Robert Nardelli

Yahoo and the rise of the activist investor

April 2, 2012: 10:46 AM ET

As activist shareholders -- at Yahoo and elsewhere -- gain prominence, corporate management ought to take notice now if they don't want to hand over the reins.

daniel_loeb

Daniel Loeb, founder and CEO of hedge fund Third Point LLC

FORTUNE -- Leadership at Yahoo has been a mess for a while. But one key element within the tangle of the tech giant's current troubles touches on a larger business trend: the rise of the activist shareholder.

In Yahoo's (YHOO) case, Daniel Loeb, founder and CEO of hedge fund Third Point LLC -- the company that owns a 5.8 % stake in Yahoo -- is threatening a proxy fight after Yahoo recently decided to keep him off the board. Yahoo appointed three new members, and it seems to be holding to its decision to turn the company around under the leadership of CEO Scott Thompson, appointed six months ago. Part of that plan will include laying off staff members, possibly thousands of them, starting this week.

Loeb could either convince the board to bend to his will or he can take his investment money and bail. But the role he's playing, that of activist investor, has grown more influential in the corporate world over the past decade, taking up a larger piece of the CEO-board-shareholder triumvirate.

"Since 2000, it seems that companies are really worried about hedge fund activism," says Yaniv Grinstein, an associate professor of finance at Cornell's Johnson School of Management. "They take it more seriously than they used to."

That's because activist shareholders generally make major changes at companies. In a paper published in 2009, NYU Stern School of Business professor April Klein looked at 151 activist hedge fund targets between 2003 and 2005. She found that out of those 151 targets, activist shareholders received a seat on the board about 44% of the time. Once there, she says, they "really did shake things up dramatically," pushing for new CEOs or major overhauls.

MORE: Facebook's patent headaches: More to come?

Surprisingly, Klein adds, these shareholders generally don't own a majority stake in the company, sometimes as little as 2%. "To me, that indicates that they were not the only people that felt that something could be changed," Klein says.

Yet the jury's still out about whether that power shift is ultimately good for companies. It certainly seems to benefit shareholders, Klein says, though not necessarily bondholders. After increased investment from activist shareholders, she says, "Companies were selling off assets and doing a lot of restructuring, so bondholders had less cash, fewer assets, and more debt." The evidence is inconclusive about whether, on the whole, activist shareholders who get on the board boost overall profit at companies.

The power struggle between management and activist investors can certainly grow ugly. "Most CEOs have pretty big egos, as do most of these activists investors," says James Shein, a management professor at Northwestern's Kellogg school of management. "I liken them to two sumo wrestlers trying to knock each other out of the ring." More

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