The sudden resignation of McDonald's CEO Don Thompson is in part a result of criticism by activist investors. They complained about the company's weak financial performance under his leadership, including poor global same-store sales.

 

Thompson's resignation reignites the debate over whether activist investors are good or bad for companies and shareholders. Are activist investors solely short-term bettors? Or are they constructive critics who push boards to implement positive changes?

 

Activist investors still buy large numbers of a public company's shares and/or try obtain seats on its board to make major changes in the company. But they have changed parts of their business practices over the years I've observed them.

 

In earlier times, they acted like schoolboy bullies, even extorting greenmail from their corporate victims. To forestall activist investors selling their stock holdings back to corporations at a premium over the market (greenmail), Martin Lipton, whose law firm advises corporations, devised the "poison pill," a technique that diluted the ownership share of corporate raiders.

 

In a 2009 New York Times article, "No Barbarians at the Gate; Instead, a Force for Change," quoted activist investor William Ackman of Pershing Square: "It used to be that boards of decent-sized companies were impenetrable. What's changed is that institutions are prepared to replace directors, including the chairman and chief executive, in light of underperformance."

 

The scale of activist investors' activity today is unprecedented. Activist funds with at least $100 billion in capital attracted about twenty percent of all cash inflows into hedge funds in 2014. Activists have targeted 15 percent of companies in the S&P index in the last five years. Those targets included Procter & Gamble, Microsoft, Yahoo, eBay, PepsiCo and Olive Garden owner Darden Restaurants.

 

With so much money flowing into activist funds, a few will make mistakes. For instance, they will force firm to take on too much debt or sell off important divisions.

 

On the other hand, activists can play a positive role. Without them, private shareholders have a difficult time replacing incompetent management. The Economist magazine, in an article last week entitled "Capitalism's Unlikely Heroes," analyzed the 50 largest activist positions in America since 2009. It found that, on balance, companies' profits, capital investments and research and development investments have risen following activist pressure.

 

Activists fill a void. Much investor money is held by index funds and exchange-traded funds that mimic the market's movements and that, by definition, are passive investors. Conventional mutual funds and pension funds have historically disliked becoming deeply involved in firms' management. Because of activist investors, mutual funds and pension funds are forced to take a stand.

 

"Big institutional players listen to both sides and are willing to back the activist fund if they believe in them," said Gregory Taxin, co-founder of Glass Lewis & Co., whose firm helps institutional investors make informed decisions about corporate governance.

 

Activist investors have earned credibility by bringing expertise, passion and financial commitment to support the financial-engineering options they use to enhance shareholder value.

 

They increase transparency, providing insight into the nitty-gritty details of a company's operations. This scrutiny can bring clarity to weaknesses in companies and shows ways they can return more to investors.

 

They have:

 

Removed poor management.

 

Reduced unseemly executive compensation.

 

Encouraged the spin off of underperforming subsidiaries.

 

Encouraged boards to increase dividends and buy back more of their stock.

 

An article in Bloomberg Businessweek, "Predators Are Good for Stocks," argued that activist investors have become shareholders' best friends, saying: "Stocks of companies targeted by activists from 2009 through 2013 gained 48 percent on average as of the end of last year, according to data compiled by Bloomberg. That beat the Standard & Poor's 500-stock index by about 17 percentage points."