Activism and Takeovers

At the core of agency problems in widely held firms is a dual coordination failure: Dispersed shareholders neither share in the cost of governance interventions (ex post free riding) nor sell shares unless the price at least matches the expected value improvement (ex ante free riding). Whether to confront the free-rider problem in its ex post or ex ante variant amounts to the choice between activism and takeovers. For small toeholds, the returns to these governance mechanisms have inverse comparative statics, and though less efficient, activism is more profitable when the potential value improvement is large. Activists are most effective when, instead of restructuring firms themselves, they broker takeovers. Such takeover activism is Pareto-improving and should earn superior returns, in part because it must pay more than what could be earned by free-riding on a tender offer instead.