Ethical CSR focus triggers hostile investor activism, study finds

Companies that rank highly on corporate social responsibility measures are more likely to be the target of hedge fund activism, academic research has found.

This is because some activist investors view CSR as a sign that a company is wasting money rather than focusing on shareholder returns, according to research conducted by Pennsylvania State University’s Mark DesJardine, Erasmus University’s Emilio Marti and HEC Paris business school’s Rodolphe Durand.

That is particularly the case if such hedge funds activists, which tend to target and call for a shake-up at inefficient companies, view a company’s efforts to do good as little more than superficial greenwashing.

Activist hedge funds look at CSR as a signal of relative misalignment

The research looked at 506 US-based activist campaigns between 2000 and 2016 and found that companies whose CSR ratings were above the industry average had a 5 per cent chance of being subject to hedge fund activism. That compares with a 3 per cent likelihood for the industry average.

In industries with poorer CSR ratings on average, companies that put greater emphasis on such issues are more likely to be targeted, the research also found.

“Activist hedge funds look at CSR as a signal of relative misalignment” with delivering shareholder returns, says Prof Durand.

A focus on ethically-oriented practices was seen as a sign of wasteful spending, which “prevent[s] firms from maximising shareholder value in the short term”, wrote the academics, who also interviewed a range of hedge fund managers for their research.

The findings coincide with a surge of interest in environmental, social and governance investing in recent years, which is helping persuade companies to improve their reputations for ethical behaviour to attract investors. Global sustainable investing assets totalled more than $30tn in 2018, according to the Global Sustainable Investment Alliance, up from $22.8tn in 2016.

While the coronavirus crisis has diverted some investors’ focus this year, many in the industry believe demand for this type of investing will continue to grow.

Paul Polman, Unilever's former chief executive, is among business leaders who have stuck to their guns in defending broader ESG mandates when challenged by outside investors. After he fended off an unsolicited $143bn takeover approach from Kraft Heinz and its private equity investors in 2017, he described the abortive bid for Unilever as “a clash between people who think about billions of people in the world and some people that think about a few billionaires”.

HEC's Prof Durand says he believes that conclusions from the research, which goes only up to 2016, are still valid despite a recent pick-up in ESG investing. He says that activist hedge funds are not fundamentally opposed to a company focusing on CSR, but rather concerned that it was an indicator of greater waste. Signalling credentials in corporate social responsibility “can be a cosmetic signal sent to customers” without any clear proof that it generates value for shareholders, he says.

An activist today should actually aim at pushing companies toward best-in-class and authentic CSR strategies

But there have been signs that parts of the hedge fund industry, known for its focus on profits, have started to view ESG as being in line with shareholder returns. Man Group and Caxton Associates are among fund managers that have been exploring ways to profit, while Marshall Wace has been looking to raise $1bn for a new computer-driven fund that will trade stocks based on their environmental and other ethical attributes.

Strong CSR performance creates shareholder value and is “fully aligned with shareholders’ interest”, says Quentin Dumortier, founder of hedge fund firm Atlas Global Investors. “An activist today should actually aim at pushing companies toward best-in-class and authentic CSR strategies as a powerful driver to create shareholder value.”

Some commentators argue however that the idea that better ESG ratings will lead to better returns is false and instead see unnecessary costs incurred through ethical behaviour in many areas.

The researchers also note that unintended attention from activist hedge funds concerned by CSR distractions can create additional costs for targeted businesses. These could include hiring lawyers or a public relations specialist, or the loss of focus as top management respond to the activist attack. Countering a hostile activist can cost tens of millions of dollars or more.

Prof Durand adds that the impact of hedge funds on companies’ ethical efforts is not straightforward. Nor is it always negative if clearly communicated. Explaining how CSR meshes into the business model reduces the chances of becoming an activist target, he says.

Hedge funds targeting such companies “are not anti-CSR, per se”, Prof Durand argues. But their scepticism over the benefits of ESG commitments made by companies is “because they prefer shorter-term rather than longer-term returns”.