Join The Investment Revolution!

Published in Investing on 14 April 2011

A few powerful investors are taking up arms against under-performing businesses.

Despite a wave of tax rises, benefit changes and public-spending cuts, we Brits have yet to join Greece in taking to the streets in anti-austerity riots.

Peaceful protest

Indeed, although Britain has a long history of anti-establishment protests, most demonstrations tend to pass off peacefully, such as the Jarrow Crusade of 1926.

Violent exceptions to this rule include the recent demonstration in Piccadilly, the Poll Tax Riots of 1990 and, a little while back, Wat Tyler's Peasants' Revolt of 1381.

Thus, in general, we Brits prefer to 'grin and bear it' and ' keep calm and carry on'!

The agency problem

This is particularly the case in British boardrooms, where few folk can be bothered to tackle one of the biggest problems investors face, namely, the 'agency problem'.

In a nutshell, the agency problem describes the conflict of interest arising between a company's owners (its shareholders) and its managers. When these two groups have different goals, or differ on how a company should be run, then it's usually the owners who lose out.

Indeed, in many cases -- particularly among smaller companies and firms quoted on AIM (the Alternative Investment Market) -- the agency problem becomes so extreme that management merrily pillage companies at the expense of their shareholders.

At its worst, the agency problem can lead to criminal behaviour. I have heard of one private company where the chairman/founder took £400,000 in dividends, despite the firm having retained earnings and distributable reserves of under £150,000. In effect, he was robbing the other shareholders and, in doing so, breaking the Companies Act 2006. Naughty, naughty!

Boardroom bust-ups

Another common conflict arising from the agency problem is excessive director rewards for poor performance. Short of fraud or dishonesty, nothing infuriates investors more than managers banking mega-bonuses while profits tumble and dividends are slashed.

However, some fed-up investors have had enough of being taken for chumps and are fighting back. These activist investors -- usually institutional investors or groups of private shareholders -- are taking to the streets (actually, the boardrooms) of Britain to protest about management excesses.

Often, these activist investors are aggressive, big-hitting outfits (notably, hedge funds) which buy sizeable stakes in companies and then agitate for change. By doing so, they aim to replace poorly performing management, sharpen company strategy and turn the tanker around.

Of course, activist investors aren't enlightened, philanthropic altruists; their aims are entirely self-interested. By beefing up a company's board and boosting its profits, they hope to make super-sized returns from improved corporate performance.

The Alliance alliance

Recently, two investor-activism campaigns have hit the headlines.

First is the shareholder showdown at giant investment trust Alliance Trust (LSE: ATST).

The £2.5 billion, Dundee-based trust has come under attack from Laxey Partners, a well-known activist fund which has acquired some notoriety for its aggressive stands against under-performing companies and their management.

Laxey Partners, which owns about a sixtieth (1.7%) of Alliance Trust, is demanding that the trust introduce a ' discount-control mechanism'. This would give the trust the ability to buy back its shares when they trade at a certain discount to their underlying net asset value (NAV). Currently, Alliance Trust's shares trade at a discount of about a sixth (16%) to NAV.

Katherine Garrett-Cox, Alliance Trust's CEO, has pleaded with private shareholders to lend their support to her and the 123-year-old trust's management team. Nevertheless, Laxey Partners wants its proposals put to a vote at the trust's annual general meeting on 20 May.

We'll see how this battle shapes up next month. 

On the buses

The second shot of investor activism comes at transport group National Express Group (LSE: NEX), which has operations in the United Kingdom, North America and Spain.

This time, the rebel shareholder is New York-based hedge fund Elliott Advisors, which aims to shake up -- and even break up -- the UK-based bus, coach and train operator.

At National Express's annual general meeting on 10 May, Elliott aims to appoint three new non-executive directors and demand a strategic review of the company's businesses. Elliott, which holds a 17.5% stake in National Express, yesterday claimed to have won the support of the Cosmen family, Spanish investors who own the second-largest stake in the group (17.4%).

However, Co-operative Asset Management, which controls almost 2.7% of National Express, said it would oppose Elliott's proposals, on the grounds that the hedge fund is needlessly distracting the board, and that its proposed board members lack industry-specific experience.

Fund group M&G, which is the group's third-largest investor with a 13% stake, has also backed National Express in its battle with Elliott.

According to the firm's shareholder register, 28 major investors own more than half (56%) of National Express, so these significant shareholders will be crucial in deciding the company's future. If Elliott wins enough support, then National Express could be broken up or auctioned off to the highest bidder.

Activism works

In my view, and to paraphrase Gordon Gecko, Michael Douglas's character in 1987 film Wall Street,

"Activism is good. Activism is right. Activism works. Activism clarifies, cuts through and captures the essence of the evolutionary spirit. Activism, in all of its forms, activism for life, for money, knowledge, has marked the upward surge of mankind."

Indeed, to me, investor activism is an essential part of shareholder capitalism. Only by shaking up poorly performing companies and replacing weak management can we hope to turn ailing companies into healthy businesses. Arguably, it's a necessary part of 'creative destruction'.

What's more, investor activism is an essential part of corporate governance, working as it does to prevent corporate excess, rewards for failure, undue risk-taking, management short-termism, and boom-and-bust behaviour.

Indeed, in some ways, activism is at least as important as dividends, because every vote should be backed by a voice!

More from Cliff D'Arcy:

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march77 14 Apr 2011 , 2:45pm

Just to add, Elliott Advisors who are mentioned in relation to National Express Group recently acquired a circa 3% stake in Alliance Trust. Discussion of this point has taken place on the Investment Trusts and Unit Trusts Board. There was an RNS on 29 March 2011 re Elliott, and since that time the discount to Net Asset Value has narrowed by around 5%.

ScottishDavie 14 Apr 2011 , 3:32pm

Laxey's attack on Alliance Trust makes me think of a dinghy trying to sink a battleship with a peashooter. I'm a long-term investor (in both senses) in ATST and I admit to having slightly mixed feelings here. ATST probably could do with a bit of a shake up but like many small investors I value its stability and I'd be very reluctant to see anything happen which could put that at risk. I understand that ATST does buy back shares from time to time without the straitjacket of a formal discount control mechanism and on balance I'd rather leave it like that than risk the law of unintended consequences.

rcharity 17 Apr 2011 , 10:24am

How many individual investors hold their shares in nominee accounts or ISAs? This disenfranchised group don't get to vote for or against anything at a company's AGM. That just leaves the institutional investors with all the votes and their snouts are sometimes in the same greedy trough as the dodgy company management.

abrahamisaacs 18 Apr 2011 , 1:05pm

Here is another example. During the financial crisis Liberty International PLC lost half its value, yet paradoxically paid a "guaranteed bonus" to its then newly appointed Finance Director. I got the list of five largest shareholders, all institutions, and wrote each a brief letter letting them know what had happened and how it had been described in the accounts. None replied. It makes you wonder whether or not they even care about the agency problem.

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