This year has seen a series of high-profile proxy fights occupy both the front pages and the attention of several boards and their governance teams. But this is no mere blip: more prevalent shareholder activism is here to stay, according to industry professionals. What used to be an outlying investment style has become an accepted fact of life on Wall Street and in the boardroom.
FTI Consulting rates the US as having an activist threat level of 10 out of 10, and describes the country as ‘the epicenter of shareholder activism worldwide.’ According to the firm, there were a record 645 campaigns in 2016, and 405 by mid-2017. In the first half of this year, more than 100 companies with market caps above $10 billion were targeted by activists – more than the total of any full year since 2010, according to Activist Insight. Institutional investors are allying themselves with activists and putting forth slates of board candidates who are not just employees of the hedge fund firm targeting a company.
Emboldened by this support, activists are in turn asking for management changes from the outset of their campaigns, observers say, adding that macroeconomic factors and evolving corporate cultures have driven activism to become more governance-oriented. At the same time, there has been an increase in operational activism and a reduction in emphasis on financial engineering. Andrew Siegel, partner at communications and investor relations (IR) firm Joele Frank, tells Corporate Secretary that activism has gained credibility as an investment class and is the new norm. ‘Activists have become increasingly sophisticated,’ he points out. Now they are formal, recognized and credible, he adds: ‘And that’s not going away.’
LOOK AT YOURSELF – AND THEM
Lawyers and consultants who track and follow the shareholder activism space say directors, general counsel, corporate secretaries and management should take a pre-emptive look at their own company through the lens of a would-be activist. Crisis planning is a standard part of overseeing any organization but there are still publicly traded companies that don’t have an activist response plan ready on the shelf and available for rapid response, according to industry professionals.
From the issuer’s dividend policy to share buybacks, capital allocations and business strategy, corporate secretaries and general counsel should ensure their boards are actively thinking about their company’s strengths and weaknesses, how it differs from its peers and where an activist might find a handhold, observers say. At a minimum, they point out, every public company should know who would constitute their core team if faced with an activist approach.
Corporate secretaries should be briefing their boards on trends in activism, Gibson Dunn & Crutcher partner Lori Zyskowski tells Corporate Secretary. Boards need to understand where their own policies differ from industry best practices or where there may be a cluster of shareholder-unfriendly provisions, she says. They should be briefed on current thinking on governance issues and, even if they don’t adopt the latest practices, boards should know and understand where there are potential problem areas, she adds.
Gardner Davis, partner at law firm Foley & Lardner, tells Corporate Secretary that many public companies go through simulations on how to respond to an activist and have completed related assessments. Some hire outside experts – sometimes even an activist – to carry out the assessments for them. These should be updated each year to reflect changing conditions at the company itself, changes relative to peers and changing best practices, Davis says. ‘No directors should get on-the-job training in real time,’ he adds.
Assessing the activists is another proactive step companies could consider. Questions issuers might ask include: what campaigns have the activists run in the past? What are their goals? What’s their investment period? Who do they consider to be the company’s peers in the industry?
Siegel says it is important to have a single day-to-day leader of the activist defense project – typically the general counsel or CFO – while the CEO often must keep running the company. Teams work well when they’re put together early, he adds. Similarly, Davis says it is important for the company to speak with one voice, generally that of the chief executive, the chair or a director.
Zyskowski points out that an early meeting with an activist would typically involve the CEO, CFO and maybe IR officials. If the activist has a governance focus, the corporate secretary or general counsel should also be involved, she says. ‘It’s important to have the experts in the room for the type of conversation [you need to have],’ she adds.
COUNTERACTING INFLUENCE
Activists are described as enjoying an increasingly cozy relationship with the community of institutional investors, including passive funds that own shares in many companies. They are engaging with such firms sometimes five or six times a year, in the context of different campaigns, over the course of many years. Boards face the challenge of counteracting this influence. A director and maybe the general counsel or corporate secretary should consider doing an off-season outreach roadshow with institutional investors to develop their own relationships and offset the imbalance, lawyers and consultants advise.
Steven Balet, managing director at FTI Consulting, tells Corporate Secretary that institutional investors may have a changing appetite for risk as a result of their greater familiarity and comfort with activists. In the past, they may have been inhibited by the risk of a disruptive management change at a target company; now, they weigh that change against the risk of doing nothing at all, he explains.
‘In today’s world, in the event of a proxy fight, the tie goes to the activist investor when it comes to interjecting fresh blood into the board of directors,’ Davis observes. ‘Also, there’s a general idea among the proxy advisory firms and their institutional investor clients that electing outside directors who are skeptical of the established order is likely to generate a better governance product.’
An off-season roadshow that engages with institutions is an emerging best practice, lawyers and consultants say. Such rapport-building exercises have been embraced by large-cap companies, and they are being considered more and more by mid-caps. Even when a face-to-face meeting doesn’t happen, funds appreciate the outreach and the demonstration that the company is engaged, professionals say. For smaller companies, those meetings can be harder to arrange, but one lever even small caps have is ESG issues, which are increasingly important to many institutional investors. As a result, these investors want to engage with their portfolio companies on such matters.
‘Since the advent of say on pay a few years ago, good companies, top companies have significantly increased engagement with institutions and specifically with index funds,’ Siegel points out, though it may be a mistake to treat an off-season ESG-related meeting as being like an investor presentation, he adds. His prescription for directors and corporate secretaries is less talking and more listening, and he advocates that companies consider not making a presentation at all during off-season engagements. ‘Those meetings need to be different,’ he explains.
Balet says recent proxy fights have shown him that boards now see it as their job to educate shareholders on the portfolio companies of the activist, a development connected to heightened ESG awareness. They might point out where there have been extensive layoffs, audit issues or compensation concerns, for example.
STAY POSITIVE
But it’s also necessary to stay positive, professionals say. In any activist situation, it’s important for the company to avoid negative, personal counterattacks, they argue. Anything that belittles the activist risks compromising the credibility of the board or management, is the advice to governance teams.
‘The natural reaction is fight or flight, and neither of those is a rational response to an activist investor,’ Davis points out. Instead, he says, the company should try to keep an open mind, viewing the activism as a chance to see itself through the eyes of investors, which bring a distinct perspective to the company and the market. The corporate secretary and general counsel have a key role in setting the tone within the company in order to assure the CEO not to take anything too personally.
Lawyers and consultants suggest constructive engagement is the biggest trend as boards increasingly understand that avoiding the circus of a full-on proxy fight is usually a more constructive path. In exchange for a private resolution, the company can make accommodations, such as undertaking a good-faith study of a particular issue or offering board representation, which can be a better outcome for the company than engaging in a public tussle.
Once the activist gets into a public fight with management or the board, the company will be damaged – even if it wins a resultant proxy contest, Davis says: ‘At that point, it’s too late, baby.’
This article originally appeared in the Corporate Secretary special edition on shareholder engagement. Click here to view the full issue.
