Activist shareholder

The power of the 'passive-aggressive' shareholder

October 4, 2012: 5:00 AM ET

There's a case to be made that activist investors are great for both the shareholders and managers at companies they partially own but aren't trying to take down.

Bill Ackman, CEO of Pershing Square Capital Management

FORTUNE -- No CEO wants to stare down the barrel of an activist investor's proverbial gun. Unfortunately for execs, it's open hunting season for many a struggling company."It seems like in the last five-to-ten years that this is happening a lot more," says David Mayer, a management professor at the University of Michigan's Ross School of Business. "It does feel like it's gone a little overboard."

Activist investors are a breed of shareholder who purchase a chunk of a company's stock with the intention of forcing changes that will, ideally, make that stock more valuable. Those changes can include anything from shaking up a company's management to waging an all-out proxy fight. These battles might get ugly, but activist investors do serve a purpose in that they can boost the value of a company's stock. But, it turns out, known activist investors could be most useful to companies for which they are shareholders, albeit in a passive mode.

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Companies often get caught in an activist investors' crosshairs after they fail to give shareholders a satisfactory return on their investments. Most recently, activist investor William Ackman put pressure on Procter & Gamble (PG) to oust its CEO, Robert McDonald. (As of Tuesday, Ackman also started to push a mall-operator he partially owns called General Growth Properties to sell itself.) For now, the P&G board has backed McDonald, and his job looks safe.

Other companies have recently felt the heat from increased activist investor activity. Yahoo (YHOO), J.C. Penney (JCP) and Home Depot (HD) have all morphed under the watch of Daniel Loeb, William Ackman, Ralph Whitworth, and David Batchelder, respectively. All of those men bought shares in those companies, agitated for change, and got it. One of messiest recent scenarios came when Loeb brought upon the dismissal of Yahoo's former CEO Scott Thompson by sniffing out a flaw in the then-CEO's resume.

These companies fit a profile: loosely, they are struggling but still have assets that they can use to generate some value for shareholders.

But activists can actually help companies without all the fireworks. Enter the so-called "passive-activist" shareholder. Activist investors tend to have passive stakes in many other companies, which they generally hold for a long time, according to a study completed by Jonathan Cohn, an assistant professor of finance and his colleagues at the University of Texas at Austin. "If you look at cases where there is an actual activism campaign, typically they've only held the shares for a short period of time," Cohn says.

But for the companies they own for longer, "The potential to become activist in those companies sends some sort of possible signal to shareholders that they are monitored," he adds. In other words, pouncing on some companies but keeping passive stakes in most could keep the latter in check. "Most academic researchers sort of buy into this idea that having shareholders in place who are willing to expend resources to keep an eye on management is good for shareholders," Cohn says. There's a case to be made that activist investors are a positive force for the shareholders and execs at companies they partially own but aren't trying to take down.

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Certainly, some companies facilitate quiet, functional discussions between CEOs and shareholders. But, Mayer says, "That's not the sort of sexy stuff that's going to get in the news," which can make good CEO-shareholder relationships difficult for academics to study.

Cohn adds, "If there was some way to get access to the relevant data to do it, I would be first in line."

The best way to keep activist investors at bay is to keep the company from becoming a likely target in the first place. An activist is less likely to win the support of other shareholders if they're already pleased, or they understand any short-term dips in the context of a larger, sustainable strategy, says Cohn: "There has got to be the combo of having established that culture where other shareholders are given weight in company decisions, but also have the performance to keep the wolves at bay."

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