Index Funds Influence Activist Investors

The presence of large passive shareholders, meaning sponsors of index funds, influences not only the actions of activist shareholders, but also what changes they are successful in pushing for.

This finding is based on an analysis of the firms with the lowest weighting in the Russell 1000 index and the largest weighting in the Russell 2000 indexes that experienced an activist event between 2008 and 2014.

Passive investors may facilitate proxy battles by reducing costs and increasing the odds of a favorable outcome. Absolute costs are reduced because it’s easier to identify shareholders who are mutual fund and exchange-traded fund sponsors than other shareholders. Activist investors contact passive investors to gauge their willingness to support certain proposals and requests. Passive investors may be willing to support changes since they track indexes and cannot sell a stock simply because of poor management.

Ownership of shares by passive investors is associated with significant increases in the likelihood of proxy fights, particularly for board representation. Activist investors are also significantly more likely to obtain an acquisition, remove takeover defenses and be reimbursed for their expenses when passive investors are shareholders. One reason why is that passive investors give activist investors more credibility or at least signal a credible threat to management of supporting a dissident slates of directors.

At the same time, activist investors curtail certain actions. Campaigns seeking incremental changes to firm policies through the use of shareholder nonbinding resolutions, exempt solicitations and other means are less likely in the presence of passive investors. Similarly, there is significantly less likelihood of an activist investor blocking a merger or pushing for a higher takeover price. There are also fewer requests for special shareholder meetings.

Not all actions by activist investors are impacted by passive investors, however. What doesn’t change is the rate at which activist investors or managers win contested elections, payouts are increased (either via dividends or stock buybacks) or spin-offs are facilitated. There is also little change in the frequency of activist investors sending letters to either the board of directors or other shareholders.

Source: “Standing on the Shoulders of Giants: The Effect of Passive Investors on Activism,” Ian Appel, Todd Gormley and Donald Keim, SSRN, March 15, 2016.