Corporate governance antecedents to shareholder activism: A zero‐inflated process

• Author: Maria Goranova,Ehsan S. Soofi,Rahi Abouk,Paul C. Nystrom
• DOI: http://doi.org/10.1002/smj.2472
• Date: 01 February 2017
• Published date: 01 February 2017

Strategic Management Journal

Strat. Mgmt. J.,38: 415–435 (2017)

Published online EarlyView 9 February 2016 in WileyOnline Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2472

Received 29 October 2013;Final revision received29 September 2015

CORPORATE GOVERNANCE ANTECEDENTS TO

SHAREHOLDER ACTIVISM: A ZERO-INFLATED

PROCESS

MARIA GORANOVA,1*RAHI ABOUK,2PAUL C. NYSTROM,1and EHSAN S.

SOOFI1

1Sheldon B. Lubar School of Business, University of Wisconsin-Milwaukee,

Milwaukee, Wisconsin, U.S.A.

2Department of Economics, Finance, and Global Business, Cotsakos College of

Business, William Paterson University, Wayne, New Jersey, U.S.A.

Research summary: Shareholder activism has become morewidespread, yet the role of corporate

governance as antecedent to shareholder activism remains equivocal. We propose a new concep-

tual model that characterizes the stochastic of observable shareholder activism as a compound

product of two latent components representing (1) shareholder activists’ propensity to target a

company and (2) executives’ propensityto settle activists’ demands privately. Our model explicitly

decouples corporate governance expectations for the two latent components embedded in activism

process, and thus allows us to relax assumptions of homogenous shareholder interests and con-

strained managerial discretion wherecorporate managers are expected to negotiate privately and

settle only value-creating activist demands. Bayesian analysis of zero-inated Poisson regression

reveals that corporate governance relationships with activism vary across shareholder demands

and private settlements.

Managerial summary: Increasing shareholder activism has generated debates as to whether

activism promotesmanagerial accountability and responsibility or instead encourages managerial

short-termism. Our research model allows for heterogeneous interests among a company’s share-

holders. We theorize and empirically investigate a broader role of corporate governance: gover-

nance mechanisms need to ensure that executives are not (1) ignoring activists’ value-increasing

demands or (2) accommodating activists’ value-decreasing demands in a private, opaque manner

that disenfranchises other shareholders. Our results indicate that corporategovernance implica-

tions differ for visible shareholder demands in contrast with private activism. A plausible appli-

cation of our model is that it provides estimates of the probability of the numbers of shareholder

demands to be received by a rm and the probability of privately settling a demand. Copyright ©

2015 John Wiley & Sons, Ltd.

INTRODUCTION

“Shareholder activism has rapidly changed how

corporate America thinks” (Solomon, 2014:1).

Studies have examined the impact of shareholder

Keywords: shareholder activism; corporate governance;

agency theory; Bayesian analysis; zero-inated model

*Correspondence to: Maria Goranova, Sheldon B. Lubar School

of Business, University of Wisconsin Milwaukee,3202 N. Mary-

land Ave., Milwaukee,WI 53201, U.S.A.

E-mail: goranova@uwm.edu

Copyright © 2015 John Wiley & Sons, Ltd.

activism on a broad range of organizational

practices and outcomes, such as establishment

of investor relations ofces (Rao and Sivakumar,

1999), utilization of ethics codes (Stevens et al.,

2005), executive compensation (Chowdhury and

Wang, 2009), environmental policies (Reid and

Toffel, 2009), R&D (David, Hitt, and Gimeno,

2001), and corporate social performance (David,

Bloom, and Hillman, 2007; Neubaum and Zahra,

2006). Corporate managers face escalating and

diverse shareholder demands for improvements in

416 M. Goranova et al

rm performance and corporate governance (Gillan

and Starks, 2007; Westphal and Bednar, 2008),

asset restructuring and cash distributions to rm’s

shareholders (Brav et al., 2008; Klein and Zur,

2011), and board representation (Gantchev, 2013).

Shareholder activists have also become more adept

in securing the support of other shareholders (Ren-

neboog and Szilagyi, 2011), extracting concessions

from targeted rms (Ertimur, Ferri, and Stubben,

2010; Thomas and Cotter, 2007), and forcing

CEO departures at companies such as Yahoo, J.C.

Penney, and Home Depot.

Shareholder activism has also generated con-

siderable controversy. Rising shareholder engage-

ment promises to hold corporations and their man-

agers more accountable (e.g., Bebchuk, 2005, 2013;

Daily, Dalton, and Cannella, 2003; SEC, 2010;

Waddock, 2004), but it has also attracted skeptical

voices (e.g., Lan and Heracleous, 2010; Stout, 2012;

Strine, 2014). Christensen and van Bever (2014)

call attention to the challenges faced by corpora-

tions when shareholders reward short-term actions

and strategies. Mayer (2013) worries that publicly

traded corporations have become a “rent extraction

vehicle for the shortest-term shareholders” (p. 240).

Such criticism raises the question about the role of

corporate governance in the context of shareholder

activism. Prior research posits that well-governed

rms will face more satised shareholders and

will be more accommodating to their demands

(e.g., Bizjak and Marquette, 1998; Cai and Walk-

ling, 2011; Gillan and Starks, 2007; Prevost and

Rao, 2000; Renneboog and Szilagyi, 2011). This

expectation implicitly assumes constraints on man-

agerial discretion that prevent self-serving man-

agers from negotiating with activists, as well as

homogenous shareholder activism that is invariably

value-promoting at the rm level. Can we equate

good corporate governance with implementation

of shareholder demands in those situations where

shareholders have heterogeneous or even conict-

ing interests (Connelly et al., 2010; Davis and Kim,

2007; Hoskisson et al., 2002; Tihanyi et al., 2003),

or where shareholders are “vulnerable to the same

forces of greed and self-interest widely understood

to face corporate ofcers and directors” (Anabtawi

and Stout, 2008: 1256)? Executives may sometimes

seek to “pacify” shareholders (Westphal and Bed-

nar, 2008), while protecting their discretion (David

et al., 2007) and managing their job risk (Neubaum

and Zahra, 2006). The current paper aims to address

this paradox and to extend our understanding of the

role of corporate governance in the context of share-

holder activism.

Weseek to contribute to the research on corporate

governance by answering calls for a broader con-

ceptualization of corporate governance (Starbuck,

2014; Tihanyi, Grafn, and George, 2014). Agency

theory has dominated governance research to such

an extent that Dalton and colleagues (2007: 42) state

“the notion of agency theory and corporate gov-

ernance are essentially equivalent.” Activism liter-

ature has similarly adopted an agency-based view

of governance in which well-governed rms are

less burdened with agency costs and thereby less

likely to incite shareholder discontent and activism

(Bizjak and Marquette, 1998; Carleton, Nelson, and

Weisbach, 1998; Gillan and Starks, 2007; Ren-

neboog and Szilagyi, 2011). Equating good gov-

ernance with frictionless implementation of share-

holder demands (e.g., Azar, Schmalz, and Tecu,

2014), however, may be more problematic in sit-

uations where shareholder activism is not univer-

sally benecial for targeted rms or their sharehold-

ers (e.g., Ertimur et al., 2010; Thomas and Cotter,

2007). Prior research posits a range of motivations

behind shareholder activism. Some activists target

rms that perform poorly or practice poor gover-

nance (Bizjak and Marquette, 1998; Ertimur, Ferri,

and Muslu, 2011; Karpoff, Malatesta, and Walk-

ling, 1996). Other activists may be motivated by

factors unrelated to the focal rm, such as politi-

cal careers (Wahal, 1996; Woidtke, 2002), advanc-

ing the activist group’s visibility and consolidating

its identity (Rehbein, Waddock, and Graves, 2004;

Rowley and Moldoveanu, 2003), or attracting new

members (Agrawal, 2012).

Managers, furthermore, are hardly passive recip-

ients of shareholder discontent (Westphal and Bed-

nar, 2008). Executives sometimes face self-serving

considerations, such as career, jobs, professional

reputation, and monetary rewards, that encourage

them to be responsive to shareholder demands

(Neubaum and Zahra, 2006) or at least appear to be

so (David et al., 2007; Westphal and Zajac, 1994).

Prior research posits that behind-the-scenes share-

holder activism is widespread (Becht et al., 2009;

Carleton et al., 1998; Logsdon and Van Buren,

2009; Rubach and Sebora, 2009). Investors often

try to engage rms privately and then take public

measures only if private negotiationsfail (Gantchev,

2013; McCahery,Sautner, and Starks, 2015). Black-

rock, for example, states that it engaged with 1,500

companies in 2012, but “most observers are never

Copyright © 2015 John Wiley & Sons, Ltd. Strat. Mgmt. J.,38: 415–435 (2017)

DOI: 10.1002/smj