Activist Stewardship

Highlights from a new article on hedge fund activism on behalf of long-term shareholder value, from Robert Eccles (Oxford University), Aeisha Mastagni (CalSTRS), and Kirsty Jenkinson (CalSTRS):

The time has come for “activist stewardship.” Simply put, this means putting the skills and techniques of activist hedge funds to work where a company’s financial performance is deteriorating and traditional engagement tools have failed to produce meaningful results to protect value and mitigate long-term risks, including recognizing the importance of environmental, social, and governance (ESG) risks. Historically, ESG issues have been the province of the engagement and stewardship group in the asset manager due to their importance in creating value over the long-term. These groups have sought to change corporate behavior through private, constructive conversations. Large asset managers, including asset owners who manage their own assets, have been rapidly increasing their commitment to engagement and, more broadly, to stewardship activities including proxy voting and advocacy work with regulators and policy makers...

Selling the stock is not an attractive proposition for a “universal owner.” In “Universal Ownership in the Anthropocene” Ellen Quigley at the Centre for the Study of Existential Risk at the University of Cambridge explains that “the Universal Owner owns a more or less representative slice of the economy and cannot reasonably sell out of individual companies whose activities add costs to the balance sheets of other companies in its portfolio.” In other words, a universal owner must be concerned about system-level effects like climate change and income inequality since it cannot diversify away from them. If the State of the World is destabilized, the universal owner cannot earn the beta it requires to meet the needs of its beneficiaries.

Universal owners have to deal with a company at two levels. The first is the company itself and the second is the negative contribution the company is making to the investor’s ability to earn returns across its own portfolio. Activist stewardship addresses both levels. It is a way of getting the changes necessary to improve the company’s financial performance. It also makes the company an example to others, in its industry and beyond, where declining financial performance and negative externalities are mutually reinforcing….

Although ExxonMobil is famous for decades of denial that climate change is real and largely a result of human activity, [the activist proxy contest] campaign is not fundamentally a climate argument. It is an economic one and summarized in “Can a Tiny Hedge Fund Push ExxonMobil Towards Sustainability.” Today the company’s market cap is around $190 billion, down from its peak of $528 billion on December 24, 2007, but up from its trough of $139 billion on October 26, 2020. One of the reasons for this destruction of shareholder value, as noted in an open letter on of December 7, 2020 from Engine No. 1 to Exxon’s board of directors is the decline in Return on Capital Employed (ROCE) on the company’s Upstream projects. Historically these have accounted for over 75% of total capital expenditure. ROCE) has fallen from an average of around 35% from 2001-2010 to around 6% from 2015-2019.

While still in the early stage of development, the model for activist stewardship contains the following elements:

  • The lead investor who identifies the target Corporate Castle. This will require identifying a small set of companies in any given industry that are likely candidates and then determining which one is best for the campaign. This will require extensive analysis and funding for this may be required
  • The army of investors (could be few but mighty) who will support attacking the castle walls. Ideally this will include some of the largest asset managers and perhaps a hedge fund or two
  • NGOs and other stakeholder representatives who can be marshalled to apply pressure
  • A funder source to provide the resources to develop the holistic approach. Initially this could be foundations, and this will be very bespoke by their interests. Eventually it would be good to have a permanent source of capital where there is broad discretion in how it is applied. Perhaps find a hedge fund manager looking for redemption.
  • The organization to do the financial analysis and partner on developing the holistic approach.
  • The law firm(s) for the necessary legal work
  • The executive search firm(s) for identifying the slate of new executives and directors
  • The appropriate media outlets who can amplify the message

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