The Changing Face of Shareholder
Posted by Paula Loop, Catherine Bromilow,
and Leah Malone, PricewaterhouseCoopers LLP, on Thursday, February 1,
Editor’s Note: Paula
Loop is Leader, Catherine Bromilow is Partner, and Leah Malone is
Director of the Governance Insight Center
at PricewaterhouseCoopers LLP. This post is based on a PwC
publication by Ms. Loop, Ms. Bromilow, and Ms. Malone. Related
research from the Program on Corporate Governance includes Dancing
with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and
Thomas Keusch (discussed on the Forum here);
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);
The Long-Term Effects of Hedge Fund Activism by
Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum
Activism is about driving
change. Shareholders turn to it when they think management isn’t maximizing a
company’s potential. Activism can include anything from a full-blown proxy
contest that seeks to replace the entire board, to shareholder proposals asking
for policy changes or disclosure on some issue. In other cases, shareholders
want to meet with a company’s executives or directors to discuss their concerns
and urge action. The form activism takes often depends on the type of investor
and what they want.
investors and hedge funds typically have the most impact. Individual
investors may submit lots of shareholder proposals, but they usually
lack the backing to drive real change.
To prepare for—and possibly to even avoid—shareholder activism,
companies and their directors need to understand today’s landscape. Who are the
activists? What are they are trying to achieve? When are activists more likely
to approach a company? What tactics do they use? We break down the answers by
the two main types of investors. Read on.
These include pension funds, asset managers, mutual funds and
Institutional investors are normally long-term shareholders. Many
hold their shares in index funds, which are popular for their low fees.
Institutions that provide index funds can’t just sell a position if they think a
stock is underperforming, or if they believe the company’s governance practices
hinder it’s long- term value. And so they turn to activism. Through activism,
they can bring attention to their concerns and drive the change that they
believe will create long-term value—including through changes in corporate
governance practices. Institutional investors such as Vanguard are vocal about
their belief that companies with strong corporate governance practices can
deliver better value in the long run.
When institutional investors have concerns, they often start by
engaging one-on-one with the company. In prior years, engagement was mostly
between the portfolio manager and the company’s investor relations team or
members of management, and focused largely on company performance. Today,
investors’ corporate governance teams are often driving the meetings—sometimes
alone and sometimes in combination with portfolio managers.
At times shareholders ask to meet with directors. They may have
identified issues in the company’s executive compensation plans, its governance
policies or practices, or its strategic plan. Other times, shareholders are
looking to lay the foundation of an open dialogue with the directors. So when
issues do arise in the future, they have an existing relationship upon which to
In some cases, institutional investors submit—or indicate they
plan to submit—a proposal if direct engagement with the company and its
directors doesn’t produce changes. Other investors view a shareholder proposal
as a way to begin the conversation with a company.
These proposals often focus on governance practices or policies,
executive compensation, or the company’s behavior as a corporate citizen.
Proponents watch how the major institutional investors are voting on issues, and
have a sense of which shareholders may be likely to support their proposal going
in. Investors also often reach out to other shareholders to encourage support
for their measure. By the time a company even receives a shareholder proposal,
its sponsor may already have a sense of whether it will pass.
Proxy access: a highly
allows certain shareholders to include their director nominees in the company’s
Institutional investors have been pushing for proxy access for
years through shareholder proposals. In the 2012-2014 proxy seasons, these
proposals got limited support. But in the fall of 2014, the New York City
Pension Fund helped proxy access to take hold through its Boardroom
Accountability Project. It targeted more than 70 major public companies with a
coordinated, highly public effort. Most proposals passed, and companies started
to implement proxy access bylaws. Efforts have continued since then, and by
mid-2017, 60% of the S&P 500 had proxy access bylaws in place.
Why does this matter now? The New York City Pension Fund has
launched version 2.0 of its Boardroom Accountability Project for 2018. This
time, they are taking on board diversity and renewal, calling on companies to
disclose the race, gender and skills of their directors in a standard matrix
“Vote no” campaigns
“Vote no” campaigns urge shareholders to withhold their votes
from director candidates or to vote against a company’s say on pay.
The vote doesn’t actually have to fail for a vote no campaign to
be a success. Overall shareholder support both for directors and for say on pay
is typically above 90%. So if support levels fall to the 60s or 70s, it sends a
stark message about shareholder dissatisfaction. It also generates media
scrutiny, and can affect a director’s reputation. Directors often serve on
multiple boards, and low support levels at one company can affect how that
director is viewed at his or her other companies as well.
A vote no campaign can send a strong signal about shifting
shareholder priorities. Just as proxy season was beginning in 2017, State Street
Global Advisors (SSGA) used the tactic to shine a spotlight on gender diversity.
They announced they would start voting against nomination and governance
committee chairs at companies that didn’t have any women directors and weren’t
making efforts to add them. Indeed, SSGA voted against directors at over 400
companies in 2017, sending a clear signal.
Different types of shareholder concerns lead to different
approaches. Although these methods can seem like escalation tactics, different
investors simply prefer to start in different places and may adopt more than one
approach on a given issue.
Preparing for and responding to
institutional investor activism
Start a pattern of regular director engagement.
Before the company
receives a shareholder proposal or is targeted by a vote no campaign, start
getting directors involved in discussions with major investors. Some investors
view a shareholder proposal as a way to begin a conversation with the board.
But if the lines of communication are already open, shareholders may not feel
they need to resort to a shareholder proposal or other means.
Respond directly to the investor.
If you have received a
shareholder proposal or been targeted for a vote no campaign, reach out to the
investor. Discuss their specific concerns. When dealing with a shareholder
proposal, the company and the shareholder may be able to agree on some action
at the company in exchange for withdrawal of the proposal. Shareholders don’t
always insist on immediate action. They know change can take time, and often
they are satisfied if the company demonstrates that it has a plan in place to
address the issue. Communication might not put an end to a vote no campaign,
but understanding the shareholder’s perspective will help the company respond.
Reach out to other shareholders.
A shareholder proposal or a
vote no campaign can be an opportunity to discuss the issue with other
shareholders. Take the chance to articulate the company’s view about why its
current course is in the best long-term interests of the company and all of
its investors. And consider disclosing the breadth of the company’s
shareholder engagement efforts in the proxy statement to give yourself credit
for your outreach. For more on shareholder engagement, take a look at our
Director-shareholder engagement: getting it right.
Blurring the lines—The future of
institutional investor activism
Some institutional investors are moving beyond their traditional
tactics. With many committed to long-term passive investments in a broad
portfolio of companies, they are looking hard for ways to find untapped value at
those companies—by encouraging governance changes, and otherwise. And so today,
some are engaging in what has traditionally been thought of as hedge fund
activism. Long-term institutional investors who previously never would have
considered themselves “activists” are getting into the fray. Some are
approaching hedge funds with a specific target in mind, backed by their own
research, to suggest teaming up. Others are turning into “occasional activists”
in their own right, without a hedge fund partner.
Hedge funds attract big dollars from investors looking for
above-average returns. So they are always looking for untapped value. Hedge fund
activists often see that untapped value in the way a company is run, or the
strategy it pursues. They see ineffective management, a stale board, or a
company missing out on new opportunities. They see the potential for a new
capital allocation strategy or changes in operations that will increase share
value. And when their efforts to engage with executives or directors about these
ideas fail, they often try to elect different directors.
Hedge fund activism today
Hedge fund activists used to focus mostly on capital allocation
issues, such as dividends and share buybacks. Many then began looking for
company combinations and break-ups—mergers, carveouts and spin-offs. Now, there
is a greater focus on operational activism, which has more of a long-term focus.
Activists join the board (or appoint independent directors), replace
members of management and help execute a new strategy. While many hedge funds
had been thought of as being too focused on short-term gains, the longer-term
operational activism has helped to shift that perception.
While a few hedge funds made significant profits for their
investors in 2017, most have failed to outperform the S&P 500. For many
investors, these returns don’t justify the high related fees, and so some large
institutional investors such as the California Public Employees’ Retirement
System (CalPERS) have pulled their investments out of hedge funds entirely. In
2016, hedge funds actually closed at the fastest rate since the 2008 financial
With competition for investments growing tighter, hedge funds are
under greater pressure to post returns, which may be driving up activism even
Some activists follow a standard playbook. Many first spend time
talking to the company, highlighting areas for improvement and value creation.
If they can’t negotiate a consensus around specific changes, they may move on to
a proxy contest or a public media campaign.
Again, not all hedge funds follow this trajectory. Some move
first to a media campaign or some other way of making a major splash. Whatever
approach, hedge funds may also have spent time talking with some of the
company’s key shareholders to gauge their level of support for the campaign.
The number of proxy fights in 2016 reached its highest level
since 2009, and companies are more willing to settle with activists than ever
before. Proxy fights are long, expensive and draining for a company. There is
greater recognition that the directors nominated by activists can sometimes add
real value to the boardroom. So for many companies, it’s just not worth the cost
and distraction of a proxy fight.
Settlements have now become so common, in fact, that some
institutional investors are concerned that companies are settling too easily.
Before rushing to settle, they urge companies to at least reach out to their
significant shareholders to solicit their views. Sometimes these investors might
agree with the activist—and sometimes they might want the company to hold their
ground against the activist.
Hedge fund activists use proprietary processes to identify their
targets. But most targeted companies have some or many of these characteristics:
Low market value relative to book value
Disappointing company performance compared to peers
Profitable with sound operating cash flows and return on assets
Excessive cash on hand
For multi-business companies: one or more significantly underperforming
business lines or business lines with markedly different growth potential
Board composition does not meet today’s preferred governance practices (e.g.,
instead has long average board tenure, lack of board renewal, lack of
diversity, lack of industry experience)
Before hedge fund activist
Companies can best anticipate, prepare for and respond to an
activist campaign if they put themselves in an activist’s shoes. Here are four
Rethink the information.
Boards may get too much
granular information that doesn’t highlight underperforming assets. Reassess
the type of information the board receives and revamp it so it gives the full
Monitor shareholder positions and understand the activists.
that the board is informed when an activist takes a significant position in
the company or in an industry competitor. And make sure the board hears about
broader activism trends that could affect the company in the future.
Understanding what these shareholders may seek (i.e., understanding their
“playbook”) will help the company assess its risk of becoming a target and
help it know what tactics to expect.
Evaluate and address your “risk factors.”
Look for the ways an
activist might criticize the company and its board. Examine company strategy
from an outside perspective, and then test whether it’s working. Ask to hear
from consultants, industry analysts or others from outside the company, to get
a better understanding of how the company is seen by investors and potential
activists and where its vulnerabilities are. Make sure they are giving their
“unvarnished view”—one that has not been white-washed by management or by an
unwillingness to give a frank evaluation.
If there are issues, take
proactive steps to address them. This can reduce the chance of being an activist
target and strengthen credibility with the company’s shareholders. Even if the
company chooses not make any changes, going through the critical process will
help company executives and directors reaffirm and articulate why they believe
the company is on the right course.
Launch an engagement plan.
Once a company identifies
areas that may attract activist attention, engaging with other shareholders
around these topics can help prepare for—and in some cases may help to
avoid—an activist campaign. Being transparent about the company’s
vulnerabilities and its strategic choices can help change a shareholder’s view
of the issue, and demonstrate that the board is fulfilling its oversight
responsibilities. Other times, the engagement should be more about listening.
We hear more and more about boards bringing portfolio managers or other
investors in to share their thoughts on the company and ways they could
improve—and possibly head off an activist.
Responding to a campaign
In responding to an activist, consider the advice that large
institutional investors have shared with us: good ideas can come from anyone.
Some circumstances may call for more defensive responses—such as litigation—to
an activist’s campaign. But in general, we believe the most effective response
plans have three components:
Objectively consider the activist’s ideas.
Activists usually do
extensive homework before they approach a company. Based on that research,
they develop specific proposals for unlocking value—at least in the short
term. And they have often discussed these ideas with other shareholders.
Assume the company’s institutional investors have already spent time
evaluating the activist’s suggestions. Investors will expect the company’s
executives and board to do the same—even when it’s uncomfortable. And it often
is. The changes activists propose are not easy and they are not
uncontroversial. If they were, the company would have already done them. More
often, they are recommending fundamentally restructuring the company or the
go-forward strategy. They might be looking for changes in the boardroom, which
may feel like a personal affront to the directors around the table. Or they
may be looking for a change in management, which will almost certainly feel
like an attack on the CEO. But none of these ideas should be dismissed out of
Look for ways to build consensus.
More companies than ever are
finding ways to work with activists. By doing so, they avoid the distraction
and high cost of a proxy contest. Companies might agree to change their
capital allocation, or even to add new directors to the board. Sometimes a
brush with an activist gives a company a welcome opportunity to refresh its
Activists are also motivated to
reach agreement. Proxy contests are expensive— for both sides. If given the
option, most activists would prefer to spend less time and money to achieve
their goals. Once they agree, the activist and the company enter into a
standstill agreement that sets the terms of their relationship going forward.
Tell the company’s story.
Now is the time to reach out
instead of hunkering down. As we’ve said, an activist will likely be engaging
with other shareholders, so it’s important these investors hear from
management and the board as well. Ideally, the company already has an
established relationship with those shareholders to build upon. If the company
doesn’t believe the activist’s proposed changes are in the best long-term
interests of the company and its owners, investors will want to know why—and
just as importantly, how the company reached this conclusion. Often we hear
that the suggestions activists make are ones that the company had already been
If the activist and company are
able to reach an agreement, investors will want to hear from executives and
directors about why the changes are good for the company. Being seen as
forward-thinking leaders, rather than victims of activism, can boost investor
Hedge fund activism is rarely
“one and done”
When the annual meeting is over, and changes have been
implemented, or the hedge fund has moved its attention to another target, it may
feel like the storm is over. But the risk of additional activism doesn’t go
away. The way the company responded to the activism, and the perception of the
board’s independence and open-mindedness can make it a repeat target.
To get ahead of this, companies periodically refresh the four
steps described earlier in the “Before hedge fund activist campaigns occur”
section. By periodically assessing risk factors and engaging in a tailored and
focused shareholder engagement program, the company can enhance its resiliency
and strengthen its long-term relationship with investors.
As activism—by both institutional investors and hedge
funds—continues to be strong, many think the number of campaigns could be on the
upswing. These campaigns may also be more likely than ever to succeed. For
companies, listening to and understanding shareholder concerns may be more
important than ever.
Harvard Law School Forum
on Corporate Governance and Financial Regulation
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