Introduction

We live in a new world. Gone are the days when the investors in a company are silent spectators. They are no longer looking to exit at the first sign of distress. Today’s investors have evolved; they are eager to play a more proactive role and do not shy away from calling out the blunders of the management. If required, they are also willing to ensure that corrective measures are taken in a timely manner to steer the company from any adverse consequences. The writing on the wall is clear i.e. the management and board cannot run the company on their whims and fancies and will have to answer for their actions.

However, while shareholder activism is often an effective means of disciplining the management, it has the capability to be misused and can become a nuisance to founders and the management. It may also act as a weapon in the hands of a motivated investor trying to protect short-term interests. In this article, we discuss the good, the bad and the ugly of shareholder activism and its impact on companies from an environmental, social and governance (“ESG”) perspective.

Rise of shareholder activism

Shareholder activism has grown multifold in the last few years due to multiple factors such as the increase of institutional investors, increase of informed investors, tightening of the corporate governance regime, and better access to information. In fact, investors’ growing preoccupation with ESG standards across the world is also giving rise to significant shareholder activism. A recent and prominent example of this includes the activism demonstrated by Engine No. 1, a small hedge-fund investor of Exxon, which was successful in mobilizing the support of other institutional investors and installing three directors on the board of Exxon, with the aim of pushing Exxon into reducing its carbon footprint.¹

Types of shareholder activism

Shareholders are increasingly engaging with the company management to influence their behavior, push for policy changes, and influence overall conduct. There have, typically, been two streams of shareholder activism. Firstly, financial activism which focuses on maximizing the shareholder value and governance issues. Secondly, social activism which focuses on the influence of the company on larger outcomes, such as company’s overall environment impact, social standing etc. Many a times, the activist investors raise both financial as well as social issues. The type of investor often determines the nature of the issues that investor is likely to raise. For instance, venture capital funds, private equity funds, mutual funds may be more interested in raising issues from a financial and governance standpoint whereas investors who are environmentally or socially more conscious may be more interested in raising such issues from a social standpoint. Having said that, when an issue is raised, each investor will attempt to mobilize support from others in aid of their view.

Objectives of shareholder activism

Activist investors can raise multiple and a varied set of demands. For example, in public companies that are valued at less than the sum of their parts (i.e. the amount they could generate if they were liquidated), the investors can push the management to:

1. break up and sell off parts of the business;²

2. issue generous dividends;³

3. divest and simplify of the corporate structure; and/or

4. conduct asset sales, with the proceeds intended for share repurchases and the repayment of debt.

In other cases, the activists typically make demands such as requiring the management:

1. to voluntarily disclose climate change risks;⁴

2. to sell prior acquisitions and split operations (e.g. design and manufacturing);

3. to revamp the human resource policies; and/or

4. to be more disciplined with capital allocation.

From a governance standpoint, the activist investors may require the company:

1. to increase or decrease the number of directors;

2. to add more independent directors;

3. to overhaul management compensation;

4. to rationalize CXO pay etc.;

5. to put in place better internal control mechanisms;

6. to change the management;

Each of these decisions can and usually do end up becoming contentious. To that end, the manner in which such issues are raised and solutions are discussed require that constant communication through dialogue remains constant. Should dialogue not take place, the matter will probably end up before the courts, which will prejudice all stakeholders.

Impact of shareholder activism

Most cases of activism are a well-intentioned attempt at addressing any issues that may be found in the company. Shareholders’ role as “watchdogs” therefore, can provide effective oversight of the management and board. It also ensures effective acknowledgement and implementation of improved ESG standards in the company, with more transparency and accountability.

However, shareholder activism has also gained disrepute as it can sometimes cause more interference than necessary in the management of the companies. Many a times, increased involvement of shareholders, howsoever well intentioned, has resulted in greater disputes between the management of the companies with the activist shareholders. One need not look further than the BharatPe controversy,⁵ or the more recent Trell⁶ and Zillingo⁷ controversies, to understand these clashes between founders and investors. These controversies are unsurprising in start-ups wherein investors, taking on immense risks at the early stages of a company, consider themselves justified in taking a more active role in the management of such companies, especially as the companies grow exponentially. We see this happening not only in Indian companies such as Flipkart⁸ and Housing.com,⁹ but also globally through the examples of Apple,¹⁰ WeWork,¹¹ Uber¹² and Twitter,¹³ amongst others.

Tools under Indian legal regime

All of these instances lead to an important question of the extent to which shareholder activism should interfere with the daily management of a company. Indian law provides several tools for activist shareholders to hold a company accountable. These tools enable the shareholders to demand information about the company and/or ensure free and fair participation in the general meetings. For instance, the Companies Act, 2013 (Companies Act) provides shareholders with a right to inspect the memorandum, articles, special resolutions and agreements relating to the appointment, renewal or variation of terms of the appointment of managing directors.¹⁴ Shareholders can also seek inspection of books containing minutes of proceedings of general meetings or resolutions passed by postal ballots,¹⁵ register of loans and investments,¹⁶ register of charges,¹⁷ amongst others. The Companies Act also ensures that the shareholders have a right to receive the notice of general meetings and to attend and cast their votes freely. In fact, shareholders holding a minimum 10% of paid-up share capital are entitled to direct the board to call for a shareholders meeting and push for any change they wish to bring about in the management of the company.¹⁸ In addition, shareholders can also file an application in a tribunal against the company if it believes that the company is operating in a manner which is against the public interest or is oppressive and prejudicial to the shareholders.¹⁹ In some instances, shareholders can also withhold their consent for any related party transaction being undertaken by a company.²⁰ It is important that activists understand and exercise their rights in accordance with law.

Understanding the motive

While investor activism is a double-edged sword, it becomes important to understand whether the sword is being used as a weapon of attack, or defense. To that end, understanding the motive and the proposed solution is key.

In the case of Maruti, India’s largest carmaker and subsidiary of the Japanese Suzuki corporation, a situation unfolded where the parent, Suzuki Motor Corporation acting through a separate subsidiary, proposed leasing a plot of land from its own subsidiary, Maruti, and setting up a plant which would manufacture Maruti cars and engine components and sell them to Maruti. It did not take long for activist investors to question the decision to house the manufacturing in a separate subsidiary and on land which was already owned by Maruti. It was argued²¹ by IIAS that Suzuki Motor Corporation was parking a profitable business in a 100% subsidiary. Extremely vocal shareholder activism led to this proposal being scrapped and Maruti setting up the Gujarat plant directly thus ensuring that the benefit was passed on to all its stakeholders. In its true sense, the company was able to derive full value of its own business and future growth.

Importance of effective communication

Communication is key. The reasons for a proposed decision form the bedrock on which investor opinion is based. We live in a world of extreme transparency where each aspect of a decision can and usually is dissected by each and every stakeholder. The opaqueness with which entities operated in the yesteryears are a thing of the past. To that end, a company’s decision-making process, if well communicated and articulated, will reduce the chances of activism in its ranks. Where the moral compass is unquestionable and the communication is well-thought out and reasonable, it will usually ensure that the stakeholders of a company will have faith in the proposals that come before them.

In addition, the management should also keep an eye on certain red flags that may invite shareholder activism. Some common red flags that may catch the eye of activist shareholders are consistently poor financial performance, poor financial planning or investment decisions, lack of adherence to ESG standards, and arbitrariness in executive compensation.

Conclusion

With the increase of institutional investment in Indian companies, more and more incidents of activism are being seen whereby activists are attempting to control or influence the day to day activities of the company.²² This is only going to increase. Shareholders are slowly but surely taking on an active role to the extent that they begin to make their voice heard within the decision-making of a company. While overreach by shareholders may arguably have an adverse effect, it does not mean that the management of a company should be free to run the company without any monitoring.

As the Companies Act also requires, directors of a company should act in the best interests of the company, its employees, shareholders, community and for the protection of environment.²³ Shareholder activism, when it rightfully seeks to push the management of the company into achieving such obligations, continues to remain desirable and will be required in the larger scheme of implementing and monitoring ESG goals.