LOS d: Explain investor activism in relation to corporate governance and discuss the limitations of investor activism.

Q1. Which of the following is least likely to limit active investor effectiveness?

A)   Managers may become too focused on short-term performance.

B)   Active investors may liquidate their shares.

C)   Active investors are strictly monitored as to their performance.

Q2. Which of the following refers to the situation where an active investor does not own the majority of the firm’s shares but persuades other shareholders of her position?

A)   The active investor has contingent control.

B)   The active investor has formal control.

C)   The active investor has real control.

Q3. In which of the following situations would an active investor be the least effective monitor of management? The active investor holds a:

A)   large block of illiquid stock.

B)   small block of illiquid stock.

C)   small block of liquid stock.

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Q1. Which of the following is least likely to limit active investor effectiveness?

A)   Managers may become too focused on short-term performance.

B)   Active investors may liquidate their shares.

C)   Active investors are strictly monitored as to their performance.

Correct answer is C)

Active investors may not be effective monitors of management because active investors themselves are often unmonitored. Institutional (active) investors rarely face the same pressure that they apply to corporations. Their compensation is usually based on assets managed instead of performance, they are not subject to proxy fights, and they do not carry debt.

Q2. Which of the following refers to the situation where an active investor does not own the majority of the firm’s shares but persuades other shareholders of her position?

A)   The active investor has contingent control.

B)   The active investor has formal control.

C)   The active investor has real control.

Correct answer is C)

An active investor must have control to effectuate change. To have control, the shareholder must have either a majority of the firm’s shares (formal control) or be able to persuade other minority shareholders of her position (real control).

Q3. In which of the following situations would an active investor be the least effective monitor of management? The active investor holds a:

A)   large block of illiquid stock.

B)   small block of illiquid stock.

C)   small block of liquid stock.

Correct answer is C)

If the active investor holds a small block of stock, then they do not have as strong an incentive to monitor management as they would if they held more shares and hence had more at stake. If the stock were liquid, they would also be less likely to be an effective monitor of management because they can easily sell their shares if management misbehaves. If instead the stock was illiquid, the active investor would likely place pressure on management to change because they could not cash out as easily.

Thx!