Could Social Media Give Small Investors Greater Say in Corporate Governance?

In a new paper, we ask whether social media could have a role in corporate governance. Prior to the advent of social media, a small shareholder faced prohibitive costs to reach other investors. For example, she would have had to obtain the shareholder lists, which the firm might have only reluctantly made available, and to pay for printing, postage and more, if a proxy solicitation firm were hired. These costs and the prospect that others would simply free ride on these efforts effectively discouraged small shareholders from playing any meaningful role in corporate governance.

The rise of social media, in particular, the internet stock message board, makes it possible for tens of thousands of investors who are interested in the same stock to voice their opinions and exchange information at almost zero marginal cost. Importantly, stock message board users come from diverse backgrounds, allowing them to tap into the wisdom of crowds, and include many non-experts with opinions that professionals may not have.  The non-experts may also have valuable perspectives as  employees of the company whose stock is being followed or as friends or neighbors of its  employees, suppliers, customers, competitors, or advisers, or, if the company is the target of an acquisition, of the acquiring company. For instance, it is possible that a user posting on social media has unique knowledge of the various connections and networks among individuals involved in a potential merger. This knowledge better allows the user to understand whether a potential transaction will harm the interests of small investors.

Thus, the unique knowledge of some stock message board users means their postings may contain incremental information not available from the other, more traditional information sources. This unique knowledge conveyed by social media is meaningful in light of corporate governance and investor protection concerns, given that timely, valuable, and -relevant information is critical for small investors to make the right investment decisions and protect their own interests.

Social media also makes it possible for small shareholders to have their voice heard by managers and regulators.  Although management can toss letters written to them by shareholders, they cannot erase or easily ignore messages posted on the firm’s public message board. Executives are aware that strongly negative comments and personal attacks may adversely affect their reputations and that regulators may regularly track these message boards for potential issues to be raised with the management. Under these pressures, managers of listed firms, in turn, may have to pay close attention to the information disseminated on stock message boards. These effects, taken together, enable small shareholders to have a more meaningful role in governance.

In our paper, we focus on the impact of small shareholders through social media on a specific type of corporate decision: whether to pursue mergers and acquisitions. A proposed acquisition often has significant impact on firm value and thus is more likely to attract intensive scrutiny from small shareholders. We examine whether social media criticisms posted by small investors can predict subsequent acquisition decisions.

An ideal test for the proposition that social media has a role in corporate governance requires two conditions. First, sample firms would be in a country where governance is generally poor, and in particular, the protection of small shareholders’ interests is weak. Small shareholders thus could not rely on other means such as legal remedies and external market disciplines to protect their interests. Second, the internet would have high penetration in the country; there are stock message boards for most stocks in which small shareholders can frequently communicate among themselves. China is a natural choice as it not only satisfies these criteria, but it also has a large enough sample of listed firms with merger announcements to enable more formal statistical analysis.

China has been known to have severe agency problems of large shareholders and management exploiting small shareholders. Small shareholders in China have few means of redress against insider misconduct. Moreover, small investors in China have limited or no ability to voice their grievances on traditional media such as newspapers, radio, and television. Major traditional media are owned by the central or local governments, which impose restrictions on media content and access. On the other hand, internet stock message boards and financial websites in China, usually under private (non-government) ownership, face fewer restrictions on apolitical communications among investors. Importantly, China does not have social media platforms like Twitter and Seeking Alpha, which makes the stock message board in China a unique venue for investors to share stock investment information. Because of its private ownership and unique status, the stock message board in China attracts a large number of anonymous messages containing investors’ analyses of different financial securities. These features facilitate the gathering of the wisdom of crowds. As a result, social media criticisms about an acquisition proposal may provide incremental information about the underlying value of the proposal.

We identify 303 large value-reducing acquisitions announced by Chinese-listed firms between 2010 and 2014, i.e., those that elicit negative stock market reaction at announcement. Among these proposals, 262 are completed and 41 are withdrawn. For these acquisition proposals, we identify 13,496 acquisition-related comments from the EastMoney stock message board. This site comprises the majority of internet stock message board users in China.

We read each comment for content and construct the variables to describe its analytical depth and tone. We also hand-collect each comment’s footprints: the number of clicks (viewers), the number of responses, and the number of responses agreeing with the comments. Our efforts are comprehensive; we try to capture both the quantitative and qualitative aspects of the comments posted on the stock bulletin board for each announced merger attempt in the period studied.

We find that the more comments opposing a proposed acquisition during the 10 calendar days following the proposal’s announcement, the more likely that management will withdraw from the proposed acquisition. This result holds after we control for the information content of the stock market reaction to the acquisition proposal, the presence of other information intermediaries (conventional media coverage of the proposal, analyst reactions, and institutional ownership), and the characteristics of the deal, acquirer, and. These results indicate that social media criticisms contain incremental information that helps predict the outcome of a proposed acquisition

Our empirical results show that negative messages are most predictive of deal results when they provide useful information concerning the viability of a proposed acquisition, are spread widely, have an intense tone reflecting strong opinions, and attract agreement from the other small shareholders.

Finally, we conduct a series of tests that are related to outcomes other than that of the acquisition: (i) whether a higher proportion of message board criticisms of an acquisition attempt is associated with a higher voting disapproval rate of a proposed acquisition at the shareholders’ meeting; (ii) whether the intensity of social media criticism on the proposed acquisition is associated with greater announcement returns around the time when the acquisition attempt is withdrawn; (iii) whether the withdrawal decision leads to an improvement in firm performance; and (iv) whether shareholder criticisms are related to a reduction in the final deal price among our subsample of completed deals.

Earlier studies demonstrate the governance role of conventional media. Our paper provides a new direction by focusing on the ability of social media to provide incremental information that has predictive value for corporate governance outcomes.

This post comes to us from professors James Ang at Florida State University, Charles Hsu at Hong Kong University of Science and Technology, Di Tang at Shanghai University of Finance and Economics, and Chaopeng Wu at Xiamen University. It is based on their recent paper, “The Role of Social Media in Corporate Governance,” available here.

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