When activist investors acquire large stakes in a company and seek influence, they traditionally push for seats on the board of directors. In recent years, however, many activists have instead appointed a non-voting observer who can attend board meetings, receive confidential information, and engage with management, but who does not have voting rights or fiduciary duties. In a new paper, we examine whether board observers provide meaningful corporate oversight.
We start by analyzing Schedule 13D filings, which are required to be filed with the SEC when an investor acquires a large stake in a company and intends to influence its management or strategy. The filings often describe in detail what the activist plans to do, including whether it has negotiated a board seat, an observer position, or neither. This makes them a natural source for studying how markets and firms respond to different forms of activist engagement.
The securities markets generally view shareholder activism as beneficial. Prior research shows that when activists get involved, firms often streamline operations, cut waste, sell underperforming divisions, or adopt more shareholder-friendly strategies. When activists win seats on boards, they gain formal voting power and legal duties that allow them to shape corporate policy directly. If observers were an effective alternative to directors, markets should react to their appointment in much the same way they do when an activist investor gains a seat on the board.
However, the evidence is to the contrary. When a Schedule 13D filing announces that an activist has obtained the right to appoint a board observer, the target firm’s stock price falls relative to where it would be if no observer were named. Investors treat the appointment of an observer as bad news, even compared with ordinary activist involvement. This pattern is robust across different ways of measuring abnormal returns and after controlling for many other factors.
Why does a move that sounds like stronger oversight produce a negative reaction? One important reason centers on authority and incentives. Unlike directors, observers do not vote on major decisions, do not owe fiduciary duties to shareholders, and do not face the same legal exposure if things go wrong. Without those levers, they have less ability to push through hard changes or hold managers to account. Markets seem to read observer arrangements as a sign that the activist’s influence will be limited or that both sides settled for a weaker form of engagement.
To address the concern that activists might choose observers when they already expect a company to do poorly, the study uses a design aimed at isolating cause and effect. Specifically, the study exploits differences in litigation risk across regions. Activists based in areas with high levels of securities class action litigation face greater personal risk if they become full directors, since directors can be sued more easily than observers. Those activists are therefore more likely to settle for observer roles. However, the litigation environment where an activist is based has no direct connection to the specific firm being targeted, which makes it a useful source of variation.
Using this approach, the study shows that observer appointments still lead to negative abnormal returns even when they are driven by outside legal risk rather than by company characteristics. This result indicates that the market views an observer role itself as inferior to full board representation, not merely as a proxy for weaker firms.
Our analysis then turns to what happens after observers are appointed, and several patterns stand out. Firms with activist-appointed observers are less likely to be acquired later on, even though takeovers are often a primary way that activists create value, either by selling the company to a stronger owner or by encouraging strategic combinations. The lower takeover rate therefore suggests that observer arrangements do not promote these outcomes and may even hold them back.
These firms are also more likely to be liquidated or delisted, which points to weaker long-term prospects, and their accounting performance tells a similar story. Profitability, measured by return on assets, tends to decline in the years following an observer appointment. While this does not prove that observers directly cause poor results, it fits with the idea that these arrangements fail to deliver the operations improvements investors usually expect from activist involvement.
The study also considers whether observer roles simply reflect tense or stalled negotiations. A firm that resists giving up a board seat might offer an observer position as a compromise. The data show that negative reactions are indeed stronger when the activist has previously engaged in activist campaigns with the same firm. Even so, observer appointments by themselves continue to show worse market responses, which suggests that the skepticism goes beyond the tone of the relationship.
Overall, the empirical results suggest that board observers are not effective arrangements for meaningful shareholder activism. They provide limited oversight, weaker incentives, and less ability to influence major decisions. Markets appear to reflect this view, and the subsequent performance of these firms is broadly consistent with it.
This study adds an important dimension to the literature on shareholder activism. Prior work has focused on whether activists get involved and whether they win board seats. Our paper shows that the form of representation matters. Rather than exerting power inside the boardroom, a non-voting observer has limited influence and governance impact.
Choonsik Lee is an associate professor and Maniraj Muthyala is a PhD student in the College of Business at the University of Rhode Island. This post is based on their recent paper, “Boardroom Observers: White Knight or Trojan Horse?” available here.