Expressing the contestation of a social policy without undermining the interests of society and the proper functioning of the market – Alain Pietrancosta, Director of the OEDF
The European Centre for Financial Law had the pleasure to receive on 18 December 2019 Mr Eric Woerth, Co-rapporteur of the parliamentary mission on shareholder activism, and Mr Michel Prada, Chairman of the working group on shareholder activism of the Club des Juristes.
Their intervention was contextualized by Mr. Alain Pietrancosta, Scientific Director of the European Centre for Financial Law.
First of all, I would like to address a series of thanks:
To the promoters and sponsors of the OEDF, first of all, for the energy deployed in the creation and launch of the Observatory, the idea of which we came up with only a few months ago in order to encourage synergies between the academic and professional worlds, to enable university researchers to better understand the issues and the environment to which professionals are subject, to make their work more widely known at the international level and to contribute more usefully to the public debate on financial issues.
To the organizers of this colloquium, for having done such a remarkable job for this first event in record time, despite a somewhat difficult atmosphere.
To the speakers, finally, for having given us the pleasure and honour of accepting our invitation, which could only guarantee the success of the event.
With regard to the theme that brings us all together this morning, I find myself in a delicate position since it is up to me to introduce it in about ten minutes, while at the same time, out of respect for our speakers, not to encroach on their presentations.
The compromise path chosen consists, before the play is performed, in setting the scene and situating the action, so as to enable us to better grasp the issues at stake and appreciate the greater or lesser opportunity of the recommended solutions.
Since we are concerned with shareholder activism, it would be unwise to settle for a static description of the set. Rather, it is important to keep in mind the forces at work within the shareholder base of our large corporations and the relationships they maintain. In particular, it seems impossible to me to understand current shareholder activism without placing it in relation to a certain shareholder passivity that has been in place for several decades.
This passivity is the paradoxical result of a twofold evolution: on the one hand, the institutionalisation of investment in financial securities, which goes hand in hand with its internationalisation; on the other hand, the rise of so-called index management.
The shares of listed companies are increasingly concentrated in the hands of institutional investors. This is a worldwide phenomenon, most recently highlighted by an OECD report, which estimates that more than half of the capital of the 41,000 listed companies in the world is held by institutional investors and the public sector. In the United States itself, a historical model of shareholder dispersion, world records for concentration are being set, with three players (Blackrock, Vanguard and State Street) constituting the main shareholders of 90% of the 500 largest US companies. In France, where shareholding is traditionally tighter, an average of 25% of the capital of CAC companies is held by 25 institutional investors.
We have thus entered into an intermediated, fiduciary or agency capitalism.
The paradox is that this financial power does not translate directly into political power, i.e. control of the companies held. The explanation lies in the mode of management favoured by these institutional giants, based on the practice of indexation, in other words the replication of indexes. In the United States, the share of passive management has more than doubled in 10 years to reach 45% of assets.
This is a rational choice, based on its advantages in terms of costs and performance, and which also responds to collective action problems and certain regulatory requirements, particularly in terms of diversification or manager remuneration.
The business model thus adopted limits the incentive and ability of these major investors to play the role of a substantially committed and active shareholder in each of the companies invested.
At most, the largest funds focus on general governance and process issues, following standardised policies supported by proxy advisors, doing governance activism at best, but not performance activism. According to the expression in vogue in the American literature, institutional investors are therefore sophisticated but reticent. And codes of engagement or stewardship are unlikely to change things fundamentally.
As a result, this agency capitalism with regard to investors itself creates agency costs for issuers at the micro level, where the management in place is no longer subject to the control and, if need be, the natural contestation of shareholders. This is precisely where the way has been paved for true shareholder activism. It is this space left free by the evolution of institutional management that they have come to occupy. The passivity of some favours the activism of others.
The two phenomena should not be considered in isolation, or even in parallel, as they interact and interact with each other. A division of labour is at work within the shareholder world. It is leading to a redefinition of the modus operandi of activism. For shareholder activism is old, but it was once linked to contestation or the claim to control society.
Today, in its long private or public form, it appears mainly in the form of specialised hedge funds, most often Anglo-Saxon, taking very minority positions in a limited number of companies in order to intervene proactively not only in the field of governance but also in corporate strategy. In its short and public form, it takes on the characteristics of a financially self-motivated whistleblower.
It is these activist risks, which are growing in Europe and particularly in France, that listed companies, whatever their situation, fear and can only ignore to their detriment. The consequences of activism are indeed cause for concern. A recent English study has established that nearly a quarter of the companies targeted by activists end up in the hands of another company and that post-IPO activism reduces the success rate of the operation from 89% to 33%.
This activism, in its long version, has the additional advantage that it not only alerts management, but also aims to bring about a change in social policy. We are in the presence of quasi-entrepreneurial or constructivist activism. This makes these conflicts rather difficult to resolve a priori. It also puts the legislator/regulator in a delicate position.
In fact, disqualification by the economic misdeeds of this activism is far from assured. While it is difficult to demonstrate that hedge fund activism is desirable or harmful for the companies directly concerned, and by the preventive disciplinary effect exercised on others, it seems certain that the extreme version of the short-termism argument, often invoked, has so far little empirical support.
In particular, it is weakened by the fact that the hedge fund has only a very minority position in society and must therefore rely on the support of large institutional investors to win its case, the latter, who have very long-term interests in society, being thus placed in the position of arbitrators of the conflict. Hence the growing importance of ESG factors in the targeting of activists, including short-sellers, who now undertake to shorten companies that are insufficiently sincere or responsible in the face of social and environmental risks, by financially attacking what they consider to be manifestations of greenwashing.
So this is not quite the situation we know in politics, where active and militant minorities succeed in imposing their views at the expense of the silent majority.
In the end, it is on the procedural level that the regulatory game shifts: the contradictory field, as it were, dear to the lawyers (even if it is difficult to have a level playing field between an issuer and a minority shareholder). How can we ensure that the contestation of a social policy can be expressed without harming the interests of the company and the smooth functioning of the market?
This balance is in fact that of the market itself, which tends to guarantee its rights. Access to stock markets implies that issuers are exposed to an increased risk of public criticism and confrontation, which is acceptable as long as it is expressed without undermining the essential guarantees of transparency and integrity for which the markets are renowned.
It is therefore necessary to regulate, no doubt without jeopardizing the useful function of protest and to shoot the bearers of bad news (messengers).
We must also, certainly, think about opening up alternative channels of collaboration between shareholders, less conflictual or confrontational, especially between institutional investors, through new modes of mediation (according to the English, Dutch or Italian examples).
Finally, we must ensure that everyone can act in conditions of optimal legal security, which does not seem to me to be the case today.
In this search for compromise and balance, which is essential for the Paris financial centre, the difficulty obviously lies in the positioning of the cursor, according to the interest that is perceived as having priority. We will see that it is not exactly placed in the same place in the reports we are now going to discuss, even if the gap is not as large as we feared at the beginning of these various works of the Paris financial centre.