Investor Engagement and Activist Shareholder Strategies

Chris Ruggeri is National Managing Principal of Risk Intelligence at Deloitte Transactions and Business Analytics LLP. This post is based on her Deloitte memorandum. 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); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System by Leo E. Strine, Jr. (discussed on the Forum here).

It’s not your imagination: shareholders and activists have asserted themselves more in recent years. For better or worse, activists are more numerous and more diverse than they were in the past, both in their agendas and their methods.

This reinforces the need for management, with the board’s oversight and guidance, to engage with shareholders proactively, to be prepared for friendly or confrontational activists, and to have a long-term plan for shareholder engagement. It’s also essential for the board to consciously craft its role in this tricky area, where it is expected to both represent shareholders and advise management.

Shareholder activism has always existed, but its goals and tactics have changed over time. In the 1980s, corporate control was the chief goal, and takeovers, poison pills, and greenmail were common tactics. Corporate raiders wanted to acquire businesses or take controlling positions with the aim of reshaping or dismantling those businesses. Today’s shareholder activism is different. The goals are more often to unleash or create value without a change in control, and to do so by leveraging a small ownership percentage—generally three to five percent.

Some investors have exerted significant influence, usually in conjunction with other investors and often by stating their view of a company’s prospects and making recommendations without undue publicity. Others have chosen to be more confrontational and public in their demands.

Regulatory and technological changes also have disrupted the traditional balance of power between management and shareholders. Regulatory measures, such as the Dodd-Frank Act in the United States, have heightened public awareness of corporate governance and, more specifically, the board’s oversight role. Dodd-Frank instituted a say-on-pay shareholder vote, and although it is not binding on companies, it has emboldened investors and amplified their voice. This is particularly true when it comes to executive compensation, which investors often view as an indicator of potential governance weaknesses elsewhere in the organization. Digital technologies have transferred a measure of organizations’ control of information to investors. Today, investors and other stakeholders can communicate with millions of people at the click of a mouse rather than waiting for reports to be delivered by mail or other pre-digital methods.

Diminishing trust in institutions and publicly held corporations, the abundance of cheap debt, and the market environment following the Great Recession have also prompted shareholders to exert more influence on management and the board. Activist investment funds have proliferated, both feeding and feeding off these trends and raising significant capital that they must invest in ways that generate returns. They typically wrangle with organizations over issues such as capital structure, shareholder value, management competence, board composition, asset sales, and major business issues or decisions.

These recent trends suggest that management should proactively engage with investors and be prepared for activists with strong points of view. The board needs to oversee and advise management regarding these efforts and the risks and opportunities that investor engagement and shareholder activism present in the short and long term. In some recent cases of investor engagement and activism, the board can become directly involved. In fact, in recent years, some board members together with management have proactively sought out investors—and have opened up a direct line of engagement. Initiatives like these highlight just how prevalent this issue is becoming for boards of directors.

No company is immune

A Deloitte survey [1] of CFOs of US public companies conducted in 2015 identified the following trends. Our experience indicates these trends still hold true, and in some cases, they have intensified.

  • Just under three-quarters of US public companies surveyed experienced shareholder activism, most often in the form of direct communication to management or the board.
  • About 30 percent experienced indirect communication in the press or social media.
  • About half made at least one major business change because of shareholder activism; the most common were share repurchases, management or board changes, divestitures, and performance improvement initiatives.

Because shareholder activism shows no sign of abating, companies may need to review their approach to investor engagement and arrive at response protocol to implement when an activist emerges on the scene.

Understanding today’s activism

Trends in shareholder activism tend to begin in the United States and then extend elsewhere. There are structural reasons why activism is relatively less common in Europe; for example, majority control by families and other organizations makes it more difficult.

In Asia, state-owned, listed companies are resistant to activism. Culture also influences where activism takes root. Some highly regulated sectors such as financial services, media, defense manufacturers, and utilities tend to have some natural insulation against shareholder actions, but that does not render them immune. Virtually any public company can be subject to shareholder activism.

Activism most often comes down to differing views on how capital should be allocated. There is an ongoing discussion in the marketplace about the short- versus long-term orientations of activists, but the fact is that different activists simply hold different views.

Many institutional investors, particularly pension funds and insurance companies that seek to match assets with liabilities over the long term, want to invest in companies with well-established strategies and an established record of performance. Senior leaders of some prominent investment funds also have expressed a strong desire for their portfolio companies to take a long-term view, but not all investors in a company will share those goals and interests. Different investor classes will have different investment goals, time horizons, and priorities, which can create conflicting objectives and opinions among shareholders and complexity for the organization’s senior leaders.

A given company’s activists and broader shareholders are not homogeneous. When the current wave of activism began, many corporate leaders and observers characterized all activists as seeking short-term monetary gains in ostentatious ways. In truth, many have been discreet, constructive, and respectful in making their cases to companies. They often have longer-term concerns and limit their efforts to conversations with management and suggestions for boosting performance or eliminating underperforming assets. Others have been quite aggressive, leveraging the media to dramatic effect with the goal of altering the structure of the board, replacing senior executives, divesting specific subsidiaries, changing ESG policies, or transforming operations.

The companies most attractive to activists tend to be those with strong cash flows, low dividend payout ratios, conservative balance sheets, recent underperformance, or assets ripe for selling or spinning off. Other targets are those companies operating in industries marked by shifting market forces and changing business models. The board should be acutely aware of all these conditions and actively discussing them with management regardless of activist activity. Activism merely sharpens the focus on such issues, and it might intensify the need to address them. Efforts to address shareholder activism are most productive when they are viewed and conducted in the context of a robust investor engagement program, usually found within the company’s investor relations department. Strong investor engagement enables management to understand the company’s shareholder constituencies and their goals, monitor changes in the makeup of the shareholder base, communicate short- and long-term strategies effectively, and cultivate both reliable supporters and trusted critics in that base.

As part of its oversight and governance responsibilities, the board should ensure that management has established an investor engagement program and has taken steps to prepare a response to either friendly or confrontational activists when needed. The board must also coordinate its thinking and approach to activism with management and the investor relations team. It is critical to create and enhance a robust capital allocation methodology that is communicated externally in an appropriate manner.

Establishing the board’s role

There is some diversity of opinion regarding the board’s role vis-à-vis interactions with shareholders, weighted toward the board leaving management responsible for engaging with shareholders. However, some maintain that the board has a responsibility to engage with shareholders as their representative. In practice, we are seeing more board engagement today than in the past, but senior executives and the board need to establish clear guidelines regarding how and when the board engages with shareholders.

A company’s investor relations group is the main channel for communicating with shareholders, and that function reports to management, and often to the CFO. Encouraging shareholders to approach the chair or board members directly could call into question the value of the investor relations function, and perhaps of the management team. If shareholders bring a concern to the board’s attention, it may be appropriate, in some cases, for the board to engage with those shareholders in concert with the investor relations group. Having the chair engage with shareholders is a common practice in a limited number of countries, including the United Kingdom, Australia, and South Africa. However, direct chair or board engagement with shareholders in the normal course of business could risk blurring the lines between overseeing management and actually managing the organization, especially if there are no protocols in place for the board’s involvement.

A company’s investor relations function exists to inform, to answer questions, and to explain the organization’s strategy, markets, and performance to shareholders and the investment community. This should not be a perfunctory exercise in information distribution, but a means of deploying an ongoing narrative and for meeting shareholders’ and investors’ genuine need for information. It should also seek to create a feedback loop with shareholders and the market. Investor relations involves sending messages to the marketplace, but also gauging how investors are receiving those messages. Do investors see the information as transparent and complete enough? Do they understand management’s short-term and long-term strategies and risks to those strategies?

Are they confident in the leadership team? Do they hold misperceptions about the company or stock? A successful investor relations function monitors the marketplace and shareholder sentiment to obtain the answers to these questions.

In the survey cited previously, we asked how companies are changing their approach to investor relations in response to activism. About half said they had changed very
little, with most citing existing programs that were working well. The half that had made substantial changes most often cited increased monitoring of activist activity, enhanced planning in response to activists’ concerns, and more proactive communication with investors. [2]

The board should be aware of the shareholder base and its needs; the investment community’s perception of the organization, including its management team and performance; and the organization’s vulnerability to activist shareholders. Management should update the board regularly on the composition of the shareholder base and how satisfied they are with the information they’re receiving on the company’s capital structure, performance, and other factors that could drive questions and activism.

Additionally, the board should be open to not only listening to shareholders, but also to collecting input from them, for example by attending investor conferences to observe the proceedings and hear what’s on investors’ minds. These efforts could also extend to more direct interaction with specific investors. But, despite a recent increase in board members engaging with investors directly, board-shareholder interactions are generally limited as long as the company is performing well and there are no concerns or crises. The primary points of contact for investors should generally be investor relations personnel and management.

If a decision is made to have a board member engage with a shareholder, he or she should be an independent director. After all, if a shareholder approaches the board, it will often be due to dissatisfaction with the organization’s performance or its handling of an issue. To add objectivity to the discussion and insulate management, this discussion should be with an independent director rather than an executive director.

Effective investor engagement provides visibility into the strategy, operations, performance, and finances of the company, as well as realistic expectations. It’s a matter of describing an investment opportunity in ways that enable investors to decide with confidence whether it meets their objectives. A company cannot be all things to all investors. By providing the clearest possible portrayal of the organization and working to deliver optimal long-term value to shareholders, management and the board position themselves for favorable interactions with investors.

That said, some investors will have activist agendas from the outset, and others may develop activist tendencies if it’s in their interest and, usually, in the interest of the company. The board has a duty to see that the company is prepared for activists and responds to them effectively.

Actions to consider in light of activism

Shareholder activism should encourage boards to step up their investor engagement oversight efforts, recognizing that different boards and different directors will take different approaches. For example, some obtain updates from their investor relations teams at every board meeting, while others do so once a year. In some cases, directors even meet directly with investors. Yet very few omit shareholder engagement from the board agenda, and those that do act at their peril.

When authorizing corporate actions, the board should consider the views and priorities of key shareholders and shareholder segments. For example, if the company is going to undertake a share repurchase program in lieu of reinvesting that capital in the company, the board should consider the potential effects of that decision on shareholders. Decisions that involve either raising or allocating capital always warrant close scrutiny and an understanding of shareholders’ views and expectations.

In that context, the board should also:

  • Exercise strong risk oversight and organizational governance. The boards of most public companies have gone well beyond simply approving management decisions. They seek to truly understand and provide advice on strategies, business models, and major investments and initiatives. True understanding requires sound governance of the processes by which decisions are made and initiatives are undertaken. Sound governance involves gauging the long-term impact of management decisions on the organization’s performance and value and the effects on investors, employees, and environments in which the organization operates. The board needs clear lines of sight into decision-making processes, reliable assurance regarding the risks implicit in management’s assumptions and decisions, and the willingness and ability to challenge management when needed.
  • Monitor the company’s shareholders and their goals. Through surveys, discussions with management, and external perspectives, the board should monitor the makeup of the shareholder base and understand the reasons for its composition. For example, industry factors may influence the diversity of shareholder institutions and objectives. Although it is outside the board’s control, the makeup of the shareholder base will reflect investors’ views of the organization and management’s strategy and performance, and the board must be aware of those views. The board should also be cognizant of issues such as a misalignment between compensation and performance, large and long-standing cash holdings, and activists targeting peer organizations.
  • Ensure that the company’s investor relations team performs well. The investor relations function should articulate a fact-based investment proposition that makes a clear case for why management’s strategy and decisions are better than alternatives. The function should stay in front of developments that could prompt activist activity, such as industry reversals, poor performance, or negative media coverage. It should also respond quickly to shareholder demands for information and cultivate good relationships with major shareholders, who can be invaluable in mounting an activist defense. An adequate staff of well-qualified people should work closely with the CEO and the CFO to communicate a compelling value proposition and strategy. Boards also need to receive periodic reports from the investor relations group; some receive them at every meeting and others only annually. Regular updates are imperative.
  • Request an activist vulnerability assessment. Companies should periodically commission an activist vulnerability assessment, which takes an objective, outside-in look at the company. It is difficult for management or the board to be objective in this sense, given that they formulate and approve the strategy and are responsible for performance. These assessments consider factors such as market capitalization relative to the sum of the company’s parts, financial performance versus that of peers, and the stock’s trading range relative to that of similar companies. It identifies underperforming lines of business as well as nonoperating assets, such as real estate, that could be monetized. The composition, skills, tenure, and performance of the board is also considered. This kind of assessment not only helps the company prepare for an activist event, but also identifies opportunities to lower the organization’s vulnerability to such an event.
  • Review management’s activist-campaign response plan. As with any event that has the potential to influence a company’s reputation, management should be prepared to respond to an activist campaign. The plan should include protocols for responding to friendly activists and those taking a confrontational approach. The plan should identify the members of the response team and their responsibilities and provide guidelines on who should be informed (including the board), when they should be informed, and who formulates and delivers which types of responses. The first rule of activist response is to never ignore or stonewall, either of which can elicit frustration and aggressiveness. Management needs to prepare an internal communications program to keep employees informed and focused in situations where activists go public. Failing to communicate internally will only foster rumors and distraction. Consider including financial, legal, public relations, and accounting advisers in the response team. Also designate specific members of the board, such as the chair of the compensation, governance, and other relevant committees to be involved in specific issues and communications. Shareholder communications should be structured to make higher levels of executives available if an issue escalates.

Ongoing monitoring, proactive engagement, and deep preparedness will generally head off most serious problems and enable a swift and effective response to those that do arise.

Engage and embrace

Shareholder activism has advantages as well as drawbacks. On the down side, confrontational activists can launch highly public campaigns that can distract management and cost millions. They can also disrupt customer and supplier relations, create openings for competitors, generate uncertainty, and discourage potential employees. On a more optimistic note, many companies have benefited from activists who have directed management’s attention to opportunities to accelerate growth, improve the bottom line, monetize assets, or return capital to investors. The management team and the board must be prepared for either constructive or aggressive activism both in the immediate future and for the long term.

Endnotes

1CFO Insights—Activist shareholders: How will you respond? Deloitte, 2015,
https://www2.deloitte.com/content/dam/Deloitte/us/Documents/finance/wallace-cfo-insight-activist-shareholder.pdf(go back)

2Ibid.(go back)

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