How Activist Investors Became Respectable

Once reviled as villains operating on the fringes of the market, activist investors like Carl Icahn are now powerful forces at work in the mainstream of business, says Professor Joseph Fuller. And their influence is only growing.
by Joseph Fuller

(Editor's Note. Carl Icahn is in the news again. On Monday, SEC filings revealed the militant investor has sold his entire stake in eBay, after successfully pushing the company to spin off its PayPal operation. Harvard Business School professor Joseph Fuller looks at the rise in respectability and influence that activist investors such as Icahn are gaining on Wall Street.)

Carl Icahn made news last month when he announced he had accumulated a large ownership stake in American International Group (AIG) and said he wanted the company split up. His letter making the case to management was posted online well before any regulatory filing disclosed his holdings in the company.

These tactics may have been designed for drama, but the investment strategy and its scale are nothing unusual today. Activist shareholders and the hedge funds they run are thinking and acting bigger than ever. They continue to raise huge new sums of money to invest, targeting some of the world’s largest and most prestigious companies.

“… Greenmailers of a generation ago are now taken seriously as hard-nosed change agents”

Beyond that, these activist investors pulled off a remarkable metamorphosis over the course of a generation. Once reviled as villains operating on the fringes of the market, they are now powerful forces at work in the mainstream of business.

Activist investing gained legitimacy and influence thanks in part to the development of a support system from professional services such a law firms, investment banks, and consultancies that once shunned the practice and from the increasing influence of proxy advisory firms. But it was the many institutional investors who eventually embraced activists in their search for better returns who gave these hedge funds their real clout.

No company off limits

The result has been explosive growth in the activist investing world. More than 500 activist hedge funds managed in excess of $140 billion at the end of June, an increase of 18 percent in just the first six months of this year. The largest single activist fund, Elliott International Ltd., oversees more than $16 billion. Compare these figures with data from 2003, when the entire asset class consisted of only a handful of funds managing about $12 billion.

Activist investors, once considered Wall Street outcasts,
are now respectable agents of change. ©iStock/Zerber

When it comes to targets, no company is off limits. Activists have recently pressed for action at Apple, GE, and DuPont. Campaigns against companies with market capitalizations of more than $25 billion nearly tripled last year.

The activist’s transformation to respectability has been equally dramatic. Just as the leveraged buyout raiders of the 1980s eventually morphed into the legitimate private equity business, greenmailers of a generation ago are now taken seriously as hard-nosed change agents who may be doing the right thing when they take on management by buying up big batches of stock. Icahn himself, once described as a vulture capitalist, now gets a serious hearing when he urges Apple to make better use of its billions in cash or Dell to improve the terms of a management buyout.

Today, university endowments and state pension funds invest with activists, corporate directors discuss how activists will view their strategy, and the business media even treat them as celebrities.

In many cases, activists have courted both investors and the public with an informative and insightful approach to individual investments. They engage in considerable due diligence and propose specific, accountable strategies to create value for shareholders. This month, for example, when Trian Partners, under the leadership of cofounder and CEO Nelson Peltz, wanted to tell investors why GE was an undervalued company, it posted an 81-page analysis online for everyone to read.

As for proxy firms, in the past, few of them dared to challenge the leadership of large companies, and ballot initiatives were rare. Today, firms like RiskMetrics and Glass Lewis evaluate everything from executive compensation to minutiae in corporate governance provisions. And as the public evaluation of public companies has become more widespread, the type of criticism activists levy seems less out of place. Glass Lewis and Institutional Shareholder Services (ISS) both backed Peltz’s campaign for a board seat at DuPont this year, for example.

Leveraging the growth of alternative asset classes

But none of that would matter much without the growing acceptance of alternative asset classes. In the heyday of greenmailers like T. Boone Pickens and Paul Bilzerian, the range of hedge funds available to institutional investors was limited. Now most of these investors are embracing a vast array of new vehicles. Activists have responded with a proliferation of strategies, from those aggressively demanding change at targeted companies to others that function more like conventional value investors searching for underpriced assets to buy.

Some traditional asset managers, such as T. Rowe Price, are going several steps further. They are not only adopting a more aggressive stance toward their own portfolio companies, but teaming up with activists. As a result, it was no surprise when T. Rowe Price supported Icahn’s opposition to the leveraged buyout of Dell.

Activist strategies have not always proved to be prudent. Their analysis can sometimes be thin and their conclusions questionable. But in an era of chronically slow economic growth, activists will find shareholders increasingly open to their overtures. Let the record show that they have evolved from slightly disreputable players on the margins of the system to a permanent force at its center.

Joseph Fuller is a professor of management practice in the General Management unit at Harvard Business School and co-leads The Entrepreneurial Manager course in the MBA program.

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