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AQRM Red Flags: Shareholder Activism

The Audit Analytics Accounting Quality + Risk Matrix (AQRM) makes it easy to identify accounting, audit, and governance red flags for public companies. This blog series breaks down the risks associated with specific firm-level events included in the AQRM.

Shareholder activism is the process by which a shareholder of a publicly traded company seeks to exercise their rights in a way that will bring about change at the company. 

Shareholder activism can allow for a single activist investor to exert significant influence over a company’s performance. The influence from outside the company can disrupt corporate governance, especially in instances where the activist investors’ goals differ from the company.

Though shareholder activism is traditionally associated with hedge funds initiating hostile takeovers and proxy campaigns, the nature of activism is evolving. Alternative forms of activism to increase long-term shareholder value are emerging that focus on promoting corporate social responsibility (CSR) and environmental, social, and governance (ESG) practices.

Institutional Shareholder Services expects there will be more frequent cases involving advocates of ESG investing in the future, using Exxon Mobil’s 2021 proxy contest as an example. In that situation, a small activist hedge fund expressed concern over Exxon’s “sustainable value creation in a changing world.” The fund, despite owning a small stake in Exxon, successfully saw several of its nominated directors elected to Exxon’s board.

While activist investors often seek to increase value in the companies they are invested in, how that value is created can be contrary to standard company operations. In cases of activism focused on CSR and ESG, there is a risk that pushing for some changes can actually decrease a company’s stock price if it is at odds with the company’s primary business or strategy.

Enacting policies that differ from a company’s standard operating procedures in response to activism weakens overall corporate governance. Differing views for a company’s future can create turmoil and uncertainty at the top that trickles down to the rest of the company.

However, not all shareholder activism is unwelcome or unsuccessful. A survey of 73 empirical studies looking at impacts of shareholder activism over 30 years found that “activism has become more value increasing over time”. Furthermore, “activism that adopts some characteristics of corporate takeovers, especially significant stockholdings, is associated with improvements in share values and firm operations.”

Due to the variety of reasons for shareholder activism, the Audit Analytics Accounting Quality + Risk Matrix (AQRM) qualifies certain events as different levels of risk:

Activist shareholders may use their positions to seek changes to policies with which they disagree by publicly applying pressure and disputing actions taken by executives and management; such an action is considered a critical red flag in the AQRM.

As shown below, in the case of Winnebago Industries [WGO], shareholder activism by Punch Card Capital – who was a beneficial owner of 7.1% of the company’s shares – disputed actions taken by management and expressed concern about stock price and management strategy.

Punch Card Capital sent a letter to Winnebago’s board reiterating previous concerns about Winnebago’s debt level and other financial management decisions. But, the shareholder also expressed disagreement with the company’s decision to furlough their employees during the COVID-19 pandemic without pay or benefits, while executives would continue receiving full compensation. Punch Card Capital requested a review of executive compensation and corporate expenses and asked that the dividend be eliminated.

A month after the letter, Winnebago issued a press release detailing financial management steps voluntarily taken during the pandemic, addressing some issues raised by the shareholder:

“Since the beginning of the COVID-19 crisis, Winnebago Industries has implemented significant cost containment and financial management measures and will continue to do so as conditions require. For any employees that remain furloughed due to either employee safety or demand factors, the Company will maintain their medical and dental insurance benefits during any unpaid leave.”

Winnebago Industries, news release: April 29, 2020.

This type of shareholder activism can provoke changes or reversals of previously announced company policies, making it important for investors and stakeholders to take note when it is disclosed.

The Audit Analytics Accounting Quality + Risk Matrix (AQRM) can be used to monitor, compare, and evaluate certain aspects of company-stakeholder events, along with many other “red flag” disclosures. For more information, please contact us.

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