Why shareholder activists are set to leapfrog North American companies
December 2015 | SPOTLIGHT | BOARDROOM INTELLIGENCE
Financier Worldwide Magazine
It appears too many North American companies are still not getting the message when it comes to preparing for shareholder activism. Boards should be under no illusion that what got them through this year will get them through the next.
At the time of publication there have been 140 proxy fights in North America – 106 in the US and 34 in Canada. The bad news for management is activists are racking up wins and are once again set to outpace them. The even worse news is activists and their tactics are evolving at a far faster rate than their targets.
Activists are attracting superior talent, more capital, and are effecting change. Gone are the days when top graduates from elite business schools wanted to be bankers; now they want to be activists, chasing the returns and fame that comes with it.
The taint of working with an activist has also dissipated. Institutional investors are setting aside capital to back their campaigns and are working cooperatively with them behind the scenes. It’s not uncommon for the more conservative, long-term funds to quietly call an activist and say, “I like what you did with my investment over here, I have another one you might be interested in...”
It shouldn’t come as a surprise – though it often does to issuers – that given the sheer number of activists, we are seeing more and more instances where multiple activists enter a stock in what is referred to as a ‘wolf pack’. Multiple activists mean it will be hard to isolate your challenger and may mean the potential for a full blown and costly proxy fight is greater if they are willing to split costs.
But the problem for issuers is twofold – it’s not just that the resources on the activist side are growing; it’s that they’re changing the way the game is played.
Activists know boards don’t want to waste time and money on a proxy fight if they can avoid it and directors certainly don’t want to have their reputations damaged in the media. This makes activists more willing to attempt to negotiate behind closed doors and use the threat of a public fight, however credible it may be, as leverage.
This new age of openness has given birth to ‘constructivists’ – activists who go past the criticism to bring forward solid ideas that demonstrate a level of sophisticated analysis companies themselves are unable to match. Constructivists are willing to sit down and talk privately, avoid making news, and work collaboratively on ideas that are no longer simply limited to the balance sheet and the board but consider improvements that require the help of management to make happen.
Tactically, the growing willingness of boards to appease has led to activists relying more heavily on a ‘short slate’ in proxy fights that only seeks to replace a portion of a board. Not only is it easier to win when you only need to prove two or three of your nominees are better than existing directors, but activists have found management is willing to consider a small expansion of the board or identify a few sacrificial lambs among the incumbent directors who can be given up to cut a deal.
When you factor in calls from governance experts and major shareholders for ‘true’ majority voting (the ability to not just withhold a vote on a director but actually vote against), proxy access (that would afford a shareholder the ability to nominate a director and have them included in equal standing in a company’s proxy materials), and the possibility that universal proxies may become mandatory, the ground is set to shift even further under the feet of issuers and open up new avenues for disgruntled shareholders.
Encountering this new wave of activism requires recognition that not all activists are equal. A nuanced approach is needed. Despite how they have been painted in the media, we are seeing activists who, like directors, are more flexible, open to negotiations and are willing to hold a position for years, not weeks. This means activist can no longer be seen by directors as a time bound crisis to manage but shareholders to be engaged.
Rather than a kneejerk defensive strategy, companies should be encouraged to start by listening and avoid the ‘not invented here’ syndrome. Ask yourself what aspects of a proposal make sense objectively or could be adapted to create value. Don’t be afraid to attribute credit by indicating you are interested in something brought forward by a shareholder and vetted by the company.
Demonstrating a degree of flexibility can help you avoid a messy battle because chances are, if a constructivist is going to take time to do a work up on your company and take time to meet, they have a pretty good idea that the prescription they are recommending makes sense to at least a few other shareholders.
Being in a position to have this conversation and deal with an activist promptly means thinking like the new wave of activists. Companies need to think holistically in terms of areas of not just vulnerability, but areas where improvement might be warranted vis-à-vis best practice or what the competition is doing. How does your growth rate compare? Is your risk profile appropriate? Are there operational innovations that should be considered? How would your strategy need to change in an X percent downturn?
Once those areas have been identified, having a clear story and rationale about what action will or will not be taken to share with shareholders is important. Ensure the theories are stress tested by outside advisers to avoid ‘groupthink’ and provide additional defence.
Yes, this will take a lot of time, especially at the board level, but the message to directors is clear – do the work now so you can win later.
Wes Hall is the founder and chief executive officer of Kingsdale Shareholder Services. He can be contacted on +1 (888) 683 6007 or by email: firstname.lastname@example.org.
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