How Shareholder Activism Became Toxic—and How to Fix It

Yves here. The fact that this post depicts shareholder activism as the province of extortionist hedge funds reflects a depressing new normal. There have long been the type referred to as greenmail artists, who would target companies with a lot of cash and a relatively underperforming stock. They would accumulate a decent-sized position and threaten a takeover. But the big objective was to secure a big dividend payout or buyback.

There’s an older school of shareholder activists who would focus on governance deficiencies. CalPERS was a big player in its glory days of the later 1980s to 1990s and much of the reputation it once had was based on that. CalPERS would enlist other large investors, particularly other public pension funds, to pressure big companies over practices that bunkered underperforming managements, like poison pills and staggered board. Several studies have found that these campaigns did increase shareholder value.

And at least one study found that CalPERS “aggressive” activism was effective when quiet activism, as in tea and cookies with top execs, is not. A high profile example was late 2009, when a group of institutional investors visited Goldman CEO Lloyd Blankfein to tell him not to poke American taxpayers in the eye by paying Goldman staffers lofty bonuses so soon after having been bailed out. (Note the article below mentions pension funds as being subject to ERISA. That applies only to private pension funds, not public pension funds like CalPERS. But public pension funds generally do hew to ERISA principles).

There is a second school of shareholder activism, that practiced by investors, often hedgies, who identify a company as having not-well-recognized problems with their operations or disclosures. They take a short position and then advertise their findings. A class of this type was David Einhorn of Greenlight Capital, who correctly called out Lehman as a garbage barge (with supporting analysis) in the months before its collapse. But that type has become almost extinct due to the dearth of success short plays in a relentlessly rising stock market.

By Lynn Parramore, Senior Research Analyst at the Institute for New Economic Thinking. Originally published at the Institute for New Economic Thinking website

New book reveals how and why hedge-fund activists have been able to suck the life from big-name companies like J.C. Penney and Samsung with their short-sighted profit-grabs. Can their harmful activities be stopped?

edge-fund activism—where funds push for quick profits by buying up big stakes in companies—has exploded in recent years. In his new book, The Rhetoric and Reality of Shareholder Democracy and Hedge-Fund Activism, economist Jan-Sup Shin of the National University of Singapore, an expert in technology and innovation, dives into how it all began and why it’s a growing problem.

Fans of shareholder activism, such as that practiced by hedge funds, claim that it drives profitability, holds management accountable, and boosts long-term returns for investors. But critics like Shin argue that the rise in activism has fueled hedge funds, pushing companies to waste resources on appeasing their demands—engaging in harmful stock buybacks and other practices that stifle innovation and harm long-term growth.

As Shin points out, most of us get to know the stock market as investors without really grasping how companies create value. In college, we might learn about shareholder value—a theory debunked by economists like William Lazonick—which holds that a company’s primary goal is to enrich shareholders, not to create quality products and services. This mindset, he warns, can lead us to think like activist investors focused on short-term financial returns and wanting companies to make changes that benefit investors above every other consideration.

This mindset has got to change, Shin argues. Because the result is a trail marked by companies we rely on left in tatters.

It all goes back to the early 20th-century “shareholder democracy” movement, which changed the way Americans perceived the stock market. While it may have started as a noble-sounding idea, it ended up morphing into shareholder primacy, where the focus shifted to maximizing short-term profits at the cost of long-term growth. In the end, ordinary people suffer job losses, plummeting quality of goods and services, and general instability, with taxpayers paying the price.

How It All Started

In August 1929, millionaire John J. Raskob, a key figure behind Du Pont and General Motors, boldly declared in Ladies Home Journal: “I am firm in my belief that anyone not only can be rich, but ought to be rich.” His secret? Invest $15 a month in “good common stocks.” It seemed like a simple, irresistible route to wealth—no one could have predicted how quickly that dream would go up in smoke.

Raskob’s words reflect the ideals of the shareholder democracy movement, which had a major impact on the public’s relationship with the stock market. Shin points out that supporters like Raskob believed that not only could workers build wealth through stock ownership, but the process would tie them more closely to companies and to the nation as a whole. The hoped-for social unity would help quell the specter of socialism, which emphasized the divide between capital and labor. As Shin puts it, “If workers became stockholders, they would, in theory, align their interests with those of capitalists, thereby blurring class divisions.” A win-win, right?

Wrong. The Great Crash took place in October 1929, a mere 2 months after Raskob’s advice. Shin recounts how the Dow Jones, which peaked in September 1929, nosedived 40% by year’s end, and by July 1932 it was down 90%. Workers who followed Raskob’s advice of putting $15 a month into stocks got poorer, not richer.

When shareholder democracy failed to make ordinary people prosper, its political appeal faltered, too. The Depression worsened social divisions, and recovery came through the New Deal and WWII, not shareholder democracy.

Shin notes that up to this point, proponents of shareholder democracy had focused on individual citizens as owners of stocks rather than institutional investors (various types of money managers like mutual funds, pension funds, etc). After all, these institutions were fiduciaries, not citizens, with no political rights. Plus, they held only about 5% of the U.S. stock market by 1929, so their influence was minimal.

New Deal policymakers, he explains, distrusted institutional investors, fearing they could boost returns and lower risks in ways regular investors couldn’t. They embraced the “Wall Street Walk” rule—shareholders unhappy with a company could simply sell and move on. Concerned that investor meddling might lead to insider trading or market manipulation, they discouraged activism and regulated shareholder voting groups like cartels. One SEC official even called mutual funds’ role limited to diversification, deeming anything more “thievery.”

Then came the go-go 80s. The separation between institutional shareholders and corporate management started to vanish just as institutional activism started to appear. Shin notes that even in 1974, Congress passed ERISA, which regulated pension funds, pushed for diversification, and stopped them from taking control of companies. Peter Drucker, the famed management consultant, argued that pension funds shouldn’t manage companies—it went against their role as trustees. Until the 1980s, financial regulators saw it pretty simply: managers created value, and institutional investors helped people invest by pooling and spreading risk—each sticking to their role was the ideal.

As Shin explains: “These two groups serve different clients, making it unrealistic to expect their objectives to always align.”

Shin highlights how shifts in rhetoric have reshaped our understanding of shareholder roles, influencing regulation. As he points out, “both rhetoric and reality began undergoing substantial transformation from the 1980s,” driven by the growing power of institutional shareholders. In 1950, institutional ownership of U.S. public stocks was just 7.2%; by 1980, it had soared to 40%, and by 2020, it reached nearly 60%. When including hedge and private equity funds, institutional ownership now exceeds 80%.

That’s a lot of leverage for corporate raiders, activist pension funds, and “entrepreneurial” social activists, like Robert Monks.

“Despite their differing motives and modes of action,” Shin says, these players “formed a common front against corporate managers whom they accused of building their fiefdoms by investing in wasteful projects while ignoring the interests of public shareholders.” This view gained traction in business schools nationwide, fueled by the rise of agency theory and the growing acceptance of the “maximizing shareholder value” doctrine.

Shin explores how it was Monks who really revolutionized shareholder democracy, making proxy voting a fiduciary duty for institutional shareholders while profiting from founding ISS, the first major proxy advisory firm. He explains that traditionally, institutional investors avoided voting, preferring to do the “Wall Street Walk.” But Monks reframed institutional shareholders as “corporate citizens” and legal owners of companies. His activism, supported by pension funds and corporate raiders, dismantled New Deal-era regulations, turning voting into a fiduciary duty and enabling proxy voting groups. Shin notes that since index funds like Vanguard showed little interest in voting, hedge-fund activists and firms like ISS moved in to capitalize on the gap.

Where We Are Today

Today, hedge funds and institutional investors see themselves as the real owners of companies, explains Shin, shaping corporate governance at every turn—and they can do it by remaining minority shareholders, unlike the corporate raiders of yore. That’s because of proxy rule changes in 1992 and 1999 that “allowed the unlimited communication between shareholders, effectively enabling activists to act together as ‘wolf packs.’” This lets activists buy minority stakes and team up, boosting their collective power.

“Taking a minority position is more efficient because it requires less capital in achieving the same objectives while lowering financial risks,” says Shin. “Activists can then allocate the remaining capital to pursue additional actions aimed at gaining profits.”

Minority shareholding lets activists profit from both influencing corporate strategy and capitalizing on stock volatility their actions create. Taking a minority position allows hedge-fund activists to distance themselves from the aggressive image of corporate raiders, presenting themselves as victims of mismanagement and champions of shareholder democracy, thus framing their actions as advocacy for all shareholders.

But that’s not how it usually goes.

A case in point is that of J.C. Penney, once a beloved store for middle-class America—until Bill Ackman’s Pershing Square Capital came on the scene. Shin recounts how from 2010 to 2013, Pershing pushed J.C. Penney to abandon its low-pricing strategy for a higher-margin approach targeting younger consumers, but this alienated its core customers, leading to a revenue decline. Despite Pershing exiting in 2013, the company’s missteps ultimately caused J.C. Penny to go belly up in 2020.

Shin emphasizes that the harmful strategies of hedge-fund activists can be hard for the average person to see – like the case of Samsung. In 2016, Elliott Management launched an activist campaign with 0.5% of Samsung’s stock, prompting the company to pay $26 billion in special dividends and execute $18 billion in stock buybacks. To fend off further attacks, Samsung focused on short-term profitability, cutting critical long-term investments like high-bandwidth memory (HBM), which led to a talent exodus and allowed SK Hynix to surpass Samsung as the global leader in HBM, causing Samsung’s share price to fall nearly 40% from its peak. Many ordinary South Korean investors were left holding the bag and didn’t see it coming.

“The impact of activist intervention may not always be immediately apparent,” observes Shin, “as hedge fund activists typically exit a company after securing short-term gains.” But the resulting confusion and bad decisions often end up hurting the company, its employees, and long-term shareholders.

Shin notes that Toshiba’s decline and ongoing struggles stem from activist pressure, notably from Elliott Management and Third Point, which led to selling its semiconductor division in 2018. Labeling it a “non-core asset,” activists pushed for the sale to strengthen the balance sheet, but losing this critical capability left Toshiba in a weakened, difficult-to-recover position.

What’s the Solution?

In his book, Shin lays out six policy changes to curb activist shareholders’ damage, with the top one being a requirement for shareholders to justify how their proposals actually contribute to value creation or capital formation.

“This measure is key for real dialogue between shareholders and managers,” Shin says.

He insists that he’s not calling for a return to New Deal rules, but he underscores that regulators must focus on the bigger economy and recognize corporations as essential: “We need to acknowledge that shareholders and managers serve different clients with conflicting goals.”

Shin adds that the role of corporations as value creators hasn’t changed since the late 19th century. Managers’ jobs are still about long-term survival and growth. The only common ground with shareholders is a shared focus on long-term growth and rising stock prices. “Asking managers to prioritize short-term gains is asking them to neglect their core responsibilities,” says Shin.

And we’ve all seen where that gets us.