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Divest or Engage: Not an Easy Choice for Activist Shareholders

Activist shareholders engage companies because they are concerned about how these businesses behave. For larger institutional investors it isn’t that simple.

Activist shareholders are targeting high-tech companies selling to China, technology they say is being used by the country to restrict human rights. But the choice for these shareholders is a tricky one. Do they engage companies and try to influence business behavior or do they divest their shares, avoid potential liability and cut off further communication with the company?

Some activist shareholders are discovering that while there is a need to make these high-tech giants accountable to their investors; the path of engagement is often long term and frustrating.

For Boston Common Asset Management, a small activist asset manager that owned 167,000 shares of Cisco Systems and has been engaged in a six-year dispute over its business practices, the choice became simple after Cisco’s annual meeting last November. Boston Common sold its shares because it was not happy with Cisco’s business practices and their refusal to engage its shareholders. Boston Common even sponsored a shareholder resolution calling on Cisco to study steps it could take to reduce the likelihood its business practices might lead to violations of rights like freedom of expression and privacy. Cisco opposed the proposal.

For Cisco, which has 5.5 billion shares outstanding and is currently valued at over $115 billion, the challenge from a small shareholder such as Boston Common is easy to ignore. But shareholder challenges will continue – from small shareholders like Boston Common to larger coalitions of shareholders who have banded together to debate investment issues and possibly change corporate behavior. Companies likely to face the activists’ ire are high-tech giants like Microsoft and Yahoo that have huge footprints in China.

It’s easy for small activist funds like Boston Common with a self-selected portfolio to sell off Cisco and say they feel good about having tried to fulfill their mission of responsible investing. And true, their action has already caused some reputational damage to Cisco. But for larger institutional investors it isn’t that simple.

Institutional investors say they often don’t have a choice of which companies are in their portfolios because they invest in market baskets that contain a diversity of stocks from companies as large as Cisco, Microsoft and Yahoo, or sector dominators such as Exxon Mobil, Wal-Mart or Rio Tinto.

Shareholders engage companies because they are concerned about how these businesses behave. “A lot of it is about risks to the investors themselves, about not subjecting investors to reputational damage,” explains Michael Garland, executive director for corporate governance for New York City Comptroller John Liu, who is investment advisor to the New York City Retirement Systems, which include NYCERS and four other pension funds. “Staying engaged is about changing behavior,” Garland adds.

Indeed, for very large, universal owners with clearly defined fiduciary standards, such as big public funds, it is not really a choice of whether to divest or engage, Garland says. The cost of divestment typically cannot be justified as a fiduciary. So if you have concerns, engagement is really the only option.

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