Introduction & Market Update

FTI Consulting’s Activism and M&A Solutions team welcomes our clients, friends and readers to our sixth quarterly Activism Vulnerability Report, documenting the results of our Activism Vulnerability Screener from the recent fourth quarter of 2020, as well as other notable trends and themes in the world of shareholder activism and engagement. Almost one year ago to the day, we sat down to write this report for the fourth quarter of 2019. Our team had just begun the shift to working from home offices and spare bedrooms, while still adjusting to full days of video conference calls due to the rapidly spreading COVID-19 coronavirus.

While it was not until the latter half of the fourth quarter of 2020, or even the start of 2021, that many of the pandemic’s biggest concerns began to subside, many areas of the market remained incredibly resilient throughout the year. The S&P 500 Index, the Dow Jones Industrial Average Index and the Nasdaq Composite Index rose 16.3%, 7.3% and 43.6%, respectively, in 2020. While the three leading indices all ended the year on solid ground, the incredible market voracity from the COVID-19 pandemic should not be overlooked. The S&P 500 Index reached an all-time peak of 3,386 on February 19, before it fell 33.9% in just 32 days to 2,237. As measured from March 23, 2020, however, the Index regained the previous high in less than five months on August 18 (an increase of 51.5%). For the S&P 500 Index and the Nasdaq Composite Index, the period of 2019 and 2020 represents the best two-year performance since 1998 and 1999, during the heart of the Dot-Com boom.

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The September Memorandum of Understanding (MOU) entered into between the U.S. Office of Foreign Assets Control (OFAC) and the Delaware Department of Justice (DOJ) could be a game changer for both domestic and foreign corporations.

The MOU appears to be the first of its kind ever entered into between OFAC and a state law enforcement agency. (Previous OFAC MOUs concerned primarily federal and state banking and financial service regulators.) As such, it appears that OFAC and the State of Delaware are gearing up to increase scrutiny of entities registered in Delaware.

The Treasury Department’s press release regarding the MOU indicates several reasons for collaboration between OFAC and Delaware. They include improving transparency into corporate structures, promoting sharing of critical information, facilitating coordinated sanctions investigations, protecting national security, and disrupting illicit activity that is inconsistent with U.S. foreign policy (i.e.,“entities that should not be operating in the United States”). (more…)

Despite the global economic and health crisis resulting from the COVID-19 pandemic, many companies have continued to intensify their efforts to improve their management approaches and communications in relation to environmental, social, and governance (ESG) issues. In many instances, the ongoing crisis has, in fact, accelerated pre-existing trends towards greater ESG integration by underscoring the role of business in confronting wider societal issueThe increasing adoption of ESG management systems is driven by two concurrent trends. First, significant social pressures, a shift in expectations for private enterprise, and ongoing regulatory changes have increased demand for companies to proactively take responsibility for potential externalities affecting the environment and society. Second, there is a growing recognition amongst investment and business professionals that ESG issues can have a material impact on company value and that the management of such risks can preserve (and even enhance) economic value for companies and their shareholders.

In this article, we review the underlying trends behind the momentum in ESG management and examine potential shifts in public policy, investor sentiment, and company behavior in the ongoing aftermath of the COVID-19 crisis. We draw some early lessons for companies reconsidering their approach to ESG as a result of the pandemic, focusing on social inequalities and workforce risks, the acceleration of pre-existing economic trends, and a continued emphasis on ESG issues.

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In the world of corporate governance and proxy voting, 2020 has been a remarkable year, not only because annual general meetings took place in the midst of a global pandemic that forced the abrupt transition to a virtual proxy season, but also because this year marked the beginning of the new decade at a time when companies and investors experience a major shift in how they engage on the topic of corporate governance. The scope of corporate governance activities is no longer limited to issues directly linked to routine meeting agenda items, such as director elections, shareholder rights, executive compensation, and audit quality. The definition of governance is expanding to include the management of environmental and social risks and opportunities.

Many investors begin to recognize ESG issues as part of their fiduciary responsibility, and several have committed to using their votes to hold boards and management teams accountable for the potential mismanagement or lack of oversight of material issues. Climate change, employee health and safety, data privacy, and human rights are only a few of the many factors where investor expectations are changing, requiring companies to demonstrate robust management systems, oversight mechanisms, and measurable performance in addressing potential risks and opportunities.

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These poor practices can result in superficial approaches to risk management, leading to missed opportunities as companies seek to adopt robust ESG strategy

A growing number of companies are recognizing the opportunity for long-term success that results from an effective environmental, social and governance (ESG) strategy. Rising expectations from stakeholders, including investors, customers, employees and communities, indicate that high ESG performance may translate to better access to capital, talent and business opportunities.

While companies are eager to improve their ESG position, some find it difficult to create a plan of action. The term “ESG” may appear somewhat nebulous, and it is sometimes interchanged with other similar, yet varied, terms like sustainability and corporate social responsibility. Further, ESG issues cover a wide variety of topics, making it challenging for companies to understand and prioritize key issues. Some companies are not able to take decisive action and may try to address ESG issues through incremental steps, which leaves them lagging behind their peers. Other companies may fail to see results or recognition despite significant efforts.

To successfully navigate the complex and evolving ESG landscape, companies must avoid approaches that may lead to missed opportunities. This post discusses a few such misguided approaches, the seven sins of ESG management. These are common mistakes companies make when attempting to deal with ESG issues. At best, they can result in failure to receive credit for their efforts and, at worst, can leave the company exposed to significant risks.

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Putting the ‘S’ in context

In early 2019, we wrote a paper highlighting that the focus on Environmental, Social & Governance or ‘ESG’ issues in the capital markets had firmly shifted from the margin to the mainstream. This shift was reflected in the scale of capital being invested in ESG oriented investment funds alongside a generally greater societal awareness (and acceptance) of an urgency to step up efforts to address environmental issues and climate change.

As we continued to engage with companies and investors during the course of 2019—and we assessed the corporate reputation challenges being encountered by many companies—it became increasingly clear that factors which fall within the ‘S’ of ESG are as common as (and for some companies more so than) those within ‘E’ and ‘G’ in contributing to business risk and, in turn, causing lasting damage to a company’s reputation.

Factors which fall within the ‘S’—frequently customer or product quality issues, data security, industrial relations or supply-chain issues—commonly impact businesses and ‘destroy value’. This prompted us to reconsider if ‘social’ was the correct word for the ‘S’ in ESG and whether ‘Stakeholder’ might be more appropriate. Indeed, the use of the term ‘social’ may have contributed to a failure to conceptualise the ‘S’ in ESG, leading to an absence of focus and measurement from the market.

The scope of ‘S’ has progressively widened over the past two decades, which reflects the evolving business environment of the 21st century where businesses and markets are increasingly interconnected and interdependent. Over and above human rights; labour issues; workplace health & safety; and product safety and quality, ‘S’ factors now also incorporate the impact of modern supply-chain systems and the adoption of technology across all business sectors.

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The COVID-19 pandemic is having a profound economic impact across the globe. Entire industries have ground to a halt and unemployment claims reached record highs, as demand has disappeared due to government-mandated restrictions. Not surprisingly, equity markets are pricing in this turmoil, with the S&P 500 index losing one third of its value from February 19 to March 23. As of April 15, the S&P continues to be down by 18% from its February 19 peak. As the global public health and economic crises continue to unfold, companies should consider more than just the impact on operations. Valuations have declined significantly across the board, and the resulting market dislocation will likely bring a rise in contentious situations in mergers and acquisitions (M&A). This raises new challenges for boards and executive teams as companies are more vulnerable to potential attacks as compared to normal market conditions.

This is Different but Also the Same

While every major economic crisis is unique, there are also common characteristics that often repeat. Similar to 2008, the current downturn is characterized by a severe slowdown in economic activity, elevated unemployment, and financial market declines. Governments and central banks are attempting to offset the economic impacts through fiscal stimulus and monetary easing, but due to the ongoing global pandemic driving the downturn, there remains great uncertainty about the duration and the severity of the crisis.

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Introduction and Market Update

In this Activism Vulnerability Report, FTI has identified the industries that are most susceptible to shareholder activism in the U.S. and Canada according to the Activism Screener’s results. The Activism Vulnerability Report, and the Activism Screener itself, are intended to assist our public company clients and their outside advisors in determining the extent to which their business and underlying industry are vulnerable to pressure from activist investors. It provides a starting point for identifying and addressing the factors and dynamics that could invite activist investors to seek material changes in the business, management team and/or board of directors.

The Report summarizes the Activism Screener’s results and evaluates 25 well-known industries, enabling us to understand which of those industries are most vulnerable to shareholder activism each quarter, based upon an average of the aggregate vulnerability scores of the components of each industry. FTI publishes the Report quarterly as financial data and other common publicly disclosed information become available. While FTI will not release a complete list of companies and their scores, FTI welcomes company representatives to contact our Activist and M&A Solutions team members to discuss their individual vulnerability score and the key contributing factors.

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Executive Summary

Ever since the financial crisis of 2008, the level of scrutiny on Boards of Directors and companies has grown, with the focus on corporate governance becoming particularly pronounced over the past five years. The 2018 iteration of the new UK Code included a number of substantive changes.

The growing capabilities of institutional investors and the broadening of the definition of governance from the Financial Reporting Council has dictated that 2019 was a year of significant change in a number of key areas.

FTI and CGLytics conducted an analysis of key areas of the new UK Code to determine the extent of that impact on UK and Irish companies. While the embedding of workforce engagement practices and disclosure has been subject to slower developments, guidance on pensions and Chair tenure have immediately influenced company and investor thinking—the result of which has been significant reductions in pensions for executive Directors in the FTSE and a sharp drop in average Chair tenure on both the FTSE and the ISEQ. However, despite the extent of change among Chairs, the level of gender diversity in those positions remains very low. The paper also includes wider potential risks for companies as the 2020 AGM season approaches.

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If the 2010s laid the groundwork for ESG corporate practices through debate and policy development, the 2020s will be about putting ESG into action. Our new decade is expected to see widespread adoption of ESG-related practices as the norm.

The 2010s: Building Momentum

To fully appreciate the shift from debate to action in ESG practices, it helps to look back at ESG developments during the past decade. While ESG efforts have existed for many decades—with considerable efforts dating as far back as the ’50s—it was around the 2010s that ESG became a mantra for most companies. At the start of the 2010s, market participants embraced corporate governance reform, focusing on restoring trust in the capital markets following the aftermath of the 2008 financial crisis. Laws, codes of best practice, investment stewardship efforts and company initiatives that were concentrated on board oversight and accountability firmly took root. These efforts included “say on pay,” which became standard practice in most major jurisdictions, as well as several regulatory and investor-led initiatives focused on board quality. Among these initiatives were board diversity, independence, refreshment and responsiveness to shareholders.

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In recent years, the level of capital flowing into funds that incorporate ESG criteria has grown considerably and what was once an issue on the fringes of investment is increasingly part of the material financial analysis of a company’s value.

Consequently, ESG rating agencies (who help investors identify ESG risk) have grown in prominence; regulators have commenced a clampdown on so-called “greenwashing”; and, investors continue to pressurise companies to provide greater details on ESG factors likely to affect their business—either through engagement or, less frequently, shareholder proposals. Indeed, a recent report found that, at least based on publicly disclosed documents, climate change was the number one issue for institutional investors in their stewardship of investee companies.

In this post, we have analysed whether the ratcheting up of pressure on companies to enhance their ESG frameworks has permeated another important area—executive remuneration at UK and Irish companies. For three decades, pay has been identified as a key driver of C-suite behaviour. Despite what appears to be a relentless focus on ESG, the incorporation of ESG measures into executive pay packages has lagged somewhat.

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On 5 December the Financial Reporting Council (FRC) published proposals for the latest revisions to the UK Corporate Governance Code (the Code), which are due to be published by “early summer” 2018 and will be effective for all accounting periods beginning on or after 1 January 2019.

The stated aim of the FRC in proposing the revisions was to make the Code “shorter and sharper” with supporting principles either removed and incorporated into new principles and provisions or supplementary guidance, such as the guidance on Board Effectiveness. The proposed revisions to the Code place particular emphasis on:

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Shareholder activists showed no signs of slowing down in 2016. These investors continue to instill fear  in corporate board rooms across America and bring their concerns to the public as illustrated by the growing number of proxy fights; 110 in 2016 alone, a 43% surge over 2012. [1] In that time, companies have more frequently succumbed to these investors and at times, accepted unfavorable settlement terms instead of pushing forward and fighting through a proxy contest.

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Shareholder activism is a powerful term. It conjures the image of a white knight, which is ironic because these investors were called “corporate raiders” in the 1980s. A corporate raider conjures a much different image. As much as that change in terminology may seem like semantics, it is critical to understanding how to deal with proxy fights or hostile takeovers. The way someone is described and the language used are crucial to how that person is perceived. The perception of these so-called shareholder activists has changed so dramatically that, even though most companies’ goals are still the same, the playbook for dealing with activists is different than the playbook for corporate raiders. As such, a corresponding increase in the number of activist encounters has made that playbook required reading for all public company officers and directors. In fact, there have been more than 200 campaigns at U.S. public companies with market capitalizations greater than $1 billion in the last 10 quarters alone. [1]

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