Activist Board Members Increase Firm’s Market Value

Board members nominated by activist investors presumably have one primary goal: change the status quo. Does that agenda create or diminish value of the firm in the eyes of shareholders? New evidence offered by Harvard Business School professors Bo Becker, Daniel B. Bergstresser, and Guhan Subramanian suggests financial markets value a new approach. Key concepts include:
  • Firms that would have been most affected by the Federally-proposed shareholder proxy access rule, based on institutional ownership, lost share price value on October 4, 2010. This finding suggests that financial markets place positive value on shareholders' access to the company's proxy statement.
  • The loss in value was greatest at firms at which activist investors such as hedge fund managers, held significant stakes.
by Carmen Nobel

Public company shareholders have long complained that corporate boards don't always act in the best interest of their investors. But does the addition of a shareholder-sponsored board member increase the market value of the firm?

The answer is important because it could support or thwart the US government's regulatory efforts to increase shareholder power at the board level following the recent financial crisis.

To help answer that question, three Harvard Business School professors performed a natural experiment made possible by changes to federal proxy rules, which began last summer.

“Allowing owners to have more power and influence in corporate board elections seems to be valuable.”

In August 2010, the US Securities and Exchange Commission passed Rule 14a-11, also known as the shareholder proxy access rule, which would allow large investors to nominate board members in the company's proxy materials, forgoing the traditional time-consuming and expensive election process that was rarely successful. In short, the rule would make it much easier for dissident shareholders to nominate and put in place new directors.

The shareholder proxy access rule limited which owners could nominate directors. In order to qualify, shareholders had to have owned at least 3 percent of a firm's shares for at least the prior three years. Still, the announcement drew ire from some business groups, including the US Chamber of Commerce and the Business Roundtable.

They argued that the rule might shift too much power to unions and special interest groups, and that highly experienced directors might not want to serve on a board if they had to work alongside shareholder-sponsored candidates. In addition, shareholders would be penalized by a decrease in the company's market value.

In September, the two organizations jointly filed a lawsuit against the SEC, arguing that the rule violated the Administrative Procedure Act and that the SEC failed to properly assess the rule's effects on "efficiency, competition and capital formation" as required by law.

The complaint did not come as a surprise to industry observers, but the SEC's reaction did. On October 4, the SEC unexpectedly announced that it was indefinitely postponing the implementation of shareholder proxy access, pending the outcome of the lawsuit.

A Natural Experiment

The delay was just what the HBS professors needed to conduct an impromptu experiment. They hypothesized that the market reaction to the SEC announcement could help determine whether increasing shareholder power would be considered good or bad in the eyes of the stock market. They detail their research in a new paper: Does Shareholder Proxy Access Improve Firm Value? Evidence from the Business Roundtable Challenge.

"The delay was a big surprise," says Bo Becker, who coauthored the paper with colleagues Daniel B. Bergstresser and Guhan Subramanian. "Nobody thought the case had much merit. But all of a sudden you sort of pulled the rug out from under any owners planning to use this rule as a tool. It was a unique situation for [research] because it was unpredicted and legally important for a subset of firms with large activist owners who might take advantage of a proxy access rule."

The professors compared stock market returns for different firms on October 4, the day the SEC announced the delay.

In particular, they compared the return for companies where investors known for being activists held large stakes. ("Activist investors" is used here to refer to hedge funds with a history of trying to change company behavior.) Presumably, these were the shareholders who would have been most likely to nominate new board members if the SEC hadn't delayed the rule.

"The Business Roundtable could be right that some shareholders have ideas that destroy firm value," Becker says. "But it is also possible that some activist hedge funds go through the trouble of taking concentrated risk for an extended time only when they believe they have good ideas for improving the firm's performance. If this is true, and if they are sometimes right, taking the proxy access rule out of their toolbox is going to reduce firm value."

The latter possibility appears more consistent with stock market evidence. The overall market fell on October 4. More importantly, the news had an especially negative effect on companies that would have been most heavily affected by the proxy access rule because they had activist investors. The stocks of those companies fell the most.

"We find that share prices of companies that would have been most exposed to shareholder access declined significantly compared to share prices of companies that would have been most insulated from the rule," the professors write in their report.

Firms in which historically activist institutions held significant ownership stakes lost considerable value on the announcement: a drop in 55 basis points for a 10 percentage point change in activist institution ownership.

"The biggest conclusion we draw from this is that allowing owners to have more power and influence with corporate decision-making, on balance, seems to be valuable in the eyes of the stock market," Becker says. "And this particular rule or some similar rule seems like it might be one way to do it."

Most people who study corporate governance and large firms, both inside and outside academia, would say that it's plausible that there are at least a few firms in the S&P 1500 where shareholders might have some useful ideas, Becker says. "This is not to say that firms in general are mismanaged, but that there are some firms out there where owners could have a positive influence."

The research could prove to be a helpful tool for the SEC.

"The best argument that the Business Roundtable raised in its criticism of the SEC rule was that the SEC did not have a careful analysis showing that the rule would be helpful, which it is required to do," Becker explains. "The SEC needs to justify its rules. So, potentially, the SEC could look at our paper to support the idea that this type of rule might be useful."

About the Author

Carmen Nobel is the senior editor of Harvard Business School Working Knowledge.

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    • Kapil Kumar Sopory
    • Company Secretary, SMEC(India) Private Limited
    The answer to the query whether actvist board members increase firm's market value is both yes as well as no for the outcome would depend on the intention with which the activist member joins the board. Is it indeed to positively watch and safeguard the interests of the shareholders - particularly the minority (shareholders) - or simply to raise criticism of board actions for the sake of criticism thereby creating disruption?
    Whoever joins a board should be well aware of his duties, responsibilities and liabilities and must possess requisite knowledge and experience of understaning matters through a standard common sense. In that case, an activist can also be a contributory factor to increasing firm's market value.
    What matters in the ultimate is how well a board delivers and not of whom it is composed.
    • Thorsten Claus
    • T-Venture of America, Inc.
    @Kapil, you are spot on that "What matters in the ultimate is how well a board delivers and not of whom it is composed." I have not read the paper, but the above abstract suggests that the stock market (as an abstract body of opinions) seems to value the influence of owners more than the influence of founders or CEOs (or pre-assigned internal and external directors, for that matter).

    I could imagine that the stock market assumes that investors would ultimately only take large risks and invest large amounts if they know the markets, the industry, the ecosystem, the value chains, the players - and can hence also decide well informed what sort of director would be needed, or what skill set or professional network and access the current board lacks.

    But that's of course only a guess on my side - it would be interesting for me to see the motivation, not just the effect of this experiment.

    In (my) VC world, startups don't take the money for the money's sake, but heavily probe and rely on a VC's network, expertise, and know-how (not knowledge!). Maybe the stock market surprises me and for once works the same way :)
    • Miss.Kanika patel
    • CEO, India Advisory Stock Research
    it seems to me that you are the Gurus of technical analysis and you have fans from all over the world. Last but not least thankyou very much for Indian market analysis. Today also happen another bull trap as per daily chart.I think as per daily chart there is lot of profit taking of short seller are finished and i think that it is very dificult for bears to get further down this market for new low. But still i believe that as per weekly chart we are still in clear 3rd wave.
    India Advisory Stock Research