"Activism" is a word with positive connotations. Generally speaking, we as humans prefer (or should prefer) to be active rather than inactive. Activism has become synonymous with change, which most people associate with a change for the better. But are activist investors good or bad? Are they agents of positive change, or just a rebranded version of the notorious corporate raiders of the 1980s? The answer is: it depends.
What is activist investing?
First, let’s briefly define activist investing. Activist investors are people or groups who invest in a company with the express intention of forcing a change in the way the business is run.
Companies are owned by shareholders, and run by managers. Sometimes, these two categories overlap - the founder of a company will often be both the majority shareholder and the head executive. In many cases - particularly in older companies where the original founder is long gone - external managers are hired to run the company in the interests of shareholders.
Naturally, this can create a conflict of interest - managers may want to extract value from the company for their own personal gain, for example, by paying themselves higher salaries and a passive board of directors may rubberstamp their proposals. Activist investors often target companies where they perceive there is a need for change. Of course, these people very rarely work pro bono - they will generally want to profit from this activity through an increase in the company's share price.
Good or bad?
So far, so good. Who could argue with the benefits of higher share prices? When activists come in to trim excess costs, optimize performance and reorganize failing processes, then their actions can indeed be beneficial for both the company and its shareholders, which can cause the share price to rise.
A problem arises, however, when the activists are interested only in short-term gains and pursue actions that harm the long-term health of the company. An example of such activity would be if an activist took control of a pharmaceutical company and slashed the research and development budget. This would certainly drive earnings higher, but it would also mean financial ruin for the company in the long run. If this seems like an extreme hypothetical, consider the example of activist investor Nelson Peltz, whose Trian Fund campaigned heavily to gut DuPont’s research and development budget.
At their core, activist investors are interested in returning cash to shareholders (which of course includes them). However, capital should only be returned to shareholders when it cannot be redeployed efficiently within the business. This is why Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) does not pay a dividend - the money is reinvested in the business’ subsidiaries.
So is activism good or bad? It depends on the investors' time frames - generally, if they plan on holding the stock for a significant period of time, the changes they push for are probably good. If not, then it is unlikely that the changes implemented will be of benefit to long-term shareholders.
Disclosure: The author owns no stocks mentioned.
Read more here:
- ”‹What Negative Interest Rates Might Mean for Investors
- The Value Investor’s Handbook: Improving Your Process
- Warren Buffett: Reading Will Make You a Better Investor
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