Are you satisfied that your company has a game plan for responding to activists? Given today’s activist environment, has your company increased its level of engagement with its largest shareholders? We posed these questions to the 1,200 audit committee members, directors, and business executives attending KPMG’s Spring 2014 Audit Committee Roundtable series, and while most said their company has increased its level of engagement with its largest shareholders, about half said their company has not developed a game plan for responding to activists.
Investor activism—led by large, well-known activist hedge funds advocating for changes and improvements at the company—is not only on the rise, but appears to be moving into the mainstream, as traditionally passive investors and pension funds are often supporting activist campaigns. In fact, one in three Roundtable attendees said their company has faced an activist campaign in recent years, and experts suggest that activists have likely evaluated most U.S. public companies. All of this points to the importance of having a robust boardroom discussion about how the company is preparing for activist investors. These four questions are a good starting point:
Do we understand the activists’ agenda? Activism has generally moved beyond demands for structural governance reforms—e.g., majority voting, de-classifying staggered boards, independent chairman—and today is often focused more on strategy, operations, and management of the company. As John Madden of Shearman & Sterling has noted, activist hedge funds often bring “a sophisticated analytical approach to critically examining corporate strategy and capital management and…[have] been able to attract the support of mainstream institutional investors, industry analysts and other market participants.” While some argue that this new “strategic/operational” activism has been largely short-term focused—and often at odds with management’s longer-term view—opinions (and research) vary widely. When asked whether shareholders have generally benefitted from recent activist campaigns, 30 percent of Roundtable attendees said “yes,” 22 percent said “no,” and 48 percent said the “results have been mixed.”
How are companies preparing for activism? As one governance observer suggested, the key is to “think like an activist.” Are we a likely target? Only 15 percent of Roundtable attendees said their company has conducted a vulnerability assessment to identify performance gaps and opportunities that activists might focus on. (A number of investment banks now offer vulnerability assessments and advise companies on how to thwart activists.) It’s critical that the company assemble an activist response team—which may include corporate officers, counsel, investor relations, investment banker, proxy advisory firm, and a director—to develop a plan to deal with activists.
Do we know and engage with our largest shareholders?Some 60 percent of the Roundtable attendees said that, as a result of the activist environment, their company has increased its level of engagement with its largest shareholders. Have we clearly communicated the company’s strategy and value creation opportunities? Do we understand the investor’s perspectives? Have we solicited their input? The goal is to establish credibility and gain the investor’s support before an activist arrives.
How should we respond to an activist? Only 28 percent of Roundtable attendees said their company has developed a game plan for dealing with activists, but given the likelihood that an activist will at least evaluate the company, having a plan in place is key. In considering how to respond, understand what the activist wants. Do they have a point? What are their tactics? What are the views of the company’s major investors and the proxy advisory firms? What is our communications and social media strategy?
Finally, determine when and how directors should engage with major shareholders and activists. Which directors should engage? What issues should be discussed? Who else should attend?
Dealing with activists is often more art than science, but the questions and considerations above can help remove some of the guesswork—and avoid unpleasant surprises—in today’s activist environment.
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KPMG’s Audit Committee Institute (ACI): With the increasing profile of activist shareholders, how have management and boards altered their approach when working with you as an investor?
Morfit: There’s been a huge change in the past couple of years. As it relates to ValueAct, we’ve worked very hard to cultivate our network since 2000. Now, we have a track record and a network base that gives us great access to directors. While some of that access is specific to us, boards in general have become more likely to engage with shareholders, both investors like us as well as traditionally passive asset managers. We’ve seen genuine outreach and willingness from independent directors who are seeking input from shareholders, rather than the views of investors as filtered through management and investor relations.
Krumsiek: We have found more openness to our requests for engagement with management and boards in recent years. And we have seen more engagement initiated by the companies themselves. There is a greater interest on the part of management and boards to understand the views of investors, to understand their priorities and concerns. We attribute this to the fact that boards and management want to develop a more constructive relationship with their shareholders…so that when an activist investor targets a company there is a relationship with other shareholders whose support the company may need. Beyond that, however, there has been much more engagement since the financial crisis. The focus on compensation, via the advisory vote on pay, has also facilitated greater dialogue.
Boards and management also recognize that ESG factors can have material effects on long-term investment performance. They are engaging more consistently on that set of issues. Pension funds and other institutional investors are using ESG as a risk-mitigation approach. This growing recognition is driving more engagement on these issues. The term “agenda” that is used to describe a focus on ESG factors is an outdated way of viewing the world. Many companies now show a positive financial impact comes from incorporating sustainability into the investment process. ESG factors have an impact on both the risk and the opportunity side.
ACI: On the flipside, has your approach to interacting with companies—and particularly with boards—changed over the years?
Krumsiek: We have been more and more focused on governance—both the longstanding “traditional governance” agenda related to board composition, executive compensation and shareholder rights, but also on the governance of sustainability factors. We want to know whether and how boards of directors are providing oversight of their company’s sustainability risks and opportunities. How is management integrating sustainability into the everyday operations of the business and where does the accountability for integrating sustainability fit on the board and management agenda? Furthermore, we are asking to speak with people in companies who have operational and senior management roles, in addition to the investor relations and sustainability professionals. And we ask to speak with members of the board more often. Conversations with senior management and board members can help us determine whether and how the company addresses key issues of concern.
Morfit: We’ve matured in many ways, but there’s no substitute for experience. If you’ve served on a board, you understand how the board thinks. And for us, relationships matter, including other investors and the entire shareholder set. We’ve always tried to comport ourselves in a way that benefits all shareholders. Choosing the path that benefits everybody also builds a constituency—which is incredibly valuable to us in our business.
Now, we are generally introduced and then we invest. We don’t sneak up on companies and show up suddenly owning 5 percent of the stock. It takes us months if not years to make our investment. There have been issues at some of the companies we have invested in in terms of performance, strategy, management or compensation…issues that have caused shareholders to reach out to the board. (Say-on-pay, in particular, has created an annual referendum on management and acclimatized not only the board but also the shareholders that this is something we need to be doing and paying attention to.)
ACI: In your view, what’s the biggest misperception that you’ve found directors to have about your views and positions or what attracts you to invest in their company?
Morfit: Time horizon. Most directors think we have a shorter time horizon than other shareholders. But our average holding period is 3 to 5 years, and many positions far longer, some for 8 or even 10 years. The long-term/short-term debate is a convenient excuse for not facing up to reality. Then, there’s the general fear or apprehension that the board may have of an activist investor in the stock and what it might mean for the company—a fear of the unfamiliar and what could go adversely. People are aware that activists have a number of tools at their disposal—from proxy fights to public communications to a hostile takeover. The fact that it’s possible is scary to people.
As it relates to the long term/short term issue, when we make a choice to join a board, we are sacrificing a lot—time, energy, but also trading liquidity. We don’t give up liquidity lightly. We make a long term commitment to our companies and we believe that the benefits will outweigh the costs. As an aside, the liquidity usually works itself out if the company performs, the market cap increases and getting out is a piece of cake. But sometimes we do end up on the other side: you can’t always be right.
Krumsiek: While directors have been aware of the growing investor interest in sustainability matters, they still appear to be surprised to have investors ask them questions about these issues and do so in a way that draws a clear connection between management of sustainability and the success of the business.
ACI: Hypothetical: You become the CEO of a major public company tomorrow, and an aggressive large investor calls with some ideas or concerns they want to discuss. How would you manage their request and approach?
Krumsiek: First I would make sure that my senior management team and I understood who this investor was, what they were really interested in and where they were coming from. I would seek to understand the investor’s track record, how have they approached companies in the past. Then I would listen. Depending upon our view of this investor and his/her agenda, we might reach out to some of our largest investors to explain the situation and lay out our viewpoints.
Morfit: I think the most dangerous thing you could face as a CEO is a highly opinionated shareholder who is ignorant of the facts. So the best thing to do is engage and find out what they are thinking, what they are seeing and what facts they have. Frankly, sometimes a shareholder might have information that the management and board doesn’t have. Once you are on the same page with what the facts are, you agree to agree or disagree on the conclusions. The worst thing a CEO can do is to go into a bunker mentality. In general, we’ve found that being engaged with shareholders is a positive for most companies. They should be treated like owners, not like enemies.