Investment: Where Does Reality End And Myth Takeover

Monday, 23 February 2015
By Robert McDowall

Folklore permeates thinking and analytical conclusions of routine events and transactions in financial markets through myths. A myth is an attempt to explain mysteries, supernatural events, and cultural traditions. Today, in the rational and scientific views of the world, the term "myth" has come to denote stories are false, and this is the most common use of the word today. Such a definition of the term assumes that scientific analysis is the final judge of what is and is not real. Mythic storytellers past and present, on the other hand, have typically assumed that reality is too complex to grasp by means of a single method of analysis. In consequence we have relied on stories to provide a glimpse of that complexity. Historically, stories about mythic worlds were often in an important sense more real than accounts of observable facts. Storytellers conceded that the people inhabited mythic worlds. The events taking place in them were directly visible only to a few, uniquely endowed visionaries (mystics). They also pointed out hidden connections between invisible mythic realities and the ordinary people, places, things and events that they and their audiences daily experienced.

In this blog I would like to set out alternative perceptions of so-called activist investors in financial markets by presenting the myth and reality in five different scenarios. The reader can determine what myth is and what the reality.

Are today’s activist investors "one club" players who through shareholder tyranny force companies to make imprudent changes in their capital structure resulting in a large dividend or share buyback programmes or force a sale of the company without cognizance of the realities of the company’s situations? Do they employ a range of strategies such as returning excess cash on the balance sheet to shareholders, restructuring company assets by selling one or combining several distinct business units to enhance e the combined trading value of the resulting companies’ shares?

Are today’s activist investors focused on “short-termism” as an investment style and is inherently bad for that very reason? Is it true that activist investors like quick returns, as all investors, because the quicker the return on an investment, the higher the IRR and the faster the investment funds can be re-invested for further gain?

Do conventional institutional investors tend to support a target company against a challenge by an activist investor because companies with effective investment returns have credibility with and the trust of their institutional investors, particularly true of their longer term investors and new investors? Alternatively, is there any longer a bias in favor of management among conventional institutional investors because institutional investors are judged by quarterly performance statistics?

Is the best defense against an activist investor is an aggressive structural defense for example by revising its existing poison pill to better target activist investors or strengthening or guard against a call for a special meeting or other proxy contest antics? Perhaps, when a company reviews its defenses, it should be circumspect about introducing new defences or tighten existing ones. Other defensive mechanisms are most likely to be incidental and ineffective because they are likely to create an impression of vulnerability on the part of the target company. Moreover they could hinder efforts to convince other investors to take the company’s side in a forthcoming proxy contest.

Since activist investors rely on stealth in building their ownership stake and in plotting an activist campaign against target companies, does a company has any way no way of knowing whether and when it will be a target of an activist investor? While activists’ investors don’t disclose their plans until they are ready to approach the company privately or publicly, they will deploy existing rules to maximize their freedom of action and to retain the initiative. However activist investors do not target high-performers. They seek out under performing companies. The best defence is for management to recognise that it is under-performing. So, the best defence is to address the reasons for under-performance promptly and decisively.

So were these just made up stories? As it just a made up story? Sometimes we want to know this when we hear these 'stories' (case studies). "What is the truth of them?" is an obvious question. There are stories (case studies) that seem to tell us something even when we know they were made up for us and we might as ask ourselves, "Does it matter whether the story (case study) is literally true?"

This article is the second of Robert McDowall's series on Folklore & Finance.