However, we know that there are cases where they have done so.

The smaller activists target the smaller listed companies. They target bad companies with bad governance, and where there are founders or insider block holders. Of course, the larger activists will target the much larger listed companies, where the shares have much more liquid market. They will try and target underperforming companies and will try to execute a change in strategy, a demerger, distributing excess cash, and possibly going private.

Activists fully research their targets, have a high level of due diligence, and talk to many stakeholders. I have noticed changes in activism. I notice a more collaborative attitude among activists, including large activists with reputations for being aggressive. Also, there is an emphasis on collaboration and quieter activism.

Of the 1,700 engagements of my study, the stock market reacted by increasing the price of the targets by around a cumulative excess return of 6%. In Asia, North American, and Europe, the stock market response to the announcement of a stake-buying activist is similar. On the whole, the stock market welcomes stakes amassed by activists.

What are the outcomes from the engagement with the activist, and the company that they have a stake in? How does the market respond to these outcomes? Looking at all the outcomes, there is an abnormal return in Asia of around 4%. Where there is a disclosure of a stake, the share price goes up by 5%. Where there is an outcome, on average, the share price goes up by 4%. Where there is an outcome, there is an excess return. The crucial question is how successful the activists are in gaining outcomes. In the case of our study of Japan, the success rate was low.

Are things changing? There is a famous Italian writer, Lampedusa, who wrote The Leopard, and he said, "For things to remain the same, everything must change." This notion can be applied to Japan. For example, CVC, a UK private equity house, has made a bid for Toshiba to take it private. It will be interesting whether shareholders support such a bid, and perhaps even more important is whether the Japanese Government allows such a bid to be executed.

GO is a company in Japan and the name stands for "Governance for Owners," which is unusual. It engages in quiet activism. It assures the target company, the company it engages with, that it will not go public even if their offers are rejected. There are no cases in which the media picks up on this engagement. This is not like quiet activism with a public activist, where the public activist might engage quietly, and in the end, go public if the company in question does not agree and collaborate.

GO Japan is not really a fund. It acts for other institutional shareholders in Europe, and I believe in one case in Japan itself. It engages in board structure, often in the independence of the board, more efficient use of cash and payout, and changes in strategy, such as the sale of unprofitable businesses, new investment, and M&A.

Regarding public activism in Japan, the success rate is about 33%, a little more than half of that of the quiet activism. There are 10 cases in our sample of public activism where the company engaged with what we refer to as the target, and it is actually put into play and acquired or taken private. Public activism is significantly less successful than private activism.

When looking at the outcomes of the companies that GO engages with, and measuring the stock market response to those outcomes, on average, returns are in excess of 4%, and perhaps 6-7%. When I compare the response to outcomes of GO with public activism, GO has smaller excess returns than public activism, and a large part of that has to do with their agenda. They are less profitable than public activism, but their success rate in engagement is much higher.

Activism has been accused of myopic behavior. If there is myopia, it is in the public capital markets. In addition, there are spillover effects from activism. Clearly competitors suffer losses, but also, other companies who are potential targets for activists seem to improve their efficiency. They also improve their stock market performance. As a result, they are not eventually targeted by the activist.

Before an activist comes on board, try and ask yourself "What would be the agenda of an activist?" Investigate whether their agenda items are helpful or not and whether there are any interests from shareholders and stakeholders. If they are not, explain to your shareholders why these strategies are not good for them and are not good for your stakeholders.

Shareholder activism has gone mainstream. Where there are outcomes, they seem to improve shareholder returns. Achieving outcomes is essential to activism. To some extent, activism is a substitute for hostile takeovers. Why have a takeover simply to change the strategy of a company? It is much better to have activist engagement. A hostile takeover is ugly, expensive, and it takes that listed company away from the public capital markets. Activism, to some extent, is replacing part of the market for corporate control.

Shareholder activism is expensive. It is not possible to multiply it 20 times across the capital markets. An important question is how do active asset managers, and indeed index managers, become more active owners? How do they engage more constructively with companies? Many fund managers, owning small stakes in 1,000 companies, engage very little. We have to have more active and more responsible ownership, and the question is how do we get to that point?


Friederike HELFER:
The label "activist" really covers many different strategies. One dimension is the different time horizon. On the one end of the spectrum, there is very short-term activism, where players often use derivatives, shorting and leverage to boost short term returns. On the other end activists like Cevian have long holding periods of up to 10 years, backed by long-term commitments by our investors. As we also don't short nor leverage, we can credibly say that our incentives are completely aligned with those of other long-term owners. So in many instances, we are exactly playing the role of an anchor shareholder in an otherwise fragmented ownership base.

One tangible example of this long-term orientation is Cevian's public demand that all our portfolio companies introduce tangible ESG targets into executive compensation plans. Customer interests are changing, if you do not offer green and sustainable products, you will actually grow less and be less profitable than those that do. Financial targets will not incentivize the necessary changes that are needed right now.

Another dimension that has also been addressed is how public or hostile activism is. Cevian is on the more constructive end of the spectrum when it comes to activism. We have made the experience that a constructive dialogue behind the scenes is often more effective. On the other hand, we see it as our responsibility to step up the engagement if necessary, as hearing different views, even if they are inconvenient for the moment, is beneficial for the success of the company in the long term.

I would also like to share some practical experience we had with alternative forms of ownership (foundations, employee board representatives, voting right limitations). Although there are many successful examples, for this discussion, it is more interesting to focus on examples that have not produced the desired results. For example, Thyssen Krupp has always had a foundation as a large anchor shareholder, and it has extensive employee participation. Unfortunately, Thyssen Krupp also has a dismal track record, and has been producing negative cash flows and underperforming peers for at least the past decade. Also, it has been extremely difficult and resistant to change.

Another example is the Swiss logistics company Panalpina. Panalpina had a foundation as a dominant shareholder, and it even had a voting right limitation preventing any other shareholder from building up an equivalent power, so that was an effective takeover defense. However, it underperformed peers and was unable to change course for more than a decade.

What has gone wrong in those cases? In my experience, employee board representatives have one major goal, namely to protect the existing German work force. That is a much too narrow focus. They are only concerned about the German workforce and for many global corporations, the majority of the workforce is not located in Germany anymore. Also, this goal is not fully consistent with an overall purpose of a corporation, which creates conflicts.

So, my question to Professor MAYER is how can one ensure that all stakeholders in the board act as true owners of the corporations rather than as pure agents, and who is holding them accountable to that?

If we turn to large foundations as anchor shareholders, they are only as good as the people running them. In foundations, especially those where the original founder family is not present anymore, you often have a self-governing, self-selecting committee. They may grow too close to the executives running the company, or be too remote to provide effective oversight on the company they control. The effect is that necessary change in a company is not happening. Some outside checks and balances are healthy for the long-term success of a company, and an activist can fulfill exactly that role.

NAKAGAMI Yasunori:
People tend to stereotype what activism is. In fact, there are so many different types of activists. Misaki has a constructive activist model. We invest in only 10 to 15 companies, and our asset owners are long-term investors like endowments, pensions, foundations and so on. Our investment horizon is probably longer than other activists, and the reason why we can invest in the long term is because we have long-term asset owners.

Today, I would like to discuss Purpose of Activism. Professor Mayer said "Company is a body which solves social problem in a commercial way", and I would talk along with this notion.

We first noticed that there is a big social problem in Japan. More than 60% of listed companies in Japan are value destroyers—not exceeding 8% ROE, regarded as the cost of equity. Another social problem in Japan is that the capital efficiency is so low, but at least kept flat, at the expense of the share of income for labor. Another graph shows real wage growth has been flat where other countries' real wages has grown substantially. Shareholders are not making money compared to other countries, either. The fundamental reason why capital efficiency is so low is explained by breaking down ROE into 3 factors such as asset turn-over, financial leverage and profit margin. However, neither asset turnover nor financial leverage are the main cause. It was profit margin which is about half of the U.S. or Europe, which dragged down ROE for the Japanese companies.

Misaki's understandings of social problem is that people surrounding Japanese companies, not only employees but also shareholders, are all getting poorer. This is what we would like to address as our Purpose. Then, a commercial way to solve this problem is to incorporate constructive investors' thoughts and techniques into the company's management. That will lead the improvement of capital efficiency and more precisely of profit margin. To that end, we work with management to change their mindset, to get involved in risk-taking decision making, and to implement employee equity ownership. In this way, employees can have sense of managerial ownership and get rewarded as a result of their effort. The aim is to encourage three of us, "management", "employees" and "investor" work together to improve the company. I believe this may be the way Misaki is able to solve the social problem in a commercial way.

Colin MAYER:
Activism of the right sort is a very important contribution to achieving what I am putting forward as being the purpose of a business; to solve problems profitably, and not to profit from producing problems. The types of engagement that we heard from both Ms. HELFER and Mr. NAKAGAMI is that the involvement of long-term activist funds that are focused on improving efficiency and performance creates real benefits and overcomes the detriments associated with failing long-term owners. That is exactly the message that I have been trying to convey. It is a mixture of the combination of long-term perspectives and the ability to increase efficiency where long-term owners are failing that is required to deliver that notion of producing profitable solutions.

The cases that Ms. HELFER mentioned about failing large block holders are right that there are many cases of companies which have stable owners that have been a serious impediment. There are also examples of where those large, long-term block holders have been the source of tremendous success on a broad scale. The recipe that is being put forward is that neither the extreme of having dispersed shareholders, nor long-term shareholders without any form of engagement by outside shareholders appear to be the right way. However, a combination of long-term shareholders, where the long-term shareholders and the employees are focused on the purpose of the business, and contributing towards the successful delivery of that purpose, and not there simply to represent their particular vested interest, seems to be effective. Those combined with the potential of outside interventions necessary to create long-term restructuring of businesses are the most productive ones in terms of their contribution to society and their contribution to their shareholders.

Julian FRANKS:
We have seen in the UK and the U.S., the more than halving of the number of listed companies on our stock markets. They have been taken private or they have merged. We have seen the partial eclipse of the public listed corporation. Activism is an alternative to private equity. We do need more active and responsible owners and activism has a very important role to play. The conclusion is that where activists gain outcomes, the long-term alpha is positive. Where they do not get outcomes, there is no alpha. So, activism has a role to play in more active ownership.