(Photo by iStock/cagkansayin)
When an activist investor targets a publicly traded company, they typically demand to name a board member to represent shareholders’ interests. This step often leads to a rise in the stock price as the activist’s delegate pushes the company to focus on short-term financial gains. But what other effects might this action have?
A new study finds that it has implications for corporate social responsibility (CSR). A company with a new activist director tends to generate more stakeholder complaints about environmental, social, and governance (ESG) issues.
“Although appointing an activist director tends to improve firm value for shareholders, we uncover a hidden externality wherein it also yields increased reports of stakeholder harm,” write authors Brian L. Connelly, a professor of management and entrepreneurship at Auburn University’s Harbert College of Business; Mark DesJardine, an associate professor of business administration at Dartmouth College’s Tuck School of Business; Wei Shi, a professor of management at the University of Miami’s Herbert Business School; and Zhihui Sun, an assistant professor at Capital University of Economics and Business’ Accounting School in Beijing.
The researchers looked at data on every company that saw an activist-linked director join the board between 2008 and 2019, encompassing the beginning of the wave of shareholder activism that started in 2010. Matching each of these companies with a similar firm that didn’t onboard an activist director as a control variable, the researchers compared the pair across three measures of stakeholder harm: CSR ratings agencies, media coverage, and regulatory actions. The presence of an activist-appointed director led to a significant increase in reports of stakeholder complaints, the paper finds.
“It’s always a bit surprising when you see a result stand up to significant testing and it just holds—it doesn’t go away,” DesJardine says.
The stakeholder reports about ESG don’t necessarily arise because the activist investor, or the director it sends in, opposes ESG concerns. The effect more likely comes from the new director focusing the board’s attention on shoring up the company’s financial performance and stock price, which is usually the reason the activist went after the firm in the first place. “It’s not, 90 percent of the time, ideological,” DesJardine says.
The arrival of an activist-appointed director can cause a stir in the boardroom. Some bring a public profile from previous stints as CEOs or executives within the industry or elsewhere; others work directly for the activist firm. They have relevant expertise and are persuasive.
“There’s an increased receptivity to the campaign and what it signals about the company,” DesJardine says. “It heightens the openness to change with these directors and the ideas they bring with them.”
As the activist director shifts the company’s orientation away from long-term strategies and toward short-term actions that will positively affect the stock price, companies tend to cut R&D spending and capital expenditures, instead spending money on increased share buybacks. That’s a good short-term outcome for shareholders, which fulfills the activist’s mission, DesJardine says. Shareholders faced with this scenario have the option to vote against the activist director. They could also sell their shares in the company. But their options are otherwise limited.
If ESG performance is important to the company or its stakeholders, they must establish measures to protect against a diminution in corporate focus, he says: “If that’s a focal piece of its strategy, what sort of buffers are in place to protect that from happening?”
The question of how activist investors behave as board members is important because placing a director on the board is the top demand that activist investors seek when they target a company, says Margarethe Wiersema, a professor of strategic management at University of California, Irvine’s Merage School of Business. Most of those directors win their seats in a settlement between the activist and the company rather than being voted in during a proxy contest, she says. That means that shareholders don’t get a direct say in whether an activist investor’s delegate can join the board.
In aggregate, activists are growing in prominence within publicly traded companies, receiving about 250 board seats per year, the paper notes.
“Given that there are roughly 3,500 publicly traded companies in the United States, activist-appointed directors have gained a significant presence in corporate boardrooms,” Wiersema says. “Yet, we know little as to the social and environmental consequences of having activist representation in the boardroom.”
Find the full study: “Corporate Social Responsibility in the Age of Activist Directorships” by Brian L. Connelly, Mark R. DesJardine, Wei Shi, and Zhihui Sun, Strategic Management Journal, forthcoming.
Read more stories by Chana R. Schoenberger.