advertisement
Columnists

Activist investors keep companies honest

A growing trend in the stock markets of developed countries – activist investors – is gaining traction and inventing corporate management of publicly quoted companies.

These are people described as individuals or groups that purchase large numbers of shares of a public company and/or try to obtain seats on the board of the company with the sole purpose of effecting a major change in said company.

In most cases, an activist shareholder uses an equity stake in a corporation to put public pressure on its management.

This phenomenon started in the 1980s notably by Carl Icahn and T. Boone Pickens who were then perceived as “corporate raiders” for acquiring an equity stake in publicly owned enterprises.

These actions have morphed into what the Economist refers to as “Capitalism’s unlikely heroes” in its February 7 edition. Heroes, because majority of investors are passive at the time when governance of listed companies is weakened by laissez faire greed.

advertisement

The Economist article says, “Being listed makes a firm open to scrutiny; and ordinary people have a chance to invest in capitalism’s wealth creating machines. But the past 15 years have cast a shadow over the public company. There was not much sign of scrutiny or wealth creation in fiascos like Enron and Lehman Brothers. Governance has been weakened by the rise of passive index funds, which means that many large firms’ largest shareholders are software programs.”

The blind adoption of laissez faire economics and weak regulatory mechanisms are causing grave damage to markets in developing economies and impoverishing innocent investors.

In Kenya, virtually all listed companies would fail the scrutiny test. The fall of Mumias, a star performing stock, is one such testimony. It was predictable, but there was no one to raise the alarm.

The company started losing focus with decisions to invest in water and energy, when they could not pay farmers for their cane.

Newspapers reported that the firm was importing cheap Brazilian sugar and repackaging it as a Mumias product but still the board did nothing.

Even as a solution to the current crisis is being sought, the board is non-representative of investor interests and barely capable of mounting an effective turnaround.

Mumias investors come from far and wide, but the matter has been localised with the county government injecting significant resources in the hope of saving small-holder farmers from the region.

We are simply hopping from one set of passive investors to passive investment by the government without fully analysing the genesis of the problem and whether the new investment could revive the company. This is why we need an objective mind on the board to ask the hard questions.

Piling up passive investments only goes to benefit the perpetrators of corporate crimes.

Clearly there are hundreds of people nursing bitterness over the possible loss of their investment in Mumias, but media has not been kind to them. It is as if the media is part of those trying to distort the facts and cover up the past in the hope that there will be a rescue plan.

This perhaps explains why the kind of analyses we see only focus on the creditors, including the farmers but nothing about the shareholding by the public.

There are other listed companies where critical information is being swept under the carpet. Board appointments are done through a network of friends yet the investors are spread around the globe.

Activist investment could break this practice and help safeguard public interests in companies that have not subjected themselves to open scrutiny.

The composition of any publicly quoted company board should be subjected to constitutional diversity requirements.

Taking an activist approach to public investing has been proven to produce returns in excess of those likely to be achieved passively.

A London-based research firm, Activist Insight, in a 2012 study showed that the mean annual net return of over 40 activist-focused hedge funds had consistently outperformed the MSCI (US-based provider of equity, fixed income) world index in the years following the global financial crisis in 2008.

When Greg Smith, Goldman Sachs VP, explained to 60 Minutes on CBS News why he quit, he said, “Getting an unsophisticated client was the golden prize. The quickest way to make money on Wall Street is to take the most sophisticated product and try to sell it to the least sophisticated client.”

This in my view is the worst form of capitalist greed and it is exactly what is happening in Kenya today. We must wake up and shake up the management of our publicly owned companies from within as activist investors.

The writer is an associate professor at the University of Nairobi’s Business School.

advertisement