Balancing Concessions to Activists Against Responsiveness to the Broader Shareholder Base

Ethan A. Klingsberg and Arthur H. Kohn are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb publication by Mr. Klingsberg, Mr. Kohn, Elizabeth Bieber, and Rolin Bissell. Related research from the Program on Corporate Governance includes The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here) and Pre-Disclosure Accumulations by Activist Investors: Evidence and Policy by Lucian Bebchuk, Alon Brav, Robert J. Jackson Jr., and Wei Jiang.

Quick settlements with activist hedge funds to recompose boards and adjust strategic plans have resulted in hundreds of new directors and changes to stand-alone plans in the S&P 500 over the last two years. The arguably outsized influence of these activists, which often own less than 5% of their targets’ public floats, led one of the leading hosts of index funds, State Street, to issue publicly a position paper earlier this year in opposition to this “quick settlement” trend. [1] Underlying State Street’s concern is the view that incumbent directors frequently settle to avoid the painful scrutiny and distraction of proxy contests while failing to take into account the sentiments of their companies’ broader shareholder bases. The views of State Street and the other major index funds matter not only because these “passive”-strategy funds regularly control up to 40% of the public floats of listed companies, but also because that figure is likely to continue to rise steeply, along with similar increases in the interest of these funds in (as well as the number of personnel at these funds scrutinizing) governance, board composition and processes, and strategic shifts at publicly traded companies. As a result, targets of activist campaigns are increasingly struggling with balancing the benefits of a quick and comprehensive settlement with activist hedge funds against the desirability of assuring that there is broad shareholder support, especially among long-term institutional holders, for making concessions to the activists.

CSX’s quick settlement earlier this month with relative-newcomer activist hedge fund Mantle Ridge fits within this mold of quick and significant concessions to less than 5% holders, but includes some novel characteristics indicative of the target company’s concerns about responsiveness to its broader shareholder base. In a mere 47 days, Mantle Ridge’s campaign netted four new non-management board seats, a promise that the board would not be expanded until the 2018 annual meeting, and the installation of a new CEO, E. Hunter Harrison, who came on board from competitor Canadian Pacific with a new stand-alone strategic plan for CSX. The scope of these concessions was on the high end of the spectrum for a settlement with an activist hedge fund. Four seats exceeds the typical activist settlement of one to three seats. Moreover, while the commencement of an activist campaign significantly increases the likelihood that there will be CEO turnover within the next one-to-two years,[2] the installation of a new CEO and operating plan does not typically happen with the speed seen at CSX.

Against this backdrop, the incumbent board of CSX took some novel steps to assure that it was acting with the support of the broader shareholder base. First, 27 days into the discussions between the activist and the company, the board announced that it had reached an impasse with the activist and would be calling a special meeting of the shareholders “to seek guidance from shareholders on whether CSX should agree to Mr. Harrison’s and Mantle Ridge’s proposals” and that the board would not be issuing any recommendations to shareholders in connection with this vote. Then, when the board reached a settlement agreement with Harrison and the activist fund 20 days later, the company abandoned the special meeting idea, but the settlement announcement provided that:

  • Portions of the new CEO’s pay package would be put to an advisory vote at the company’s next annual meeting of shareholders (on which vote the board again indicated that it would not provide any recommendation)
  • The decision of the board whether to have the company assume these portions of the package would be deferred until after this advisory vote, and
  • The new CEO intended to resign if the board elected not to have the company assume these portions of his package.

Harrison’s aggregate package was reported to be valued at about $300 million over four year—high relative to peers, but low relative to the approximately $10 billion surge in CSX’s market capitalization in response to the initial news that Harrison was considering the job. The portion subject to a vote is a requested reimbursement for the $84 million of compensation and benefits forfeited by Harrison as a result of his separation from Canadian Pacific, and the provision of a related tax indemnity. If Harrison resigns because the company does not agree to be responsible for the $84 million payment and related tax indemnity, it appears that he will be entitled to a severance payment of approximately $5 million and that Mantle Ridge will in turn cover the $84 million reimbursement and related tax indemnity.

Putting this, or any, portion of a CEO’s pay package to an advisory vote of shareholders is highly unusual and categorically different than the usual say-on-pay vote about pay policies generally. Through this additional say on CEO pay vote, shareholders are being given the gift of a unique opportunity to register their opinions on a controversial topic and arguably the strategic direction of the company which is tied to the new CEO’s presence. This aspect can be seen as a positive development for shareholder rights generally, and more specifically can be seen as responsive to State Street’s open letter criticizing companies for settling with activists too quickly and without long-term shareholder input. However, a reasonable argument could be made that the shareholder vote is less a move toward shareholder rights and involvement, than a veneer to shield the board from a tough call. Do shareholders or the board really have a choice? [3] If the compensation is not approved, CSX will suffer from the disruption of having to undergo another transition at the helm as well as interference with the implementation of the company’s strategic plan.

Where does this leave the board? Although the board has publicly indicated that it is uncomfortable with certain aspects of the CEO’s compensation, the board is unwilling to make a recommendation to shareholders on the matter. While there is established precedent that informed and uncoerced shareholder votes insulate director liability, the CSX board’s approach in the instant situation may raise as many issues as it solves. In particular, the board’s decision not to make a recommendation raises the question of whether the directors are abdicating their duty to manage the affairs of the corporation.

CSX is incorporated in Virginia, where the applicable standard of review of compliance by directors with their duties is arguably more favorable to the directors than the standard applicable to directors of a Delaware corporation. The board of directors of a Delaware corporation has not only the statutory authority to manage the corporation under 8 Del C, §141(a), but also the fiduciary duty to carry out that statutory authority with due care. [4] Under Delaware law, the failure of the board to disclose to the shareholders its informed view on the advisability of approving a matter on which the shareholders are being asked to vote will expose such board to the charge that it has failed to carry out its duties to manage the affairs of the corporation in good faith and to disclose all information material to the shareholders’ decision. [5] In short, the board of a Delaware corporation could not submit for a shareholder vote this matter of the CEO’s pay package without disclosing the reasons why the board’s informed deliberations led to a determination that approval of the pay package was either advisable or inadvisable. Furthermore, although federal securities laws do not impose the same duty on directors as state corporate law to arrive at an informed view, a similar disclosure issue would exist under the Securities Exchange Act of 1934 to the extent the directors have informed views but are holding them back while asking the shareholders to vote without guidance. [6]

Moreover, under Delaware law it is even doubtful that, as a matter of statutory mechanics, a corporation may submit a matter to a shareholder vote without the board’s having first resolved to approve the matter in question. 8 Del C. § 146 permits a corporation to agree to submit a matter to a shareholder vote “whether or not the board of directors determines at any time subsequent to approving such matter that such matter is no longer advisable and recommends that the stockholders reject or vote against the matter.” (emphasis added) This language contemplates that a board must approve a matter before agreeing to submit it to shareholders. Although a board may later change its recommendation, there is no procedure under Delaware law for putting a matter to a shareholder vote without the board’s having at least initially determined to approve the matter in question.

Finally, the efficacy of a stockholder vote and any insulation from liability the board may wish to gain from it is premised on the assumptions that the vote is un-coerced and the voting shareholders are fully informed. As discussed above, these assumptions may not hold up to close scrutiny in this instance.[7]

Nonetheless, the advisory shareholder vote concept is a novel mechanic for attempting to address the tricky balance between responsiveness to the broader shareholder base and the benefits of settling with activists. The pressure on companies to strike this balance will continue as the fount of “good ideas” from activists with minority equity positions continues at full force while the nature of public company shareholder profiles continues to increasingly skew toward huge positions by index funds. These “passive”-strategy fund shareholders in turn can be expected to become more focused in the coming years on assuring that they have a say.


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2A 2016 study by FTI Consulting stated that CEO turnover when an activist gained board seats was 34.1% and 55.1% over a one and two year period, respectively, compared to 16.6% and 30.9% over the same respective periods without an activist in the boardroom.(go back)

3See, e.g., “CSX CEO Hunter Harrison’s Pay Is No Great Train Robbery”, Fortune Magazine (March 24, 2017), at (the “Fortune Article”) (“Earlier this month, when Harrison took the job of CEO of the nation’s No. 3 railroad CSX some critics said the exec, who has proven adept at turnarounds, was essentially holding up his new shareholders by demanding they make good on the $84 million payday he walked away from when he exited his old job. It seemed to be another example of CEO pay going off the rails.”)(go back)

4See e.g., CA, Inc. v. AFSCME Employees Pension Plan, 953 A.2d 227,240 (Del. 2008)(determining that a proposed shareholder adopted bylaw mandating election expense reimbursement was invalid because the bylaw contained no language or provision that would reserve to CA’s directors their full power to exercise their fiduciary duty to decide whether or not it would be appropriate, in a specific case, to award reimbursement at all); and Smith v. Van Gorkum, 488 A.2d 858, 873 (Del. 1985) (in connection with a shareholder vote on a merger, directors not permitted to abdicate their duty to “act in an informed and deliberate manner” by simply leaving the decision up to the stockholders).(go back)

5Malone v. Brincat, 722 A.2d 5, 12 (Del. 1998).(go back)

6See e.g., Rules 14a-9 and 12b-20 under the Exchange Act.(go back)

7See the Fortune article (“Nixing the $84 million would send Harrison packing and the share price tumbling. Chances are excellent he’ll get the cash.”).(go back)

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