Shareholder Activism and Voluntary Disclosure

Jordan Schoenfeld is Assistant Professor of Accounting at the University of Utah. This post is based on an article authored by Professor Schoenfeld and Thomas Bourveau, Assistant Professor of Accounting at the Hong Kong University of Science and Technology. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here), The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here), The Law and Economics of Blockholder Disclosure by Lucian Bebchuk and Robert J. Jackson Jr. (discussed on the Forum here), and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.

Information is the foundation on which traders form their beliefs about a company and ultimately their investment decisions. In empirical settings, information often arrives in the form of a company disclosure. Since managers have significant discretion over disclosure, researchers have extensively studied the relation between disclosure and trading via the price system. In our paper, Shareholder Activism and Voluntary Disclosure, which was recently made available on SSRN, we study the relation between disclosure and a specific class of traders, shareholder activists. The activism literature has only indirectly explored the link between company disclosures and activism. For example, several papers include financial statement variables as regressors in their empirical models of activist targeting (e.g., Brav, Jiang, Partnoy, and Thomas, 2008). We extend this literature by looking at disclosure explicitly.

Any structural model of the relation between activism and disclosure must account for all the strategic reporting preferences of both managers and activists. Finding reasonable empirical proxies for all of these preferences would prove difficult (Leuz and Verrecchia, 2000). We therefore exploit activism peer firm settings and construct reduced form empirical models for the relation between activism and disclosure. Gantchev, Gredil, and Jotikasthira (2015) empirically show that activism in one firm is a strong instrument for an increase in the likelihood of activism at a closely matched industry peer firm.

The peer firm setting is precisely where we expect managers to use the disclosure mechanism in connection with activism. Our intuition unfolds as follows: Managers have significant motivation to avoid activism because activism is associated with a drop in CEO compensation, an increase in CEO turnover, and an increase in director turnover. Disclosure has several properties that make it suitable for deterring activist intervention: (1) it reduces information asymmetries between shareholders, including management and the board; (2) it signals managerial credibility to the board and existing shareholders; (3) it erodes activists’ private information advantage; (4) it corrects mispricings; and (5) it increases stock liquidity. Establishing credibility with the board and existing shareholder base is critical for managers in preparation for activist negotiation settings, because low credibility makes it easier for activists to effect their agenda (Levit, 2015). For example, passive shareholders with large voting blocs have a strong preference for high disclosure and can vote against management in a proxy contest if they are dissatisfied with a firm’s disclosure regime (Boone and White, 2014).

This intuition leads to the hypothesis that, when faced with the increased possibility of activism, managers will increase disclosure to strengthen their personal negotiating positions with their boards and deter activist intervention. This expectation is confirmed by practitioner literature. In a May 2015 report, PricewaterhouseCoopers noted: “Companies that can articulate their strategy and demonstrate that it is grounded in a well-considered assessment of both their asset portfolios and their capabilities may be more likely to minimize the risk of becoming an activist’s target.”

Our findings indicate that activism peer firms respond to activism by significantly raising their level of earnings guidance in the two years following the announcement of the activist campaign relative to the two years before. The change represents a 28% increase and occurs quickly, within one quarter after the activism campaign announcement date. We also find that 9.2% of activism peer firms disclose guidance for the first time in the post period. We extend the analysis and find the effect to be stronger in non-dividend-paying firms, firms with less entrenched managers, and for activism campaigns in which the activist releases a public letter to management and/or shareholders.

Next, we test whether the increase in disclosure affects the probability that a firm will be targeted by an activist. We need to test this hypothesis directly because disclosure can theoretically encourage or discourage activism. On one hand, disclosure can encourage activism by further advantaging traders with expert disclosure processing abilities (Harris and Raviv, 1993; Kim and Verrecchia, 1994). In turn, managers may not increase disclosure or disclosure may not have the intended effect of deterring activism. On the other hand, and consistent with our economic intuition, disclosure can discourage activism by signaling managerial credibility, reducing information asymmetries between shareholders (including management and the board), eroding activists’ private information advantage, and correcting mispricings. We split the activism peer firm sample into two groups, high disclosers and low disclosers. High-discloser firms include guidance-initiating peer firms and peer firms above the sample median percent change in guidance from the pre to the post period. We report that high-disclosing peer firms are 16% less likely than low-disclosing peer firms to be targeted by an activist in the two-year period following the activist campaign announcement date. Disclosure appears to comport with the second set of properties previously mentioned and thus lowers the likelihood of being targeted by an activist in our setting.

Our findings contribute to the shareholder activism and disclosure literatures in several ways. First, this study speaks to the question of how managers’ disclosure choices relate to influential investors. Ertimur, Sletten, and Sunder (2014) find that managers strategically disclose to benefit venture capitalists, and Bushee and Noe (2000) argue that managers may adopt certain disclosure practices to attract institutional investors. We show that managers appear cognizant of the threat of activism and adjust their disclosures accordingly. Second, our results connect to activism studies that focus on mandatory disclosure. Brav, Jiang, Partnoy, and Thomas (2008, Table 4) show that activists target companies with high ROA, low dividend payout, and strong cash flow; and Ertimur, Ferri, and Muslu (2011) show that activists target companies with excessive executive pay. The added value of our analysis is that we show that voluntary disclosures like earnings guidance factor into activists’ targeting decisions. Third, we relate our study to influential governance theories that assume that a firm’s information environment is an exogenous force in activism settings (Coffee, 1991; Maug, 1998; Edmans, 2009; Edmans and Manso, 2011). Our perspective is that managers have significant influence over their firms’ information environments because they can strategically disclose.

The full paper is available for download here.

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