Activist interventions are being increasingly resolved by way of settlement agreements, with 3% of activist interventions in 2000 having resulted in a settlement agreement versus 16% in 2011. In light of this emerging trend, the Columbia Business School recently published a paper, Dancing with Activists, in which the authors sought to provide the first systematic analysis of the drivers, nature, and consequences of such settlements. The authors identified 4 main drivers of settlement agreements: (1) the activist’s stake; (2) market reaction to a SEC Schedule 13(d) filing; (3) settlements in past engagements; and (4) past firm performance.
It is of note that in reaching their conclusions, the authors only reviewed activist intervention in the United States.
The Activist’s Stake
When the activist has a larger stake in the company, it is more likely that a settlement will result. A higher stake provides a signal of the activist’s confidence that it would be able to increase the target firm’s value. A large activist stake also means that the activist has more votes and therefore has more leverage in reaching a settlement because they pose a more credible threat to ousting the incumbents. The authors found that when the activist’s stake is above the median (6.4%), the probability of a settlement increases by about 4-5%.
Market Reaction to 13(d) Filing
An activist holding a stake in a U.S. target is required to file a SEC Schedule 13(d) upon acquiring more than 5% of any class of securities of a public company if they have an interest in controlling the management of the company. The market reaction to this filing will affect the likelihood of a settlement. A favourable market reaction signals the market’s approval of the activism campaign, thereby increasing the activist’s bargaining power.
Settlements in Past Engagements
Activists with a track record of obtaining settlements in past contests are associated with an increased likelihood of a settlement. This track record is likely a result of having high credibility to win proxy contests, therefore providing the activist with better chances of reaching a settlement in the future. The authors found that each past settlement adds about 3% to the probability of reaching a settlement in the current campaign.
Past Firm Performance
If the target firm has poor past performance, a settlement is more likely to take place. Again, this relates to the bargaining power of the target. The activist is more likely to gain approval from other voters if they are dissatisfied with the management of the target. This bolsters the activist’s credibility in succeeding and therefore leads to an increased likelihood of settlements.
Nature of Settlements – Incomplete Contracting
Hedge fund activist investors want to effect operational changes to the target company or require an increase in shareholder payouts. Despite this, many of the settlement agreements do not contract for these large scale changes and agreements are mostly restricted to boardroom turnover. Postponement of the operational changes allows the incumbent directors to save face – the immediate firing of a CEO, whom the incumbents had been previously supporting, may be publicly viewed as “throwing the CEO under the bus”. Instead, settlements often result in the appointment of a number of activist-affiliated directors to the board who then join the independent incumbent directors. The open-minded board can be persuaded by the activist’s directors thereby allowing for greater changes downstream without the immediate costs of taking the conflict to a contested election.
 See Dancing with Activists, Table 1 at Page 46.
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The author would like to thank William Chalmers, Summer Student, for his assistance in preparing this legal update.