Is Shareholder Activism Hurting Bondholders?

A recently released research report by Moody’s Investors Service examines the credit impacts of activist shareholder activity, arguing that shareholder initiatives do not always benefit bondholders. In fact, the report suggests that the means by which shareholders drive change in capitalization and strategy, including through share repurchases, increased dividends and divestitures of cash-generating assets, often stresses credit metrics, increasing the risk of holding corporate bonds.

Moody’s argues the risk for bondholders is growing as activists increasingly identify opportunities in larger credit rated companies and as these companies take more proactive steps to avoid being targeted. The report found the industries at the highest risk are technology, health, energy and retail, which accounted for approximately 60% of the 220 activist campaigns in 2013. Among other things, activists generally prefer these industries because of their elevated cash levels, flexibility in capitalization and less restrictive regulations. At the opposite end of the spectrum, the tighter regulatory environments, consistent cash flows and asset mix of companies operating in the financial and utility sectors, make them much less amenable to shareholder change. However the risks to bondholders should be put into perspective. Companies in the financials and utilities sectors are also the most highly leveraged, boast more robust credit ratings and generally offer more contractual safeguards for debt holders, while industries that are more amendable to change carry much less debt, typically rated at more speculative grades.

In addition, shareholder campaigns that are motivated by desires to improve corporate governance by demanding more accountability and strengthening balance sheets through more disciplined management of capital can improve credit profiles and enhance bondholder value. A recent example of this is Canadian Pacific Railway Limited (“CPR”) where shareholder concerns at that company were viewed as credit positive and changes in management nearly two years ago have resulted in improvements in cash flow generation and liquidity such that Moody’s is now reviewing CPR’s rating for a possible upgrade.

Ultimately, the credit impacts of shareholder initiatives will vary by company and industry; however, shareholders who initiate changes and companies taking proactive steps to enhance shareholder value should be mindful of the impact on a company’s bondholders as well as its broader stakeholders. In the context of Canadian corporate law that has been more open to imposing broader responsibilities on directors to treat all stakeholders equitably and fairly, shareholder initiatives that fail to consider the potential impact on various stakeholders will generally face a higher risk of litigation that may interfere with the implementation of desired changes.