Shareholder activism has increased significantly in the last few years, particularly after the financial crisis of 2008. However, it has since then been a debatable topic, as it is difficult to quantify “appropriate” level of shareholder engagement, which is desirable for achieving effective governance, while adding to business value. Quite often there is an apprehension that excessive shareholder intervention may consume a lot of valuable management time and result in short term profit orientation.
A business needs capital to finance its growth Shareholders are the providers of capital to a business and as such are part owners of the business. Shareholders invest in the business hoping for a higher potential return from the investment while accepting a greater potential risk than other providers of capital. As shareholders own a share of the organization in which they have invested, this entitles them to ownership rights (i.e. rights to profits and assets in proportion to their shareholding) and in most cases control rights (i.e. rights to have a say in the running of that company, e.g. they may vote on key issues).
Management makes use of the capital to run the business and has an obligation to do so in a fair and transparent manner while maximizing value for the shareholders. However in practice management may take actions that benefit themselves, at the cost of the dispersed shareholders, who are not involved in the day to day operations of the company.
The board of directors oversees management to ensure that it is allocating capital appropriately. As a result, the board has a responsibility towards all the shareholders of the company to represent, manage and protect their interests in the company.
Shareholders engage with company management and boards to ensure that their interests in the company are protected. If shareholders are not satisfied with the performance of the directors, they may remove the directors or refuse to re-elect them.
All shareholders are not alike. Shareholders can be either private individuals or large corporations such as mutual funds, hedge funds, bank trust departments, insurance companies or private equity funds.Due to the differences in their portfolio types, investment objectives, nature of information available to them and their ability to influence the management, different types of shareholders have different priorities and motivations for engagement with companies. Where promoters are the dominant shareholders in the company, they have substantial power and control over the enterprise. Minority shareholders being dispersed, generally lack the resources required for coordination and active engagement with the companies. In contrast, the institutional investors are often in a position to exercise considerable influence in corporate decisions.
Widespread flaws in corporate governance were revealed after the financial crisis of 2008, which lead to a significant increase in shareholder activism in most countries. Though there is no empirical evidence about impact of shareholder engagement / activism on long term performance of companies but it is believed that effective shareholder engagement does help in strengthening corporate governance practices within companies. Board-shareholder engagement gives companies a better sense of shareholder concerns and allows them to gauge shareholder interest on significant proposals. Reliable information from companies, transparent disclosure policies and insight into management’s priorities, allow investors to balance risks and to allocate their capital accordingly. In turn, better governance practices augment the companies’ ability to attract risk capital from domestic and foreign investors for funding new or expansion projects. So overall we tend to believe that effective shareholder engagement is good for companies.
In the next article we will discuss the scope for shareholder engagement and different approaches to shareholder engagement.