Who Stephen Davis, associate director of the Harvard Law School Programs on Corporate Governance and Institutional Investors and a senior fellow at the Program on Corporate Governance. Davis is also a nonresident senior fellow in governance at the Brookings Institution and, from 2007 to 2012, was executive director of the Yale School of Management’s Millstein Center for Corporate Governance and Performance.
Involvement Davis is privy to many emerging under-the-radar governance trends. And lately, he’s spotted another—increased cooperation between mainstream funds and activist investors. In this realm, his observations on shareholder behaviour and strategy provide important intelligence for directors, senior managers, company and proxy advisers and others with a stake in governance power dynamics.
Listed Recently you’ve noted the emergence of something you call investor-to-investor engagement, or i2i. What’s it mean? Why is it important?
Stephen Davis Within the last couple of years there’s been a focus in the marketplace on engagement between boards and investors. That makes sense and there’s been a lot of constructive progress on that, very constructive progress. But what struck me is that [while] boards need to listen to investors with large enough stakes to matter, in many cases activist institutions, or activist funds, hold a relatively small percentage of shares, in some cases a pretty trivial percentage of shares, and the company may be very large. So the question is why would a company, why would a board, need to devote time to engage with smaller holders or owners? And the answer really lies in the fact that the activists, in particular, make headway by leveraging support with other investors. And the only way they do that is through a trust relationship with those other investors. So alongside and linked to the engagement between boards and investors, really, is engagement between investors themselves, which sort of led me to coin this term ‘i2i,’ investor-to-investor engagement.
And we see now a greater instance of mainstream investors, such as mutual funds, setting out guidance for themselves, and guidance showing under what circumstances and what conditions they would liaise with activists.
Listed Activists have always needed to make a compelling case to win over other shareholders in a vote. So what’s changed?
Stephen Davis What’s different is not so much that the activists have changed, but that the mutual funds, and so the mainstream investors, have changed. We’ve seen, really in the last couple of years, the staff numbers, the governance professionals at mutual funds have grown in number and capacity and also in the flexibility they have to deal with activist funds. And that’s a big difference. Whereas in the past mutual funds really wouldn’t have had much to do with activists, now they are seeing that in certain circumstances activists can prompt value and allow those funds to not have to worry about exiting or playing an activist role themselves in order to tackle risks at troubled companies.
It means that activists don’t actually have to have as large a stake as they once did at target companies, but what they do need to do is develop trust relationships with these mainstream funds, and be able to put their cases in a way that speaks the language of mainstream funds and seeks to align with the objectives of mainstream funds.
Listed What are the implications for companies, for boards?
Stephen Davis For boards it means when an activist comes on the register, even with a small percentage, they can no longer be brushed off. The size of the stake is not a critical metric, in other words, when assessing the risk posed by an activist. What’s more important is to understand whether the activist is someone who has the capacity to draw in a larger group of investors. So, you’d need to know and assess the track record of this activist fund, whether it’s got good relations with mainstream institutions, the quality of its analysis and its track record.
Listed How do you see this evolving from here?
Stephen Davis As activism has proven itself as a value creator, at least for some prominent funds, there are lots of funds that are rushing into this space, trying to become activists. And as that universe expands the qual- ity level is much more variable. You’ve got some activists who are very, very skilled professionals. And others that are looking for a quick buck. So mainstream funds have to spend a lot more time trying to sort the wheat from the chaff, to figure out who they really should be listening to.
Listed So it’s a further wrinkle for boards, even as many are still struggling with board-to-investor dialogue?
Stephen Davis One of the things that is attached to this is that boards are going to have to develop more intelligence resources on investors. They’re going to have to understand more about who they are, what their capacities are, who’s aligned with whom, and what their key issues are. So what they’re going to need to do really is do R&D on their investor base just as they do R&D on the products that they may produce.