Download Trends in shareholder activism

International Governance
Shareholder activism is on
the rise — would you know
how best to handle an activist
shareholder or even what your
options are in this regard?
Trends in shareholder
activism
Would you know the difference
between an active investor and
an activist investor?
By Brendan Sheehan, Principal, Global
Governance Advisors
The following article by Brendan
Sheehan provides some valuable
insights into shareholder
activism, what it is, what it means
and options to minimise and
manage the negative aspects
of the increasing trend toward
activism. The article also
provides very practical tips on
how to recognise and manage
the underlying issues, which are
not always the publicly stated
issues put forward to justify an
activist approach.
The growth in shareholder
activism is a trend that is
generally seen as emanating
from the United States and most
would agree it’s a trend that is
here to stay.
I hope you can use the article to
be better prepared to deal with
activist tactics.
Peter Turnbull FCIS
International
Representative
The past year and a half
has seen a significant shift
in the world of shareholder
activism. Once regarded
as the realm of short-term
hedge funds looking to
effect change at a company
in order to achieve an
immediate return — often
at the expense of long-term
investors — activism is now
considered mainstream.
While still in the minority in terms of
share ownership — a recent study
placed total holdings of traditional
‘activist’ investors at a little over
1 per cent of the market in the US —
activist investors are gaining support
from many sectors of the investor
community including major pension
and mutual funds. And this, in turn, is
impacting the way they interact with
corporate boards and management.
Activist and active investors (more on
the distinction later) are increasingly
gaining both political and public
support largely through targeting
corporate management on grounds
of underperformance. It is hard not
to agree with such arguments — no
matter have accurate they actually are.
Overall activism changed significantly
in 2013 and the first three quarters of
2014. Activists are increasingly seizing
on governance issues as the ‘point
of entry’ for the conversation. They
look for underperforming companies
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and look for governance issues like
board structure, voting practices or
compensation models. CalSTRS, for
example, played a part in 77 companies
implementing majority voting in 2013
in the US. The reality is that these
structural governance issues are rarely
what an activist is really interested in
but governance failures are a very easy
and popular way to target a company
and garner strong voting support from
institutional investors.
By the numbers
There is no doubt that activism globally
is on the rise. An analysis of 2014
disclosures shows that almost one in
five S&P 500 companies have been the
target of a public activist campaign so
far this year. That number more than
doubles when you include behind-thescenes approaches that never make it
to the public eye. In fact, a recent study
from EY suggests that nine out of ten
boards say that shareholder activists
impact the board agenda. While still
largely a US phenomenon, instances
of activism are rising in Europe and
other jurisdictions like Australia as
shareholder see the success being
achieved in the US and as regulatory
environments shift to support greater
shareholder access.
There are a range of reasons for
why activist investors are gaining
mainstream acceptance and support.
Firstly, the activist themselves are
much larger. The amount of money
invested in activist funds has increased
significantly in recent years. According
to a study from US law firm King &
Spalding, funds controlled by activist
hedge funds have increased from
US$12 billion to over US$100 billion in
the last decade. This does not include
many massive pension and mutual
funds that do not consider themselves
‘activists’ but are ‘active’ in the way
they invest and have come to support
some activist campaigns. This includes
giants like CalSTRS, CalPERS, TIAACref and OTPP.
Activists, and shareholders in general,
are also communicating much more
than they have in the past. Despite
laws restricting collusion or acting in
concert many investors share strategic
information about companies they
are targeting and investing in. In fact,
several websites and blogs exist for this
specific purpose. Some are public but
most are private, members-only forums.
Big-name support
Perhaps one of the most significant
developments is the increasing
‘activeness’ of long-term holders like
the pension funds. These groups have
traditionally not supported activist
hedge fund campaigns on the grounds
that the desired outcome of the hedge
fund is a short-term capital event
that may not be good for the longterm performance of the company.
This view is changing rapidly. Many
large investors now see some value
in activist arguments and will support
proposals and campaigns that increase
transparency, board access and
changes to compensation models.
In evidence to this point, CalSTRS
recently co-sponsored a proposal with
well-known and respected activist
Relational Investor. Additionally many
large institutional investors also invest
directly in hedge funds so they have a
vested interest in seeing these groups
be more successful.
When you combine all this with a much
friendlier regulatory environment and it
is little wonder activism is on the rise.
During the past decade in the US many
traditional take over defenses have
been stripped away including supermajority voting, staggered boards,
removal of shareholder rights plans
(poison pills) and plurality voting, and
an increased ability for shareholders
to call extraordinary meetings. It is fare
to say that the pendulum has swung
decisively in favor of shareholders in
recent years.
Another important tool in the activist
toolkit is the say-on-pay vote. As of
September, a total of 60 companies in
the US have failed to secure majority
support for their compensation
plans. A further 139 got between 50
per cent and 70 per cent support.
This is considered the ‘danger zone’
as companies getting below 70 per
cent will get additional attention the
following year.
As mentioned earlier, compensation is
rarely the problem in and of itself but
increasingly pay is seen as a window
into the broader governance of a
company. Activists and other investors
feel that if the board is approving
poor compensation structures then it
must be making mistakes elsewhere.
After all, compensation is a capital
allocation decision and in this business
environment capital allocation is an
extremely important activity. For the
most part, say-on-pay votes focus on
pay for performance. Investors are
casting an eagle eye over what hurdles
and metrics management must clear to
receive bonus payments. Elements such
as severance payments and accelerated
vesting of options are a particular sore
point, as are structures that allow for
board discretion to pay executives even
if they fail to outperform peers.
Pay for performance has been a very
successful lever for activists in the
past 12 months. These votes take on a
greater importance, however. There is
emerging evidence that board directors
at companies, which receive say-onpay votes less than 70 per cent, are
likely to face ‘Vote No’ campaigns
against members of the compensation
committee. Given that a key desire
of activists is to gain board seats it is
vital that companies have a complete
understanding of best practice in
executive compensation and set up
pay structures that have a strong and
strategic link to performance.
Golden parachutes and severance
are the most likely elements to upset
investors. Underperforming CEOs
getting large payouts is a massive
focus. New share issuance to fund
executive pay plans (which is dilutive
for existing shareholders) was another
contentious issue. Just under 17 per
cent of plans seeking new issuance for
executive compensation plans were
voted down in 2014 so far.
There is no doubt that 2013 and 2014
have been watershed years for activist
investors in the US and globally.
Companies must take them more
seriously. In fact the entire relationship
between investors and corporate
management/boards is shifting. There
was a time, not so long ago, that an
activist hedge fund targeting a megacap company — with its deep pockets,
expensive lawyers and professional
investor relations teams — was almost
unthinkable. That is certainly no longer
the case. By the time 2014 comes to a
close it is likely that over 50 companies
with market caps greater than US$10
billion will have been publically targeted
by activists in the US. We have also
seen major companies in Canada and
the UK being aggressively targeted.
Now that we have established that
activism is more prevalent we should
examine how successful activists are?
At the moment the research is not
definitive as to whether or not activists
actually create value for shareholders
over the long-term. For every study
suggesting they drive long-term value
there is another disputing it. There is
no doubt that the announcement of
activist campaigns typically leads to a
short-term increase in share price.
What is true is that activists are
becoming far more successful in
contested fights for board positions.
In 2013 activists won 68 per cent of
short slate contests (fights to secure
one or more board members that
are less than a majority), according
to King and Spalding. This figure will
likely be similar in 2014. Looking at
the numbers in a little more detail,
Schulte, Roth & Zabel counted 237
public activist actions globally in 2013
— 71 per cent of which were in the
US. This is a 9 per cent increase from
the year before. Of those, activists
achieved a 59 per cent outright
success rate but that figure increases
to 78 per cent when partial success is
included. These are instances where
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International Governance
There is also a rise in cross-border
activism where investors from
one country target a company
listed elsewhere.
the activist may not have achieved all
its stated objectives but the company
implemented some of them. There
were 67 actions that sort board seats
for an activist representative. The vast
majority of these actions did not go to
a full proxy fight and in many cases the
company settled without the need for a
shareholder vote.
There is also a rise in cross-border
activism where investors from one
country target a company listed
elsewhere. This is most common among
US investors and Canadian firms but
also with UK and European investors
starting action against US firms.
Importantly for Australian companies
a number of activist US hedge funds
opened Australian offices in 2014 which
may be a sign of increased activity
locally in the year ahead.
Dealing with an activist
So, what is a company to do if, or
rather when, it receives ‘that call’ from
an activist investor? There are many
things that corporate management and
boards need to be doing in this age
of heightened transparency and the
reality is that most of the work done to
deal with an activist needs to be done
well in advance of ‘that call.’
Firstly, a company should conduct a
governance risk assessment. This is
a detailed and honest examination of
the company’s governance practices
and should be done on both an
absolute and relative basis. This means
that the company should assess its
internal practices, board governance
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procedures, director skills, and perhaps
most importantly its compensation
structures as a stand-alone policy but
also compare their practices against
those of the peer group. This type
of risk assessment usually requires
the help of professional advisers
and should ideally be conducted at
least bi-annually. By performing this
assessment a company will be able to
identify areas where its practices differ
from the norm — and thus are likely
red flags for investors.
The next step in preparing for
shareholder engagement is to
understand your shareholder base.
It is important to always have a good
understanding of which investors make
up the top 25 or 50 holders. It is likely
that compiling this list will require
professional assistance since it is not
always publicly disclosed. It is possible
to identify major holders on a quarterly
basis in the US once by monitoring
13-d and 13-g filings. But in this
modern age activists can accumulate
positions very quickly and it is possible
a new holder could move into a
position of significant ownership in a
matter of days without management
being aware. There are professionals
who are skilled at actively monitoring
corporate share ownership and can
advise investor relations departments
on any movement of interest.
In knowing your shareholders it then
becomes possible to understand their
attitudes. The old way of doing this
was to employ a proxy solicitation firm
with knowledge of and connections to
the investors. This is still an effective
method although emerging technology
is making it far easier and more cost
effective to examine institutional
voting practices. Sophisticated data
collection tools will permit a company to
examine how all its shareholders have
voted at peer companies, the sector
or market as a whole in current and
previous years. This is a powerful tool
for identifying institutions that are most
likely to support or oppose management
and identify the issues that are of
greatest concern to those investors
both as a group and individually.
Engagement, engagement,
engagement
Of course, as with all market
intelligence, it is only as useful as what
you do with it. Boards and management
must use this information to create
an outreach strategy to effectively
engage investors in dialogue. Most, if
not all, the investors on the register
are unlikely to be activist hedge funds.
Activist funds usually only hold very
small percentages of a company's
overall stock and rely on the support
of major institutional investors to
put pressure on management or, if it
comes to that, a vote on a dissident
proposal. By identifying and engaging
with major institutional holders on a
regular basis and ensuring their voice
is heard in the boardroom it is possible
to greatly minimise the likelihood of an
activist targeting your company.
Activists tend to go after the easiest
targets. If a particular company
has effective outreach and a good
relationship with shareholders then it
may deter the activist from approaching.
This leads to a larger and perhaps
more important strategic issue. More
often than not the reason an activist
targets a company is because of real
or perceived failures either in the
financials or governance processes.
By conducting a detailed governance
risk assessment the board will not
only be able to anticipate areas an
activist might target but it can also
use that information to address the
underlying issues and make changes
or improvements to its processes.
This is arguably where activists have
the greatest positive impact. By
attacking companies with questionable
governance or financial performance
they are shining a light on issues that
companies can address. In going
through that process it is not unusual
for long-term efficiencies to be created
within the company.
Preparing for a fight
Of course there are often times when
corporate management may disagree
with the opinions and demands of
shareholders. If this is the case and
management does not intend to cede
to investor demands it is vital that the
company has a well-prepared investor
relations and communications plan.
Telling the corporate story to the
wider investor base and the media is
important. Management should also
review its takeover defense options
and prepare legal defenses if it plans
to fight.
There are still many major pension
funds and other long-term investors
who view activists with suspicion so it
is definitely possible to get out in front
of a situation and explain to the longterm holders why the activist is wrong
and how management is more focused
on achieving long-term value creation.
Technology and financial services
sectors were the most popular targets
for activists in the US although
healthcare and basic minerals were
also well represented.
with better governance in the long
term. More and more pension funds
are turning to activism and supporting
hedge funds. Having a plan is vital.
Know your investors. Understand how
your governance practices stack up
against best practices. Ensure the
board fully understands executive
compensation plans and stress test
the payouts. And most importantly,
don’t automatically dismiss active
investors. They may have valuable
insight and ignoring their voice or
shutting them out will likely end in
expensive and distracting clashes with
investors. Look at it this way, these
people have invested in the company,
why not make sure they feel valued and
will be there for the long term.
Brendan Sheehan can be contacted by
email at [email protected].
Top 10 activist investors in
the US:
1. Icahn Enterprises — run by
famous billionaire Carl Icahn.
Recent targets: Apple, Hertz,
Dell, Chesapeake Energy
2. Value Act Capital. Recent
targets include Microsoft.
Takes quiet approach. 75
targets in last 14 years
3. Third Point Partners — headed
by Dan Loeb
4. Clinton Group — run by Greg
Taxin. Mostly targets small cap
companies
5. Starboard Value
6. Elliott Management
7. Jana Partners — shot to fame
with contested fight with
Canadian giant Agrium
8. Gamco Asset Management
9. Pershing Square Capital —
founded by Bill Ackman
10. Bulldog Investors
In short, activism is here to stay and
it is important for companies to be
prepared. Today’s activists are clearly
not the corporate raiders of the 1980s.
Despite their reputation they tend to
leave companies in good shape and
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