The Impact of Shareholder Activism on Corporate Governance

Corporate governance plays a crucial role in ensuring that a company’s operations are conducted transparently and responsibly, aligning the interests of management with those of its shareholders. In recent years, shareholder activism has emerged as a powerful force in reshaping corporate governance, with activists pushing for greater accountability and higher returns.

This is particularly evident in regions like Hong Kong, where many companies are controlled by family or state-owned entities. This article explores the dynamics of shareholder activism in Hong Kong’s controlled firms from 2013 to 2017, focusing on the strategies used by activists and the role of legal mechanisms in shaping corporate decision-making.

Corporate Governance

Corporate Governance is a system that enables management to handle day-to-day business operations effectively. The main principle of corporate governance is to fulfil the demands of company shareholders. Corporate governance is planned and implemented by the board of directors. Corporate governance ensures transparency, accountability, and security in the organization.

The central issue of corporate governance is to balance the power and conflict of interests between the shareholders and the board of directors.  To empower shareholders, enhance corporate transparency, and maintain a long-term relationship with the shareholders, the European Council established the Shareholder’s Rights Directive in July 2007.  

shareholder activism

However, these rights are fully used by the outside shareholders to oppress the management or existing shareholders of the company. The other shareholders do not exercise their rights to influence the business operations. However, the US Hedge funds in the past have changed the corporate governance in public companies.  Shareholder Stewardship has changed the point of view of policymakers and encouraged the active involvement of shareholders to enhance corporate governance within the organization. 

Problem Statement

The Case study discussed how shareholder activism impacted corporate governance in corporations in the past.  In this case study, the author has collected and analyzed the data about the activities in the controlled firms in Hong Kong from 2013 to 2017 to show the impact of legal mechanisms on the company’s strategic planning and the outcomes of shareholder activists. The case study also shows how hedge fund activism works in an organization with controlling shareholders. 

The case study focuses on showing the activism’s impact on the controlled firms, the war between the controlling shareholders and the activists, and the financial impact on the ownership of the firm because of activism. The case study shows the importance of the legal tool- the minority veto rights used by the shareholder activists against the controlled shareholders or firms. 

Shareholder Activism

Shareholder activism is the activities of shareholders to influence the management of the organization and to make changes in the corporate operations to protect the interest of shareholders and to increase profits. Hedge fund activism is the other side of shareholder activism, where private investors invest in the hedge funds to make changes in the corporation to increase the returns on investment.

The hedge fund activists used to control the management and the business operations and used legal laws to protect themselves from external and internal issues in the company.  The hedge fund activists are more aggressive and control the management and other shareholders. According to the study, more than 65% of hedge fund activists present focus on the US public companies. 

Though shareholder activism does not have full ownership of the firm, they control the firm by taking the support of other shareholders, legal remedies, cross-shareholding, and support of external shareholders.  According to the study, from 2013 to 2017, public activist demands took place in more than 257 Asian companies, and most of the companies were from Hong Kong.

In Hong Kong, the majority of companies are controlled by families or the state government. The government of Hong Kong started to create a law by releasing a doctrine of The Principles of Reasonable Ownership in 2016 concerning shareholder activism and encouraging active participation of shareholders. This promulgation was similar to the Stewardship Code of the UK. The hedge fund activism does not affect the long-term activities of the company. 

The report of Hong Kong from 2003-2015 shows that the intervention of activism in the companies has increased the stock return and the firm value in the market.  The report on activism in Hong Kong differs from the report on the impact of shareholder activism in the United States because the ownership structure of the companies in the Asian jurisdiction is different from the United States. 

Shareholder Activism In Hong Kong

Shareholder activism was rarely practised in Hong Kong because most of the companies were either controlled by the families or by the state. Because of the controlling shareholders, institutional investors, and cross-shareholding practised in the firms, the minority shareholders are not allowed to participate or use their rights in the company’s decisions. 

Hedge funds were not practised in Hong Kong in the past, and the institutional investors also used to not take part in the company decisions. As the institutional investors have little share in the company, they do not take part in the decisions. Shareholder activism was practised internally.  As the shareholders were unable to afford to proceed in the company legally, they used to practice behind-the-scenes activities.

Later, the government of Hong Kong started to support shareholder activism to change the point of view of controlling shareholders and the board of directors on the activism. In 2016, The Principles of Reasonable Ownership was adopted by the companies to encourage the involvement of shareholders in the company’s decisions to improve the performance of the organization in the market.  This has enabled institutional investors and other minority shareholders to raise their voices and use their rights against the board of directors. 

Strategies Used By The Activists Against The Controlled Firms

The shareholder activists used to communicate with the controlled firms privately about their demands. When private communication fails, they make their demands publicly.  In private engagement, the activities communicate with the institutional investors or the manager o of the company to build a long-term investment relationship. In this process, the manager and the investors communicate about the long-term goals of the company and the changes made to earn higher returns both for the company and the investors. 

It helps to build trust among the investors, and the company enjoys the long-term partnership.  The legal protection to the minority investors and the activist gives them the power to win over the controlling shareholder.  The legal law grants veto rights to the minority shareholders to win in the conflict of interest battle between the controlling shareholders and the activists.

According to the case study results, there is legal protection for the monitories that have higher influence over the ownership level in the private engagement with the controlled firms. The activist uses public communication when the controlling firms do not fulfil demands. They release the list of demands in the media to force the controlling shareholders. Public communication affects the reputation of the controlling shareholders and decreases the share prices.

Some of the success factors of activists are that the company should have reserved board seats for the minority shareholders. If the company uses cumulative rules to elect the board members, then the activist can successfully win in the controlled firms. If the company uses the staggered board, then activities can take over the controlling shareholders.  The activist can also go to court to pressure the controlling shareholders by proceeding legally. 

Key Findings Of The Case Study

To examine the role of legal remedies on the activist strategies and outcomes of the activists in the controlled firms, the author has analyzed the data of shareholding activists in the controlled firms from 2013-2017, the data about the legal strategies used by the hedge funds, institutional shareholders and the advisors against the controlled companies.

The author found that legal mechanisms and tools like Veto rights helped shareholder activists make their position in the controlled firms stronger and more effective. According to the research, two-thirds of the activists in Hong Kong companies have influenced corporate operations using legal remedies even though they have little share.  However, the activist has to make their demands publicly to deal with the shareholders, who enjoy the majority of shares in the company. 

The researcher has collected data about the legal strategies used by the activists, the outcomes, the percentage of shares gained by the activists, and the data about the controlling shareholders in the targeted companies to understand the role of the legal institution in shareholder activism. The list of data contains twenty-four activities events data, out of which two-thirds of engagements were processed privately with the targeted firms, and one-third of engagements were conducted publicly. 

The activities used hedge funds to initiate engagement in the companies with 50% of controlling shareholders.  The case study outcomes are that the activities win over the ownership level because of the legal remedies and corporate governance. If the activist’s demands are related to corporate governance, then they can go legally to force the targeted company to fulfil their demands.  They can enhance their bargaining position using legal remedies. 

The activist does not use legal remedies when the controllers have the majority of the shares in the targeted company, and they engage with the company and the controlling shareholder privately to communicate their ideas and benefits to both the company and the investors.    In Hong Kong, most companies are ruled by families or state controllers. In this case, legal remedies will not benefit the activists, as the controller will win over the activists with higher votes from the board members. 

Finally, the cases with formal legal mechanisms will have a higher success rate for the activists. The Hong Kong government does not provide any board support to the minority shareholders.  The minority veto right, a legal mechanism, has effective results in controlling the high ownership shareholders in the targeted companies.  The policymakers also encourage the activists to use the minority veto rights to win the battle with the controlled shareholders.                         

Conclusion

Shareholder activism is rarely used in controlled firms as the minority shareholders are not given full rights in the companies because of the shareholders with higher shares. Using legal mechanisms and laws, the shareholder activists can increase their bargaining power over the controlled shareholders in the targeted company. The case study has shown the successful use of the minority veto rights tool by activists to win over the controlled shareholders. 

In this case study, Hong Kong-controlled companies data was collected from 2013 to 2017 to analyze the activism practised in the country and found that formal legal mechanisms will help the activists to influence the company and enhance the corporate governance within the organization. With legal rights, activists can win the battle in the controlled firms.

However, in the battle with the shareholders with major shares in the company, the activists should not use legal proceedings. Instead, they should engage with the shareholders privately to achieve positive outcomes.  Policymakers should use shareholder stewardship to enhance corporate governance in controlled firms, encourage activists to use legal mechanisms, and increase their bargaining power. 

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