Top 10 Topics for Directors in 2016: Shareholder Activism

In the first half of 2015, more than 200 U.S. companies were publicly subjected to activist demands, and approximately two-thirds of these demands were successful, at least in part.ⁱ A much greater number of companies are actually targeted by activism, as activists report that less than a third of their campaigns actually become public knowledge.ⁱⁱ Demands have continued, and will continue, to vary: from requests for board representation, the removal of officers and directors, launching a hostile bid, advocating specific business strategies and/or opining on the merit of M&A transactions. But one thing is clear: the demands are being heard.

Many activist investors have evolved from corporate gadflies to powerful and increasingly dominant forces as they have gained support and credibility from institutional investors. According to a recent survey of more than 350 mutual fund managers, half had been contacted by an activist in the past year, and 45 percent of those contacted decided to support the activist.ⁱⁱⁱ Mutual funds supported many prominent activist campaigns in recent years, including ValueAct Capital Management LP’s board seat at Microsoft, Starboard Value LP’s removal of the entire board at Darden Restaurants and an investor’s push for a quicker stock buyback at General Motors.^iv

With the threat of activism in the air, boards need to be prepared. Directors — who are charged with overseeing the long-term goals of their companies — must also understand how activists may look at the company’s strategy and short-term results. They must understand what tactics and tools activists have available to them. They need to know and understand what defenses the company has in place and whether to adopt other protective measures for the benefit of the overall organization and stakeholders. Some specific steps companies should take include:

• Understand the company’s potential vulnerabilities. Boards need to carefully review their business and strategy to identify any weak areas. Boards should be doing this irrespective of whether the company may be an obvious activist target, but they must also be mindful of whether specific areas of concern exist among its investor base. Underperformance, particularly as it relates to industry peers, is the easiest way to draw activists’ attention. Other lightning rods are large cash balances that could be returned to shareholders through dividends or stock buybacks, unrelated or underperforming divisions or business units that could be spun off, and other assets, such as real estate, that do not generate a sufficient current return and could be sold. Once vulnerabilities are identified, boards need to determine how to address them while focusing on what is in the best interests of all shareholders.
• Understand the company’s defense profiles. It is critical that boards assess what defenses the company has in place or that may be readily deployabl Many companies have become more vulnerable to an activist attack after having acceded to shareholder demands to de-stagger boards, eliminate poison pills, and give shareholders the right to vote by written consent and call special meetings. By the time activist investors approach a company, they have done hundreds or thousands of hours of homework. Boards that do not understand their company’s existing defensive profile prior to an activist overture are disadvantaged from the start.
• Prepare for an activist approach. Companies need to be prepared to respond to an activist overture. Understanding the activist’s objectives and carefully evaluating the activist’s proposal in a timely manner is critical. Companies should assemble a response team, which may include a small team of corporate officers, legal, financial and proxy advisors; and investor relations personnel, to develop a pla Having a game plan in place that addresses various scenarios will lead to a more thoughtful, productive and effective response.
• Know and engage your shareholders. Knowing and engaging your shareholders has never been more important. Companies should regularly monitor and identify their shareholder base and trading activity of the company’s shares.^v With the 10 largest shareholders of an S&P 500 company, on average, holding 44.7 percent of the company’s stock,^vi the support of major shareholders can make or break an activist campaign. Companies should make it part of their platform to reach out to significant shareholders, not only to better appreciate their perspectives on the company, but also to build credibility and stronger relationship In addition to cultivating relationships with investors, companies must continually and effectively communicate their business strategies and plans for value creation to the marketplace. Companies should take advantage of the power of the Internet by making sure their Web sites are up to date and fully articulating the company’s message. Companies should also actively monitor shareholder concerns and opinions that are expressed through blogs and other shareholder forums and proactively respond to shareholder issues before they escalate.
• Determining director involvement. As part of shareholder engagement, companies need to determine whether, and to what extent, directors should be communicating directly with shareholders on the company’s behalf. According to PwC’s annual survey, nearly seven-in-ten directors said their board regularly communicated with the company’s largest investors during the past year, and 32 percent of directors reported that their board interacted with activists this past year.^vii Director engagement is important to investors, and boards should consider establishing protocols and practices regarding permissible discussion topics for directors and shareholders, as well as a process for shareholders to request direct dialogue with the board. Approximately six-in-ten directors surveyed reported that their companies have either established or discussed such protocols and practices.^viii

Understanding the influence of proxy advisory firms. Proxy advisory firms — namely Institutional Shareholder Services (ISS) and Glass Lewis — significantly impact shareholder activist campaigns, with institutional investors often relying on the recommendations of these firms to assist them in voting all manners of proxy solicitation. A compilation of institutional investor voting in recent contested director elections revealed that the top 10 institutional investors voted, on average, the same way as ISS 91 percent of the time and Glass Lewis 94 percent of the time.^ix Further, evidence suggests that a “no” recommendation from these firms results in a roughly 30 percent “no” vote by institutional shareholders.^x The fear and reality created by opposition from proxy advisory firms has led many companies to negotiate a settlement with the activists, which continues to be the most common way to resolve an activist campaign. But some companies do fight back — with this year’s most notable being DuPont successfully taking on Trian Partners’ campaign to install four new board members. While the vote was close, DuPont’s existing board prevailed, given that several key shareholders ultimately rejected the advice of ISS and Glass Lewis.

This post was excerpted from our annual Top 10 Topic for Directors in 2016 alert. To read the full alert, please click here.

ⁱ Activist Insight, “2015: The First Half in Numbers,” Activism Monthly (July 2015).

ⁱⁱ Activist Insight, “Activist Investing – An Annual Review of Trends in Shareholder Activism,” p. 8. (2015).

ⁱⁱⁱ David Benoit and Kirsten Grind, “Activist Investors’ Secret Ally: Big Mutual Funds,” The Wall Street Journal (August 9, 2015).

^iv Id.

^v Fifty-six percent of directors surveyed are now using a stock monitoring service to provide them with regular updates about changes to the company’s ownership. PwC’s 2015 Annual Corporate Directors Survey, at p. 17.

^vi David Benoit and Kirsten Grind, supra.

^vii PwC’s 2015 Annual Corporate Directors Survey, at p. 17.

^viii Id., at p. 14.

^ix Proxy Insight, “Why ISS Couldn’t Win it for Peltz,” Activism Monthly (July 2015).

^x Nicholas Donatiello and Harvey L. Pitt, “Protecting Shareholders from Activist Proxies,” The Wall Street Journal (May 28, 2015).