For many, shareholder activism is a welcome way to hold management teams and board members accountable. But management teams must be prepared to defend the value creation ideas they articulate and understand that shareholders have different views about what’s best for a company.
Tactical Voting
Whether a company becomes the target of an activist investor’s proposal or finds itself on the receiving end of a proxy fight, it can feel like an unwelcome intrusion into boardroom dynamics. In addition to understanding how the legal environment affects a board’s responsibilities in a proxy contest, management teams, and boards must have a plan for responding to various types of shareholder activism.
One of the biggest challenges in responding to shareholder activism is that activists have a different knowledge of a company’s business than its management team or board. This lack of depth can lead to misunderstandings or misinterpretations of an activist’s proposals and ideas. Consequently, management teams and boards must evaluate their ability to communicate effectively with shareholders. Lastly, management teams and board members need to understand that while one institution may not have much impact on a voting outcome, a critical mass of like-minded institutions can. This is especially true for proposals related to environmental and social issues.
Shareholders’ Rights Mechanisms
Shareholder activism can take many forms. Whether an institutional investor seeking engagement with companies around governance matters, a retail investor filing a shareholder proposal, or a hedge fund engaging in a proxy contest, each activist has their agenda. Regardless of the specifics, most companies can expect that a campaign from an activist will be disruptive to operations, distracting the board and management team and causing a pause in strategic initiatives. For example, a company may face pressure to divest underperforming assets, restructure its business, or change executive compensation. In addition to financial reasons for shareholder activism, activists seek to address social issues such as environmental reporting and discrimination. Gaining board seats is often a secondary objective for an activist but can be essential to sustaining a campaign and achieving the ultimate goal of changing corporate policies. For that reason, boards need to understand the legal framework surrounding shareholder rights and the responsibilities of directors and management.
Aside from the legal aspects, a successful defense against an activist requires preparation beforehand. By identifying areas of vulnerability, such as a high level of indebtedness or inefficient balance sheet, and reaching out to significant shareholders to solicit their views, the board can avoid an unwanted activist incursion. It may also be beneficial to seek common ground with activist investors, focusing on ideas that increase value rather than relocating value from one place to another.
Conflicts of Interest
Companies may find themselves a target for activist engagement if they have governance weaknesses or their financial policies must align with investors’ interests. For instance, activist investors may want to see changes in those areas if a company carries out costly acquisitions or is hoarding cash on its balance sheet.
Hedge fund activists often look to unlock value they believe is unrealized. For example, they might encourage a company to boost dividend payouts or reduce its debt leverage. They may also press for changes in corporate financial policies like capital structure, asset sales, and spinoffs. They might also call for companies to divest from politically sensitive areas or require better worker treatment or greater accountability on environmental issues.
As such, boards need to understand that their interests are sometimes at odds with those of shareholder activists. They should participate in shareholder activism simulation exercises to learn how to adapt their responses when confronted with an activist campaign quickly. In addition, they should evaluate actions that can decrease their vulnerability to activist pressures, including effectively communicating with shareholders and articulating a business strategy’s long-term value-creation potential. Lastly, they should consider incorporating ESG and governance/ESG considerations into their investment decisions and stewardship practices, as these have become increasingly important to many investors.
Leadership Transitions
As we head into 2020, shareholder activism looks to rise. Activists will continue to focus on various issues, including board independence, majority voting policies, and “say on pay” votes. While many companies have a good record of defeating activists, the fact remains that institutional shareholders are increasingly pushing for greater influence and more direct interventions.
While naysayers will likely sing the standard chorus that greater shareholder engagement could make it even harder for boards to attract and retain directors, the opposite is true. The presence of activist shareholders and the potential for more aggressive intervention by shareholders can give boards the spine they need to stand up to management in difficult situations.
Another trend boards should be aware of is the increasing ability of activist investors to gain traction in non-US markets, particularly Europe and Asia. These global activist funds have become more sophisticated and are often willing to enter a settlement with a company that includes a standstill undertaking. This will prevent the activist from reengaging with the company until certain changes have been implemented, giving the company time to address its concerns and prove that they work. Boards must be open to the possibility that an activist will seek to engage them and be prepared to do so thoughtfully and respectfully. A well-structured approach that leverages basic negotiation theory (such as the principle of bundled bargaining) can increase the likelihood of meaningful progress in improving corporate governance and boardroom dynamics.
