Activist Settlements

Abstract

Recently, activist investors have been reaching settlements with boards more often than they have been challenging boards in a proxy fight. In this paper, I provide a theoretical framework to study the economics of these settlements. The activist can demand that his proposal be implemented right away ("action settlement") or demand a number of board seats ("board settlement"), which also gives the activist access to better information. I find that the information that will be conveyed by the incumbent's response is a critical strategic determinant of the activist's settlement demand. Compared to action settlement, the incumbent's rejection of board settlement reflects more of its private information, increasing the activist's credibility to run a proxy fight upon rejection. As a result, consistent with the empirical evidence in literature, demanding board settlement leads to a higher likelihood of reaching a settlement, the likelihood of board (action) settlement increases (decreases) with information asymmetry, and the average ex-post shareholder value upon reaching board settlement is lower than upon reaching action settlement. By contrast, the ex-ante value created by demanding board settlement can be higher. Moreover, even though value-destroying projects are typically not implemented following settlements, the existence of settlements may nevertheless destroy shareholder value due to the free-rider problem, and strikingly, making activism more costly may actually alleviate this free-rider problem. Finally, obtaining fewer seats can increase the activist's "real" control within the board.