Corporate governance mechanisms that mitigate problems associated with the separation of ownership and control include board monitoring of managers, compensation incentives, a market for corporate control, and government regulation. Recently, shareholder activism has become an increasingly popular tool as well. Typically, activism involves a hedge fund or other institutional investor with an arm’s-length relationship to a firm acquiring a concentrated stake in that firm and prodding management to make value-enhancing changes. In our study, we find that individual investors who are at the periphery of control, such as founders and former executives, also launch activist campaigns, a phenomenon we term as insider activism.
Because hedge fund activism has been widely discussed and shown to be effective, in our study we compare insider activism to hedge fund activism and note that insider activists differ from hedge fund activists in several key ways. First, as individual investors, insider activists are likely to face capital constraints that could prevent them from owning equity stakes that are as substantial as those held by hedge funds, particularly in larger firms. Second, insider activists are likely to have held, and to continue to hold, their stakes longer. Third, insider activists have more incentive to extract private benefits. Finally, as a result of their relationship with target firms, insiders are likely to possess private and potentially valuable information about their target firms, as well as firm- and industry-specific expertise and connections with other shareholders that differ from those possessed by other activists. These characteristics suggest that potential differences between insider activists and other activists in the objectives they pursue, the tactics they employ, the firms they target, and their rates of success.
We identify activist campaigns in FactSet’s SharkWatch corporate activism database that involve any individuals with existing or former employment ties to the target firm. We find that 8.3 percent of 2139 campaigns in our sample involve activists who are founders or former (and occasionally current) CEOs, chairs, presidents, directors, or other employees of the target firm. Many campaigns involve more than one insider.
We find insider activists are more likely to seek corporate control and hedge fund activists are more likely to pursue strategic or operational improvements. Perhaps as a result of their more ambitious goals, insider activists are more likely to use aggressive tactics such as proxy fights, litigation, and direct solicitation to other shareholders and to own larger stakes in their targets.
In addition, insider activists target a different type of firm than hedge fund activists do. Specifically, we find that insiders pursue smaller, more undervalued companies with lower recent financial performance, more R&D spending, and less institutional ownership. We trace each of these traits back to the differences between insiders and hedge funds highlighted above. For instance, insider activists’ capital constraints limit the size of target firms and the propensity for insiders to participate in activism except in extreme cases of underperformance. In addition, insiders’ firm- and industry-specific expertise is particularly advantageous in opaque firms, like those engaged in R&D.
An issue of interest is whether insider activists destroy or create value. On one hand, insider activists could be viewed with skepticism because they may have personal incentives to lead campaigns that do not align with other investors’ interests. On the other hand, insider activists could be viewed as being in a unique position to enhance value because of their firm- and industry-specific knowledge. While we find that insider activists are less likely to meet their stated objectives than hedge fund activists are, we find that, like hedge fund activists, insider activists are successful in improving firms’ operating performance, and their campaigns exhibit similarly positive announced returns. This suggests that insider activists create rather than destroy value.
Insider activism may be a more pervasive phenomenon than our study suggests. The insider activist campaigns that we observe are likely to have materialized only after less confrontational tactics were first attempted, which would indicate that out study provides an insight on the tip of a large iceberg. The main conclusions on insider activism that we can draw from our analysis are that insider activists target firms that are less likely to be targeted by hedge fund activists and that, like hedge fund activists, they are effective in bringing about improvements in firm value. In our view, this suggests that insider activism is a complement rather than a substitute for hedge-fund activism.
This post comes to us from professors Mitch Towner and Aazam Virani at the University of Arizona. It is based on their recent article, “Insider Activism,” available here.