Shareholder activism and the timing of blockholder disclosure

Transcription

1 Sareoder activism and te timing of bockoder discosure Simon Gueguen University of Paris-Daupine, Tis version: January, 207 Simon Gueguen is member of Daupine Recerce en Management (DRM), CNRS Unit, UMR 7088, University of Paris-Daupine, Pace du Maréca de Lattre de Tassigny, 756 Paris, France.

2 Sareoder activism and te timing of bockoder discosure In tis paper, we propose a mode incuding te trading stage (acquisition of sares and bockoder discosure) and te governance stage of activism. We anayze te bockoder s timing of discosure, aowing for a strategic beavior. In some cases, te bockoder vountariy renounces to use te fu reporting window and makes an immediate announcement. Te key to te anaysis is te idea tat wat appens during te trading stage infuences te governance stage via te beief of te firm s incumbent about te wis or capacity of te bockoder to aunc a confrontationa activist campaign if e does not cooperate. Tis mode aso offers te possibiity to discuss te consequences of a sortening of te ega discosure period. It predicts tat sortening te ega reporting window woud ony affect te expected benefit of te bockoder wen te cost of activism is ow or te created vaue is ig. Suc a reform woud favor minority sareoders. Keywords: Reguation, discosure, bockoding, sareoder activism. 2

3 . Introduction Te roe payed by activists in te sareoder vaue creation as been we documented by te empirica iterature in recent years. It appears tat most of te positive impact of activism on te sare price appens wen te presence of an activist bockoder in te sareoding structure of te company is reveaed (e.g. rav et a., 2008). However, te underying teoretica modes ony focus on te governance stage of activism, and ignore te first stage were te potentiay activist sareoder acquires a bockoding and as to announce it. Te beief of te firm s incumbent on te abiity of te bockoder to aunc a confrontationa activist campaign is key to te outcome of te governance stage. Incuding te possibiity of a strategic beavior in tis first stage aows a more compreensive anaysis of sareoder activism. In Marc 20, a ruemaking petition as been submitted to te Securities and Excange Commission (SEC) by a prominent aw firm, Wacte, Lipton, Rosen & Katz (WLRK). Considering tat te reporting rues for te acquisition of bockodings are not up-to-date in today s financia markets, tey ask for a tigtening of tese rues. Te main caim of tis petition is a reduction in te discosure deay, wic dates to te Wiiams Act (968). Currenty, te time to pubicy discose acquisitions of over 5% of a company is 0 days; te WLRK associates propose to reduce it to one business day. Tey argue tat te bockoders take advantage of tis ong-time period to continue to accumuate sares above te 5% tresod, wie te sare price did not incorporate te vaue reevant information of te presence of te bockoder. Market transparency and protection of sma, uninformed investors, require to sorten te ega deay. Some researcers ave taken position against tis petition. Tey expain tat te bockoder discosure reguation soud not take fu transparency as a fina objective, and tat any cange in tis reguation soud not be undertaken before an examination of its economic impications for investors (ebcuk and Jackson, 202). Using te empirica evidence tat bockoding announcements by activists ead to positive stock price reaction (rav et a., 2008, Cifford, 2008, Greenwood and Sor, 2009, Kein and Zur, 2009, ect et a., 205), and tat tey create vaue in te ong run (ebcuk, rav and Jiang, 205), tey consider te abiity for tese 3

4 bockoders to capture a bigger part of tis created vaue during te reporting window as egitimate. Tey deveop te argument tat sortening tis deay woud deter activist bockoders to enter te sareoding of companies, and tat tis woud resut in ess vaue creation for a te sareoders. As a resut, te effect of suc a cange in reguation woud aso be detrimenta to te minority (uninformed) sareoders, contrary to te aeged objective of te petition. Tis opinion, owever, is based on te idea tat te trading profit obtained by activists troug buying sares from uninformed investors during te ega deay is necessary to make activism profitabe. Te existing iterature does not provide evidence supporting tis idea. Tere exists a teoretica iterature on sareoder activism, but it as mainy focused on te governance aspect of tis activity, especiay te trade-off faced by te activist between te costs and te benefits of monitoring (Admati, Pfeiderer and Zecner, 994, Maug, 998). In order to discuss te impact of a cange in te ega deay, we need to take account on te fact tat te bockoder may adopt a strategic beavior wen se acquires and discoses er participation, and tat tis beavior may ave an impact on te governance stage. Te objective of tis paper is to provide a teoretica mode considering te interactions between te trading and discosure stage, and te governance stage of activism. To our knowedge, tis is te first mode of tis kind in te iterature. Interestingy, ebcuk et a. (203) provide an empirica study on discosure timing and prediscosure accumuation of sares by bockoders (on te U.S. market). Tey notice tat most bockoders use te fu ega deay (tey discose 8 to 0 days after crossing te 5% of ownersip tresod), but a significant portion of tem decide to discose immediatey (more tan 0%). Anoter important finding is tat investors oter tan activist edge funds aso make a substantia use of te ega deay. Tey use tese resuts to sustain te idea tat tere is no need for a cange in reguation. However, tese findings are aso compatibe wit te idea tat te bockoders beave strategicay regarding te timing of discosure, and tat te difference between activist edge funds and te oter kinds of bockoders are smaer tan ypotesized in tis iterature. Activism is a governance mecanism by wic a sareoder of a company, generay oding a (possiby sma) bock of te company s equity, imposes te management to take specific measures. Tese measures can go from financia poicy decisions (increase dividends, start a sare buyback program ) to a cange in te strategy or in te perimeter of te firm. Activist 4

5 campaigns, owever, are costy. Gantcev (203) estimates te cost of a confrontationa activist campaign at $0.7 biion, wic is about two tirds of te return obtained by te activist from te campaign. In suc cases, bot te activist sareoder and te current management of te firm woud be better-off if te operationa canges coud occur before te campaign. Te management as an imperfect knowedge of te abiity of suc minority bockoders to aunc an activist campaign. Some sareoders are usua suspects of future activism (ike activist edge funds or some industria sareoders). However, te border between active and passive sareoders as become burred. On one side, usua activists try to avoid costy activist campaigns by putting pressure on management. In Marc 205, te activist investor Harry Wison agreed to witdraw is nomination at te board of directors of Genera Motors after te firm announced a $5 biion sare buyback program. On te oter side, investors usuay considered as passive are increasingy wiing to beave ike activists wen tey consider tat te firm faces serious governance probems. Te word reuctavists as emerged to describe tose reuctant activists. Overa, te beavior of te management once te presence of suc a bockoder is reveaed depends on te beief tat tis bockoder wi become active if canges are not impemented. For tis reason, being seen as a potentia activist is important for te bockoder, because it may induce te management (or te controing sareoder) to undertake favorabe actions by imsef. If te bockoder reay as te intent and abiity to aunc an activist campaign, it may aow er to obtain te poicy decisions se expected witout bearing te cost of te campaign. If se does not ave tis intent or abiity, se sti as a cance to be seen as a potentia activist and to obtain vaue creation. In tis paper, we sow tat te timing of bockoder discosure may be used as an instrument to convince te management to undertake tose actions before a confrontationa activist campaign is aunced. Discosing eary, wie te reguation does not require er to do so, is a way for te bockoder to sow tat se is more interested in te vaue created by governance improvements tan in te possibiity to reaize trading profits by accumuating sares at a ow price in te days preceding te announcement. We argue tat te discosure timing decision is te resut of a trade-off between tis abiity to appear ike a potentia activist (eary discosure) and te possibiity to egay trade sares on superior information (ate discosure). Te aim of tis paper is to provide a teoretica framework aowing to study tis trade-off, te conditions 5

6 under wic te bockoder discoses earier or ater, and te consequences of a sortening in te ega discosure deay. Te rest of te paper proceeds as foows. Section 2 reviews te existing iterature on sareoder activism and discosure timing. Section 3 and 4 present te mode and its equiibrium. Section 5 derives te empirica predictions of te mode and anayses te consequences of a cange in te discosure reguation. Section 6 concudes. 2. Reated iterature Most teoretica and empirica studies reated to corporate discosure consider announcements as exogenous. Tey predict or measure te impact of tese announcements on stock prices or investors beavior. For exampe, Pevzner, Xie and Win (205) measure te market impact of earnings announcements in different countries. However, oter papers consider te strategic decision of vountary discosure. Teoretica researc on tat issue as mainy focused on te information fow from managers to investors. Ferreira and Rezende (2007) propose a mode were managers decide to revea teir strategic pan or keep tis information private. Tey face a trade-off between keeping te possibiity of canging project impementation (no discosure) and providing incentives for partners to undertake project-specific investment (discosure). Cemmanur and Tian (202) sow tat many companies decide to deay te announcement of upcoming dividend cuts to te market. Ony te companies wit temporary difficuties decide to discose eary. Te most common discussion point in tis iterature is te intention by te manager to reduce or not information asymmetry wit outside investors. Good news is usuay discosed eary. ad news may be discosed eary in order to reduce information asymmetry and increase iquidity (aakrisnan et a., 204), or ate wen te news fow in te market is suc tat te impact of te bad news wi be ower (ouand and Dessaint, 205). Te intraday discosure strategy as aso been studied, wit te same idea of an asymmetry between good news and bad news discosure. For exampe, Gennotte and Trueman (996) sow tat managers prefer to reease positive news during trading ours and negative news after trading ours. Micaei, Rubin and Vedrasko (204) provide evidence tat te immediate 6

7 market impact of earnings announcements is 50% smaer wen tey occur during trading ours. In te same vein, Deavigna and Poet (2009) find tat investors temporariy underreact to news wen tey are discosed on Fridays (owever tis resut may be due to seection bias, as noted by Micaei, Rubin and Vedrasko, 206). Niessner (205) sows tat managers take advantage of tis effect and discose negative news on Fridays or before oidays, wen investors are supposed to be distracted. Takeover bids constitute business situations were vountary discosure occurs frequenty. For exampe, rennan (999) study te vountary earnings forecasts discosure from targets of takeover bids on te U.K. market between 988 and 992. He sows tat tese targets tend to discose more frequenty in case of ostie takeover, wit a discosure bias in favor of good news. In te same vein, on a Frenc sampe of takeover bids between 2006 and 20, Negre and Martinez (203) sow tat bot te bidder and te target use vountary press reeases to try to infuence te outcome of te (friendy or ostie) bid. Corporate insider trading aso constitutes a possibe cause of vountary discosure. Fisman and Hagerty (995) propose a mode of insider trading were te market cannot observe if te supposed insider is reay informed. Tey sow tat making discosure mandatory can ead to iger profits for uninformed insiders (tey can misead te market about teir information and obtain trading profits). Ceng and Lo (2006) sow tat strategic discosure may be used by informed managers to manipuate sare prices and obtain trading profits: tey tend to discose bad news before te acquisition of sares. ockoder discosure coud not precisey be considered as vountary discosure, since te announcement is mandatory. However, te bockoder is not obiged to discose immediatey and may keep er trading private information for a few trading days. Te fact tat se sometimes decides to discose eary wie se coud discose ate is a vountary (possiby strategic) eary discosure. Tis issue is cose to te question of vountary discosure, since te bockoder decides to give a vauabe information to te market wie se coud keep it private for a few more days. Sareoder activism as been te subject of severa studies in te ast 0 years. Most of tem are empirica studies and focus on edge fund activism. For exampe, rav et a. (2008) find a 7

8 +7.% CAR of te target on a 20 days window centered on bockoding announcement by an activist edge fund. Tey aso sow tat tese activists earn a significanty iger return tan te size-adjusted vaue-weigted stock portfoio. Simiary, Kein and Zur (2009) and Greenwood and Scor (2009) find a significant market reaction of bockoding announcements. A tese papers focus on activist edge funds on te U.S. market, and tey measure CARs between.6% and 7.2% around te announcement. On an Itaian sampe, Croci and Petrea (205) found a positive CAR around discosure date (+0.93%) and trading date (+.76%). On te onger run, ebcuk, rav and Jiang (205) ave sown tat tere is no price reversa. In a study based on activist campaigns on U.S. pubic firms between 994 and 2007, tey find tat return and vauation (measured by Tobin s Q) are consistenty iger five years after te activist campaign. Tey suggest tat te positive cumuative abnorma returns (CARs) observed at bockoder discosure are not a sort-term price effect but represent te anticipation of a permanent vaue creation for te target due to future activist interventions. Tese empirica studies generay ignore passive bockoders. Te U.S. bockoder discosure reguation makes a big difference between active and passive bockoders. Active bockoders are submitted to te Scedue 3D rue: wen teir beneficia ownersip (defined as proportion of cas-fow rigts or voting rigts in te firm s equity) reaces 5%, tey must discose teir position witin 0 trading days. If a bockoder as no intent to become active, se is submitted to te muc igter discosure requirement known as Scedue 3G (te discosure may occur severa monts after te trade). Despite tis difference, Cifford (2008) compares te market impact of active (3D) and passive (3G) bockoders, and sows tat te CAR is iger for 3D. Tese empirica studies are buit up on governance modes were bockoders create vaue by monitoring te firm or treatening to se teir sares. Tose two ways to create vaue are caed voice and exit since te semina artice of Hirscman (970). However, tere is a ack of teory on anoter aspect of bockoding announcements: te discosure strategy. ecause te bockoder is not obiged to discose immediatey, se can use te 0 days ega deay to continue to accumuate sares at a price wic is ower tan te price tat woud prevai in a we-informed market. Te objective of tis paper is to fi tis gap. We propose a mode expaining te timing of discosure by te bockoder, and aowing a conceptua anaysis of te impact of an eimination of te ega deay, as caimed by te WLRK petition. 8

9 3. Mode framework Tis section presents a muti-period mode of ownersip discosure and activism by an outside bockoder. Start of te game Wen te game starts, a pubic firm is under te contro of an incumbent ( I ), wo may be a manager (in case of disperse or passive ownersip from current sareoders) or a controing sareoder. An investor, denoted in te foowing as te bockoder ( ) and possiby owning a previousy acquired toeod K of te firm s equity, considers buying an additiona quantity of sares of te target. Typicay, K is te eve of ownersip just one sare beow te ega tresod of bockoder discosure (5% of sares outstanding in most reguations, minus one sare). Te existence of tis bockoder is not a pubic knowedge. Te prior probabiity of presence of suc a bockoder in te firm s capita is. In tis paper, we study te situation were te announcement of a bockoder as a significant impact on te firm s stock price. Typicay, soud be sma, so tat te announcement is a reevant news. In te mode, we set ypotesis H. H:. 3 Te bockoder is described as ig type (t ) if se as te abiity to aunc an activist campaign on te firm ( ) and ow type ( t ) if se ony may remain passive ( ). At te start of te game, ony te bockoder knows er type. In te foowing, q is te prior probabiity of te bockoder being ig type (conditiona on er existence). Te prior beiefs and q are ed by I and a te uninformed agents in te market (outside investors, oter sareoders of te firm); te type of te bockoder is ony known by ersef at te start of te game. Trougout te game, te incumbent and te uninformed agents wi update teir beiefs using ayes rue. 9

10 Te rest of te game consists of two stages, eac of tem incuding severa steps. Te trading stage represents te acquisition and/or sae of sares by te bockoder, and its discosure. Te governance stage is a game were te payers are te incumbent (current controing sareoder or manager) and te bockoder. Te ink between te trading stage and te governance stage is tat te former wi infuence te beief of te incumbent about te type of te bockoder. Trading stage In te trading stage of te mode, (in case of existence) as te possibiity to trade sares of te target. ecause se aready owns K, se knows tat if se acquires at east one more sare se wi ave to discose er ownersip. may trade on er two informationa advantages reative to te pubic: er existence and er type. We assume tat is risk-neutra, so tat se simpy maximizes er expected fina weat (denoted W if t or W if t ). Tere are two rounds of trading in te trading stage (trade and trade 2). Regarding te price at eac round of trading, I appy standard vauation concepts were te current vaue of te firm is equa to te discounted vaue of future cas fows. Here te ony cas fow is te fina vaue of te firm v. Te discount factor is set equa to, so tat te current price of te firm p i prevaiing at trade i is te expected vaue of v conditiona on te pubic information wen te sares are traded (semi-strong form efficiency): pi ( v Ii) for i,2 were I i is te pubic information at te date of trade i. Let s denote t i as te percentage of te firm s sares traded by at trade i ( ti 0 if buys sares, ti 0 if ses sares). Te bockoder pays (receives) tp i i wit ti 0 ( ti 0 trading i. At eac round of trading, a maximum portion L of te firm s sares may be traded by : ) at t, t [ L; L]. 2 0

11 If t 0, te acquisition triggers a discosure obigation since te tota size of te bockoding becomes at east equa to te first ega ownersip tresod. must trutfuy discose er ownersip, but se is not required to do so immediatey. Se may discose eary (eary announcement, d a) or ate (ate announcement, d b). Discosing eary means tat se announces er ownersip (arger tan 5% if tis is te ega tresod) immediatey after te first trade (if positive) at step T. Discosing ate means tat se does not make any announcement at tat step. In case of acquisition, se wi be obiged to discose after te second trade. Ten te second round of trading (trade 2) occurs at step T2, after ( d a) or before ( d b) announcement. Foowing tis second round, is obiged to discose. In case of eary announcement, se must update er notification. In oter words, at te end of te trading stage, te compete trading and discosure beavior of is pubicy known. Notice tat under te U.S. Scedue 3D reguation, te bockoder must prompty update er fiing after any materia cange in te fact discosed, ike te acquisition (or disposa) of anoter % of te sares of te firm. Under te Frenc reguation, a notification is required wen te bockoder ownersip reaces 0% or fas beow te 5% tresod. If te announcement occurs severa days after crossing te ega tresod, te bockoder must discose er ownersip at te date of announcement (incuding te sares acquired during te reporting window). In tis mode, tere is fu discosure after te trading stage, eiter because te bockoder cose to discose ate, or because se discosed eary and ad to update er announcement after te second round of trading. In te foowing, et s denote x as te portion of te firm s equity tat ods at te end of te trading stage: x K t t2. X wi stand for te maximum possibe ownersip after te trading stage: X K 2L. It wi be sown, under te assumptions of te mode, tat te ig type bockoder aways od a portion X of te firm s equity at te end of te trading stage. wi

12 Governance stage Te end of te trading stage eads to te second stage of te mode (governance stage). Like in Gantcev (203) and Jonson and Swem (206), activism is sequentia and its cost depends on te beavior of te incumbent. Te fina vaue of te firm is v. We normaize te status quo vaue of te firm at zero (witout oss of generaity). Tis status quo vaue v 0 is beow te fu potentia vaue V, because reacing v V woud require an additiona effort from te incumbent ( I ), ike a stronger monitoring, a reduction in te private benefits e extracts from te firm, or a manageria effort. Obviousy, I may aso benefit from an increase in te vaue of te firm (variabe compensation if I is a manager, capita gain in proportion of te percentage of ownersip if e is a controing sareoder); owever, tis benefit must be ower tan te cost of effort, oterwise I woud make tis effort even witout te intervention of an activist sareoder. Let s denote e te net cost of effort for te incumbent wo decides to make tis additiona effort. In te foowing we ypotesize tat e is stricty positive ( e 0 ). I as 3 possibe eves of utiity ( U ). Te status quo utiity of te incumbent is set to: I UI R, wit R e. For exampe, R may represent a eve of private benefits tat I can extract from controing te firm. Te utiity of te incumbent wen e decides to make te additiona effort (wat we ca cooperation ) is: UI R e. Finay, in case of confrontationa activism from, te eve of utiity of I woud be significanty reduced. Te utiity of I in case of confrontationa activism is normaized at: UI O. 2

13 In oter words, R represents te oss of utiity due to a confrontationa activist campaign. Te incumbent is better off making te additiona effort ( U R e) tan suffering from suc a campaign ( U I O). I In te foowing, we wi aso use as an indicator of aversion to activism from te incumbent, R were ( 0 ). is ig if te status quo utiity of te incumbent is arge compared e to te cost of cooperation. Remember tat tere are two types ( t or t ) of bockoders. Some bockoders ( are abe to aunc an aggressive (confrontationa) activist campaign. However, since tis kind of activism is costy ( c represents te cost of activism for ) ), te bockoder wi aunc a campaign ony if I does not make te effort e. Te cost of activism is stricty positive, but it is sufficienty ow tat wi aways engage in activism if se as bougt sares at bot rounds of trading and I did not make te effort. Tis is ypotesis H2. H2: 0 c XV. Te ow type bockoder ( ) is not abe to aunc suc a campaign. may make profit ony by beaving ike and oping for an effort from I, or by manipuating te sare price and seing its sares during te trading stage. Remember tat te proportion of ig types of bockoders q is common knowedge (wit 0q ). Te sequence of events is presented in figures and 2 and described beow. [INSERT FIGURE AROUND HERE] 3

14 Sequence of events Te timing of te game works as foows. Step T0. Wit a probabiity, a bockoder aready owns a toeod K of te target firm s equity and considers buying or seing sares (wit ( ), tere is no suc bockoder and te game stops). K is one sare beow te tresod wic triggers mandatory discosure. Wit probabiity q, te type of te bockoder is ig ( ), wit probabiity q it is ow ( ). Ony may aunc a (costy) activist campaign during te governance stage. Trading stage Step T. decides to trade sares of te firm. Te maximum number of sares tat se may trade represents a portion L of te firm s equity. Te tota price of te firm s equity at tat step is p. Te trading of is t [ L; L], and te tota price paid (received) is tp if t 0 ( tp if t 0 ). If t 0, must (trutfuy) discose er trade and tota ownersip. Tis announcement may be done eary ( d a ) or ate ( d b). Eary announcement means tat discosure is made at step T just after te acquisition. Late announcement means no discosure at tat step. Step T2. Tis step is te second round of trading. decides to trade a portion t 2 of te sares of te firm, wit t 2 [ L; L], at price p 2. After step T2, if t 0 or t t 2 0, must discose er trade and ownersip at te end of te trading stage. In case of eary announcement ( d a), se must discose er second trade and er fina ownersip. In case of ate announcement ( d b), se must discose er tota trade of te trading stage and er fina ownersip. Notice tat if t 0 and t t 2 0, tere is no announcement. However, as wi be sown in equiibrium computation, tis absence of announcement wi revea tat tere is no ig type bockoder, wic is a sufficient information for te incumbent at governance stage. 4

15 [INSERT FIGURE 2 AROUND HERE] Governance stage Tis stage occurs ony if a bockoding announcement as been made (if tis is not te case, it means tat tere is no ig type bockoder in te game, and te vaue is v 0 ). Step G. Te incumbent I decides to cooperate ( g wi improve te firm s vaue, or resist ( g 0 ). e ) and makes an additiona effort wic Step G2. If, te bockoder may aunc an aggressive activist campaign ( c) or remain passive ( 0 ). If, te bockoder remains passive. Step G3. Te vaue v of te firm, te weat of and te utiity of I are reaized, and te game ends. Te vaue of te firm is v campaign. It is v 0 oterwise. V if I cooperated or if aunced an activist 4. Equiibrium of te mode Te bockoder coses a trading, announcement and activism strategy to maximize er expected fina weat. Te incumbent coses a cooperation strategy to maximize is expected utiity. Te market price of te firm s equity is equa to te expected fina vaue of te firm given te pubic information avaiabe at te date of trading. Te existence and type of te bockoder is er private information. Te beiefs of uninformed agents are updated using ayes rue wen an information is made pubic. Te equiibrium is defined as foows. Definition. An equiibrium is a set of trading { t, t 2}, discosure { d } and governance { } strategies for eac type {} t of bockoder, wit market prices { p } at eac trading date, and cooperation beavior { g } from te incumbent, tat satisfy: i 5

16 (i) Weat maximization from te bockoder, suc tat te trading, discosure and governance beavior maximizes te expected weat of te bockoder given er type, market prices and te cooperation beavior of te incumbent. (ii) Utiity maximization from te incumbent, suc tat is cooperation beavior maximizes is expected utiity given te expected governance beavior of te bockoder. (iii) ayesian updating, suc tat te incumbent revises is priors on te presence and type of bockoder regarding er trading and discosure strategy, and te market prices at eac date of trading are te expected fina vaues of te firm given te pubic information at tat date. Tis definition corresponds to a perfect ayesian equiibrium for a muti-period game, as formay defined by Fudenberg and Tiroe (99). We sove te game using backward induction. Te soution of te governance stage is rater simpe. ecause of te ypotesis H2 ( 0 c XV ), if te bockoder as bougt te maximum possibe sares at eac round of trading, se wi aways aunc an activist campaign if se is ig type and te incumbent didn t cooperate. Lemma presents te soution of te governance stage wen t t 2 L, wic means x X. We introduce G as te probabiity of te bockoder being of type t according to wat se did in te trading stage. G is obtained by te incumbent using ayesian inference. Tis variabe is a resut of te trading stage, and is key in te resoution of te governance stage. Lemma. If x X, tere is te foowing equiibrium at governance stage: e - if G, ten I decides to make te additiona effort ( g e); R 6

17 e - if G, ten I decides not to make te effort ( g 0 ); R e - if G, ten I is indifferent about making or not te effort. He may use any pure R strategy, or even any mixed strategy were e makes te effort wit a probabiity k, wit k [0,] ; - if I makes te effort, does not aunc an activist campaign; if I does not make te effort, decides to aunc an activist campaign if er type is t if er type is t. and remains passive Proof. See appendix. Soving te governance stage for x X is a sufficient intermediate resut to sove te trading stage, since at equiibrium te resut of te trading stage wi be x X in case of presence of a ig type bockoder. If x X, te updated beief about te type of te bockoder wi be 0, and te governance stage wi be straigtforward (no cooperation and no activism). G e Te case G is te resut of te trading stage wit a non-zero probabiity; terefore, in R e Lemma we ad to specify te beavior of I at equiibrium wen G. Te consequence R of Lemma is tat te fina vaue of te firm depends on te type of and te decision of I ; and tis decision depends on te beief of I about te type of. Te vaue wi be v t V wen, since wi aways buy at trading stage wen er type is ig (as wi be sown in propositions and 2). In tis case, eiter I wi cooperate, or wi aunc an activist campaign. Te vaue wi aso be v V if is ow type but te beief about er type is ig e enoug ( G ). Tis is te reason wy wi (sometimes) beave ike R incumbent wi cooperate., oping tat te Propositions, 2 and 3 are te main resuts of tis paper. Proposition presents te equiibrium wen te prior probabiity of t is ig, so tat te bockoder wi aways buy even if se 7

18 is ow type, and te incumbent wi aways cooperate. In tis case te announcement wi aways be ate ( d b). Propositions 2 and 3 present te equiibria wen te prior probabiity of t is ow, so tat te ow type bockoder wi not aways beave ike a ig type bockoder, and wi foow a mixed strategy. Proposition If e q, tere exists an equiibrium were te bockoder aways buys and never announces R eary, and te incumbent aways cooperates: - t t2 L - d b - G q - g e - Te market prices are given by p p2 V Proof. See appendix. Tis intuition of te proof is te foowing. If te prior beief of t is ig enoug, even if te ow type bockoder aways decides to beave ike te ig type bockoder, te updated probabiity of t remains ig so tat te incumbent is better off wen e cooperates. In turn, because I wi aways cooperate, te bockoder aways buys since se knows tat te fina vaue wi be v V and se wi not need to aunc an activist campaign. In terms of discosure strategy, proposition says tat te discosure wi be ate wen te prior beief of t is ig. ecause a arge proportion of te bockoders are abe to aunc an activist campaign, announcing eary wi increase te price of te second trading round p 2 (by reveaing te presence of te bockoder); tis iger price wi not induce te bockoder to se at tat step if se is ow type, since se knows tat er type wi ave no effect on te governance stage (no need to become active). As a resut, an eary announcement woud ony negativey affect te fina weat of te bockoder by increasing te price paid at step T2. 8

19 Tis is te source of te first important prediction of tis mode: wen te bockoder is ikey to be a potentia activist, se tends to discose ate. Her reputation wi be strong enoug at te governance stage, so tat se does not need to discose eary to put pressure on te incumbent. e We now turn to te more interesting case were q. In tis case I wi not aways R cooperate. We wi sow tat after an eary announcement ( d a) te incumbent wi tend to cooperate more often tan after a ate announcement ( d b). Te intuition of te resut is tat an eary announcement wi increase te price because it reveas te presence of a bock ( p 2 wi be iger). As a resut, if te bockoder is ow type ( ), it wi be more expensive for er to imitate (buying L at price p 2 ) and more profitabe to se at step T2. y announcing eary and continuing to accumuate sares ate step T2, sends a signa about er type. We wi ave a mixed strategy equiibrium were I needs to cooperate more often wen d a to make indifferent between buying and seing at step T2. Tus, if te bock is ig type, an eary announcement reduces er expected cost of governance. Atoug, tis eary announcement increases te price at te second round of trading, because it reveas er presence. Consequenty, it reduces te potentia trading profit of te bockoder. Te discosure strategy wi depend on te resut of tis trade-off between cost of governance and trading profit. Proposition 2 describes te equiibrium wen te reative cost of activism c V is ow, and proposition 3 wen it is ig. In te first case, tere wi be a ate announcement in case of acquisition at first trading round ( d b); in te second case, tere wi be eary announcement ( d a). Te trading and governance strategy of te bockoder wi now depend of er type (wie it was not te case for e q ). R Proposition 2 If 9

20 q e R and c M V, were M [ X ( ) 2 Lq ] 2( 2 ), ten tere is an equiibrium wit te foowing caracteristics: (i) Prices at step T and T2 are given by p b and p 2b, respectivey. (ii) If, ten t t 2 L and d b. (iii) If, ten te bockoder as a mixed strategy. Wit a probabiity m, imitates t t L and d b); wit a probabiity ( m) ( 2, ses sares at bot rounds of te trading stage ( t t 2 L ). (iv) If t t 2 L and d b, ten I decides to cooperate ( g e) wit a probabiity k b, and not cooperate ( g 0 ) wit probabiity ( k b ). (v) If t t2 L and d a (out-of-equiibrium), ten I decides to cooperate ( g e (vi) If t ) wit a probabiity k ba, and not cooperate ( g 0 ) wit probabiity ( k ba ). In tis case te price wi be p 2ba. Lor t 2 Lten I does not cooperate ( g 0 ). (vii) If and g 0 ten decides to aunc an activist campaign. In a oter cases remains passive. Wit p p V b 2b 4L q X q m q 20

21 k b X 4L q k ba 3 k 2 p 3p 3p b 2ba 2b b Proof. See appendix. Proposition 3 If q e R and c M V, ten tere is an equiibrium wit te foowing caracteristics: (i) Prices at step T and T2 are given by p a and p 2a, respectivey. (ii) If, ten t t 2 L and d a. (iii) If, ten te bockoder as a mixed strategy. Wit a probabiity m, imitates t t L and d a); wit a probabiity ( m) ( 2 buys at step T, announces eary, and ses at step T2 ( t L, d a and t 2 L). (iv) If t t 2 L and d a, ten I decides to cooperate ( g e) wit a probabiity (v) If t k a, and not cooperate ( g 0 ) wit probabiity ( k a ). L, t 2 Lor d bten I does not cooperate ( g 0 ). (vi) If and g 0 ten decides to aunc an activist campaign. In a oter cases remains passive. Wit 2

22 p p a 2a p 2a V 2L q X q m q k a X 2Lq Proof. See appendix. Te genera idea of propositions 2 and 3 is tat te ig type bockoder faces te tradeoff between te trading stage benefit of a ate announcement and te governance stage benefit of an eary announcement, wie te ow type bockoder as a coice between imitating (buying at eac round of trading and foowing te same discosure strategy) or seing sares. For, te coice of announcing eary or ate is te resut of a trade-off between: - paying a ower price p 2 wen se announces ate (trading stage benefit of d a) - obtaining a iger probabiity of cooperation wen se announces eary (governance stage benefit of d b). At equiibrium, wi aways buy at trading stage, and aunc an activist campaign if I does not cooperate. Te expected utiity of wi tus be: ( U t L, t L) XV Lp Lp ( k) c 2 2 Te coice to announce eary or ate comes at step T, just after te first trade. So, te trade-off tat is facing may be formaized as a comparison between te trading stage benefit L( p p ) and te governance stage benefit c( k k ). 2a 2b a b 22

23 L( p p ) c( k k ), ten discoses ate (se does not make an announcement after If 2a 2b a b er first trade). If L p2a p2b c ka kb ( ) ( ), ten discoses eary in order to increase te probabiity tat te incumbent wi cooperate at governance stage. Tese conditions are equivaent to c M V and c M V, respectivey. Notice tat te condition c M V (respectivey c M V ) for proposition 2 (proposition 3) is sufficient for equiibrium but not necessary. A we need for proposition 2 (proposition 3) equiibrium is c X V (respectivey c X V 2 ). X We sow in te demonstrations tat M ], X[. Tis means tat tere is a range of vaue for 2 te reative cost of activism c V were bot pooing equiibria ( d a and d b ) coexist. Te tie-breaking rue we used is te foowing: te cosen equiibrium is te one wic maximizes te utiity of at te end of step T. Notice tat te ow type bockoder aways foows te same discosure strategy as tat wit tis tie-breaking rue, wen se crosses te discosure tresod ( t L ). Notice aso does not aways cose te equiibrium wic maximizes er tota utiity, since se cannot commit to a discosure strategy at te start of te game. It means tat, since te price at step T is ower in case of ate announcement ( p b p a ), woud prefer a ate discosure more often tan described by te tresod M if se coud commit not to discose eary. [INSERT FIGURE 3 AROUND HERE] Overa, discosure wi be eary wen te ex ante probabiity of te bockoder to be ig type is ow enoug, so tat te incumbent wi not aways cooperate, and te reative cost of activism 23

24 is ig enoug, so tat te bockoder wants to increase te probabiity of cooperation from te incumbent (figure 3). Next section presents te empirica predictions of te mode. 5. Empirica predictions of te mode In tis section, we derive te empirica predictions of te mode. Te two main points of controversy are discussed: te discosure strategy of bockoders, and te possibe impact of a sortening of te ega discosure window. Discosure strategy of bockoders Proposition estabises tat wen te prior probabiity of being of ig type is ig, te bockoder wi aways coose to discose ate. Tis is te first empirica prediction of te mode about te discosure strategy of te bockoder. Wen a bockoder as te reputation to be a potentia activist, se does not need to discose eary because wen er presence is reveaed te pressure on te incumbent is ig enoug to generate cooperation. However, tis mode aso considers te case were te prior beief of to be active is ow. In tis situation, an eary announcement is a way to increase te pressure on te incumbent at te governance stage. y discosing eary and continuing to acquire sares at te second round of trading, signas tat er intent is not a sort-term trading profit but te creation of sareoder vaue. Notice tat te signaing effect does not come from te eary announcement itsef: at equiibrium, wen te conditions of proposition 3 are satisfied, a types of bockoders wi announce eary (te equiibrium is pooing in discosure strategies). Te signaing effect appears at te second round of trading, wen te bockoder continues (or not) to buy wie se announced eary. Te discosure strategy of te bockoder depends on te cost of sareoder activism (c), reative to te fina vaue of te firm in case of activism (V). If te cost of activism is reativey ow, wi prefer to announce ate since te trading stage benefit of a ate announcement wi exceed te governance stage benefit of an eary announcement. Regarding, if we are in te case were a ig type bockoder woud announce eary, se wi aso buy at step T and 24

25 announce eary, so tat se does not revea er ow type. At step T2 se foows a mixed strategy and buys wit a probabiity m and ses wit ( m). Se wi buy more often wen te prior beief about er type is tat se is ikey to be ig type ( q is ig). In tis case, se tends to buy because te probabiity of cooperation from I is iger. wi aso buy more often wen te aversion to activism ( ) is iger ( k a is increasing in q and ). In case of ate announcement, te mixed strategy of occurs at step T. Since we ave a pooing equiibrium were bot types of bockoder announce ate (and obviousy, tere is no announcement if tere is no bock), seeing no announcement provides no information about te existence or te type of te bock. Tus, p b p2 se se soud do it at step T. Te probabiity of imitating q eary announcement ( m q ), and for te same reasons. b. Tis is te reason wy if wants to is te same as in te case of an To derive empirica impications of te mode about te discosure strategy of te bock (wen q is ow), we need to anayze te tresod M wic separates te two equiibria. M [ X ( ) 2 Lq ] 2( 2 ) Wen te reative cost of activism ( c V ) is iger tan M, tere is eary announcement if a bockoder crosses te notification tresod ( t 0 ). If it is ower, tere is ate announcement. As a consequence, in order to study te empirica predictions of te mode, we ave to anayze ow M varies wit te probabiity of arising of a bockoder ( ), te prior beief about te type of tis bock ( q ), te iquidity of te firm ( L ), te size of te toeod ( K ) and te aversion to activism of te incumbent ( ). For a given reative cost of activism, eary announcements (respectivey ate announcements) wi be more frequent wen M is ower (iger). 25

26 Probabiity of arising ( ) Wen is iger, te bockoder tends to discose ater. In te trade-off c( k k ) versus L( p p ) 2a 2b, ony impacts k b and Lp. Using p2 2b b XV kb we ave: 4 a b XV ck Lp2 ( c ) k 4 b b b We know tat if XV c, te bockoder wi cose a ate discosure ( d b 4 ). If XV c, 4 because kb is increasing in, a iger wi improve te net gain from ate discosure. Wen te probabiity of arising of a new bockoder is ig, tis bock wi tend to discose ate. Tis finding may be combined wit te previous one (from proposition ) tat tere wi be ate discosure wen te probabiity of te bockoder to be a potentia activist is ig. Overa, a prediction of te mode is tat te bockoding announcement wi be ate for te firms tat are most ikey to be targeted by activist sareoders. Prior beief ( q ) and aversion to activism ( ). Te prior beief about te type of te bockoder and te aversion to activism ave te same impact on te discosure strategy. Wen tey are ig, eary announcements are more frequent ( M is decreasing in q and ). Tis resut is not straigtforward since a iger q or increases te cooperation and te prices in bot announcement cases ( k a, k b, a increasing in q and ). p 2a, and p 2b are Tecnicay, te resut comes from te fact tat te infuence of q and is iger on ka tan on kb because of te roe of in k b. Intuitivey, if te prior beief is tat te bock is ikey to be a potentia activist, and/or if te incumbent as a ig degree of aversion to activism, I wi cooperate more often to avoid a confrontationa activist campaign. Tis is te case after a ate announcement, but even more so after an eary announcement because in tis case te second 26

27 round of trading wi pay a signaing roe about te type of te bockoder. Terefore, a iger prior beief ( q ) or aversion to activism ( ) induces an earier discosure. Toeod ( K ) and iquidity ( L ). Te impact of te toeod can be seen troug X ( X K 2L ). A iger toeod reduces te probabiity k of cooperation. Tis comes from te beavior of, wo wi prefer to imitate wen te toeod is ig because te potentia gain if I cooperates is arge. Tus, I must cooperate ess frequenty to make indifferent at equiibrium. ecause of te possibiity of aving no bock, te (negative) impact of K is arger on k a tan on k b, so M is increasing in K. Wen te toeod is arge, te bockoder tends to discose ater. A arger iquidity ( L ) aso increases M and makes a ate announcement more ikey. Te variation of M wit L is easy to study: we ave a factor 2( ) 2q at te numerator, wic is positive (using ). q Tere are in fact two competing effects regarding iquidity. On te one and, L as te same impact as te toeod: wi want to imitate because te benefit in case of cooperation is iger, and as a resut I wi cooperate ess frequenty. On te oter and, it aso as te same impact as te prior beief ( q ): if L is arge, te incumbent knows tat imitating te ig type is costier for and e wi tend to cooperate more often. Te net effect owever is in favor of a ate announcement (wen q e ). In oter words, a prediction of te mode is tat wen R iquidity is arge, te bockoder wi tend to discose ate. 27

28 Anaysis of a cange in discosure reguation Te main point of controversy about bockoder discosure reguation in te U.S. is te possibe sortening of te discosure window. Te SEC is considering tis possibiity, wic was te main point of te WLRK petition. ebcuk, rav and Jiang (205), among oters, are against tis idea. Te consequence of a arge discosure window is tat it gives te possibiity for te bockoder to continue to accumuate sares at a ow price before announcing te trade to te market (trading stage benefit in te mode). Teir argument is tat tis possibiity aows te activist bockoder to capture a arger part of te vaue creation tat woudn t occur witout er. In oter words, sortening te window (to one trading day, as suggested by te petition) woud deter some activist bockoders to enter te capita of firms, wie tey are a source of vaue creation. Tey suggest tat minority sareoders benefit from a arge discosure window, since te gain from encouraging activist bockoders is arger tan te oss due to te possibiity for tese bockoders to trade on private information. Tey aso sow tat, frequenty, te bockoder decides to discose eary. In an earier study, ebcuk et a. (203) aso find tat te bockoder does not aways use te fu ega deay and sometimes makes announcement immediatey after crossing te 5% of ownersip tresod. However, tey do not consider te possibiity of tis eary announcement being te resut of a strategic coice. Te mode is compatibe wit tis empirica evidence, but I concude te opposite regarding te interest of minority sareoders. Te WLRK petition and ebcuk, rav and Jiang (205) agree on te fact tat te purpose of te bockoder discosure reguation soud be te best interest of te minority uninformed sareoders. Te mode supports te idea tat tigtening te reguation woud fufi tis purpose. Sortening te discosure window wi ave a consequence wen te bockoder woud prefer to discose ate. And tis is te case wen te reative cost of activism is ow ( c M V ). In tis case, te expected gain obtained by te (activist) bockoder is reduced; but tose are te situations were te profit from activism is very ig (ow cost of activism, ig vaue creation). In oter words, if suc a decision wi reduce te tota gain of te bockoder, it wi not deter er from buying sares and creating sareoder vaue. 28

29 On te contrary, te bockoders wo ave a ower gain from activism (because activism is costier to tem, or te tota potentia vaue is ow) are tose wo coose to announce eary anyway, and sortening te announcement window wi not cange teir discosure strategy. Notice tat, if te bockoders are obiged to discose eary, it wi not deete te governance stage benefit from tis eary announcement. Te signaing effect comes from te beavior at step T2 (not seing sares, wie te sare price went up), not from te eary announcement itsef. A reduction in te ega deay wi not reduce te expected benefit from te bockoder wen te reative cost of activism is ig ( c M V ). Tese are te situations were te potentia activist bockoders are te most ikey to renounce te acquisition of sares if te expected gain from teir operation is reduced. However, tese aso are te situations on wic te reduction of te reporting window caimed by te WLRK petition woud ave no effect. According to te mode, sortening te discosure window wi not inder activist campaigns. It wi ony affect te distribution of te created vaue wen te cost of activism is ow. Te activist bockoders wi sti obtain substantia benefits from teir campaigns, but tey wi not be abe to continue to trade against uninformed investors during te ega deay. As a consequence, a arger part of te created vaue wi go to te minority uninformed sareoders. 29

30 6. Concusion Te SEC is considering to sorten te ega discosure period for bockoders after an acquisition above te 5% of ownersip tresod. Te WLRK petition asks for a reduction from 0 days to day of tis period. ot te supporters and opponents to suc a cange consider te best interest of te uninformed minority sareoders as te reevant purpose of bockoder discosure reguation. However, te scarce empirica evidence and te absence of a teoretica mode of bockoder discosure precudes any argued prediction of te impact of a cange in reguation. Te proposed mode incudes te trading and governance stages of activism, aowing te beavior of te bockoder during te trading stage to affect te outcome of te governance stage. Tis mode igigts te strategic aspect of te coice in te timing of bockoder discosure. Te bockoder may discose ate, in order to accumuate sares at a ow price during te deay. Doing so, se captures a arger part of te vaue created by its activism, as expained by ebcuk and Jackson (202). Se aso may discose eary, immediatey after crossing te 5% of ownersip tresod. Discosing eary and not seing er sares after te announcement is used as an (imperfect) signa of se being a potentia confrontationa activist. As a resut, te incumbent wi coose to cooperate more frequenty in order to avoid an activist campaign. Te bockoder wo as te potentia to aunc suc a campaign ( ) faces a trade-off between te trading stage benefits associated wit a ate announcement, and te governance stage benefits associated wit an eary announcement. Tis mode predicts tat, wen te cost of activism is ow compared to te vaue creation, te bockoder wi use te fu ega deay, wie wen tis reative cost is ig, se wi discose immediatey to put pressure on te incumbent and avoid te costs associated to confrontationa activism. Wen te bockoder does not ave te abiity to go for a confrontationa activist campaign ( ), se may trade on te price increase after te bockoder discosure, or ope for cooperation from te incumbent at governance stage. Considering te possibiity tat te trading stage of activism infuences te governance stage, tis mode offers te possibiity to anayze te discosure strategy of bockoders, and study te possibe impact of te reguation cange advocated by te WLRK petition. ebcuk et a. (203) find empirica evidence tat some bockoders decide to discose immediatey after 30

31 acquisition, wie tey are not obiged to do so. Te mode is compatibe wit tis evidence, but its predictions regarding te effect of a sortening of te reporting window are te opposite. Atoug suc a cange wi reduce te part of te created vaue tat te activist bockoder is abe to capture, we do not find tat it woud prevent or inibit activism. Sortening te ega reporting window woud ony affect te expected benefit of te bockoder wen te cost of activism is ow or te created vaue is ig; it woud not restrain te acquisition of sares by bockoders or teir invovement in te process of vaue creation. Tus, te mode predicts tat, if te purpose of te reguation is te best interest of te minority uninformed sareoders, te proposition of te petition soud be adopted. Te proposed mode makes severa oter empirica predictions, concerning te key variabes in te timing of announcement. An empirica anaysis of te timing of bockoder discosure, studying te variabes expaining te coice of te bockoder (eary or ate discosure), coud confirm or contradict te mode, and improve te overa understanding of sareoder activism strategies. Tis paper focuses on te best interest of te minority uninformed sareoders, since bot te supporters and opponents to a cange in bockoder discosure reguation agree tat tis soud be te purpose of financia reguation. Tis mode ignores te interest and possibe infuence of oter kinds of investors in te activist process. First, it does not consider te effect of compex sareoding structures wit severa bockoders, and te possibiity of coaitions during te governance stage. Tere is empirica evidence tat te presence of mutipe bockoders in te sareoding structure of a firm may affect its vaue (for exampe asu, Paegis and Ranamaei, 206). Second, debtoders pay no roe in te mode, wie tey may react to sareoder activism, wit an impact on oan spreads (Sunder, Sunder and Wongsunwai, 204). Aowing different kinds of investors to pay a roe in te process of activism woud certainy be a vauabe extension of te mode. 3

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35 Figure. Trading stage. 35

36 Figure 2. Governance stage. Figure 3. Discosure strategy of te bockoder. 36