investors at bay: how corporate boards can help
Photograph by Brendan McDermid — Reuters
Sue Decker serves on the boards of Berkshire Hathaway, Costco
and Intel. She previously served as president and chief
financial officer at Yahoo.
Boards are empowered to protect
shareholders, but many have become sympathetic to activists because
they believe directors are subject to conflicts of interest.
The hottest topic in many corporate boardrooms today is
shareholder activism — or more specifically, the vulnerability of
becoming the target of a shareholder
activist and what to do about it. Instead of dreading this
or, worse, have to defend against it, boards of directors should be
proactive about getting out ahead of it. As insiders, we are in a
better position to act on our fiduciary responsibility to represent
the interests of shareholders than is an independent party, and we
have more tools and power at our disposal to do so. Done right, this
might result in some healthy, but managed changes.
The influence the activists are having in the market
has never been greater. Simply put, what they are doing is attracting
more interest and more capital, now estimated at north of $115
billion, 10 times the levels of the 1990’s. Distributing their
messages has also become easier. They often communicate via social
media and business news channels to emotionally pressure management
and collaborate with other shareholders.
So what is a board of directors to do? Boards are
empowered to protect shareholders, but many shareholders have become
sympathetic to activists because they believe the system has inherent
conflicts of interest; that directors are more interested in
collecting paychecks and preserving their status quo than in
exercising their fiduciary duty to shareholders.
Conversely, the board’s time horizon for creating value
is by definition much longer than that of any one activist, and many
boards and management teams feel activists are too short-term and just
don’t get the complexities of the landscape in which they operate.
Operating realities include balancing the interests of customers,
suppliers, employees, and regulators. Implementing well-managed
changes, while navigating these factors, often takes longer than
investors may realize.
But there are many things public company boards can do
to better align with their core responsibility to the stockholders—and
they can do it in a way that is proactive and more long-term in nature
than if it is in response to an activist.
Here are three ideas, which are meant to be directional
rather than prescriptive.
Let shareholders air it out.
Most boards only receive input from reading reports by
sell-side analysts, who are not their shareholders, and from the CEO
and CFO, who directly talk to institutional shareholders. Imagine, as
an executive, never meeting with your boss to get feedback, but
instead receiving it filtered from someone on your staff. That’s
essentially what happens for many boards.
The shareholders are ultimately the “boss” of the board
in the sense that the board serves as their proxy for enhancing
intrinsic value. Yet boards typically hear about shareholder concerns
indirectly and often not attributed to any specific shareholder.
A huge opportunity is missed without direct contact.
This is exactly the opportunity the activists are availing themselves
of by contacting blocks of shareholders to exchange views on
underperforming companies and collaborating on remedies.
Boards should do the same. There are a variety of ways
to accomplish this. For example, Coca-Cola Co. Director Maria Elena
Lagomasino, Chair of the Compensation Committee, met directly with one
large shareholder and also considered specific feedback derived from
major institutional shareholders of Coke (KO)
on the issue of executive compensation. This input led to
the revised approach to equity compensation, communicated by her
directly with shareholders through the company’s website.
This could even become part of a regular process. For
example, a designated board member could invite large shareholders to
periodic get togethers to air their thoughts and concerns. This
feedback could either be summarized for the board by that board member
or delivered directly by a representative from the group at a board
Berkshire Hathaway Inc. (BRK)
is even more ambitious. It hosts more than 30,000
shareholders in Omaha annually and allows them more than six hours to
ask unfiltered questions. Recently, Chairman and CEO
Warren Buffett offered some sage
advice on the subject. “I believe in running the company for
shareholders that are going to stay, rather than the ones that are
going to leave.”
If a designated director or a designated third party
representing the board were to reach out to shareholders from time to
time, both sides would learn and benefit. It would allow key directors
to educate shareholders, as well as build credibility and a
relationship before problems arise. In addition, shareholders can add
insight to the board, because they often speak with competitors,
customers, and suppliers of the company and can bring an “outside in”
perspective that can be hugely valuable.
Limit terms, but don’t install terms limits.
This means setting up a mechanism for both attracting
new directors with some of the skill sets of long-term shareholders,
as well as a mechanism for rotation off the board to create room for
new thinking, more diversity, and women.
For removing directors, the solution that activists
primarily advocate is a hard term-limit. As an alternative, many
companies instead opt for a retirement age. I am not a fan of either.
Why create a system that force out good board members?
Then again, most boards have at least one or maybe a
few directors who are not adding as much value as a new member might
bring and therefore represent an “opportunity cost.” Once directors
are on a board, it can be extremely difficult to naturally rotate them
off. Firing a friend is tough under the best conditions, and even more
so because there is no economic incentive.
It’s emotionally easier just to “wait it out.” This is
even more complicated when a CEO inherits a board that was picked and
groomed by her predecessor and doesn’t have the collective skills for
her new strategy.
My view is that boards would be well served to adopt a
process that specifically outlines the rotation process and that is
understood and implemented for new directors. In other words, limited
terms, but not unified term-limits. By making this change for all new
directors, it side-steps the issue of those already on the board,
making it easier to implement on a go forward basis.
I lean toward a system in which each new member of the
board agrees to hand in their resignation every six to eight years,
with the idea being that some directors will be asked to serve
multiple terms it they are uniquely qualified to help the CEO and
company build value, but many will be thanked for their service and
move on after that time frame.
The decision regarding whose resignations to keep, or
whose to accept, could be made either by an appointed director, or by
an absolutely confidential and binding majority vote of the other
board members. This latter approach might be easier socially.
Think like an activist.
Directors must insist on asking management to analyze
strategic choices as an activist would: by looking at alternatives to
the strategies the CEO is recommending. This is not typical. The more
common pattern is for the CEO to consider options and present only the
recommended one to the board.
The road not taken is the one the activist will surface
so the board must have analyzed these alternatives. This means
understanding what it would mean to get out of underperforming
operations, split up the company and evaluate varying alternatives for
measuring and handling excess cash versus the ones being recommended.
If these choices are not discussed, the board will be poorly prepared
to articulate and defend its alternative course.
Importantly, an analysis of the break-up or private
transaction value of a company that shows a higher value than where
the stock is trading does not oblige a company to make a sale. There
have been many times in history where macro-economic or other
conditions have made the current stock market and private transaction
values poor indicators of intrinsic value. The board’s duty is to
enhance the latter, exercising its duty of care, by fully
understanding what strategic choices the company is making and why.
By proactively using their power to align with
long-term shareholder value creation, boards can help companies avoid
the disruption that a shorter-term activist agenda will bring.
Sue Decker serves on the boards of Berkshire Hathaway, Costco and
Intel. She previously served as president and chief financial officer
at Yahoo. This article is an excerpt from a more detailed version
published on Sue’s blog,
deckposts.net. The opinions
expressed are her own and not necessarily those of the companies on
whose boards she serves or her colleagues on those boards.