Judging by what she has said in recent years, directors of US companies have not had much time for activist investors, recalls Maria Castañón Moats.
“I felt like the activists’ questions and stuff like that were not a good thing,” says the head of the Governance Insights Center at PricewaterhouseCoopers (PwC).
How times have changed for activists pushing for change at public companies after acquiring a sizable minority stake. “Where you are now, it’s understood, expected, and the directors and the companies are trying to find common ground with the activists,” says Dallas-based Moats. “They even have directors now who meet with investors. So I’d tell you, it’s not a bad thing, and it’s one of those things that you get involved with.
For board members, the question is how to work constructively with an activist investor – and proactively prepare for his attention.
In the wake of the pandemic, shareholder activism is on the rise again. “During COVID, activists have been unwilling to put some of their dry powder into some of these investments, especially at many companies that were in pretty tough shape a few years ago,” says David Farkas, a New York-based chief executive at the practice for activism and M&A solutions at the management consultancy FTI Consulting. “But we’re finally seeing how they’re putting their money to good use.”
FTI Consulting has just published the latest issue of its quarterly magazine Activism Vulnerability Report, which includes trends in shareholder activism. Activist investors launched 321 campaigns involving U.S.-based companies in the first half of 2022, a 23% increase from the same period last year. Activists secured 31 of 71, or 44%, of targeted board seats in the second quarter, up from 14 of 43 (33%) for the same period in 2021. Among the 10 sectors covered in the report, Technology & Media, and Telecommunications (TMT) were in most heavily targeted in the first half, accounting for 25% of all US campaigns.
Boards are increasingly under scrutiny from activists, says Michael Useem, William and Jacalyn Egan, professors emeritus of management at the University of Pennsylvania’s Wharton School. “You’ve shone the spotlight on boards like almost nothing in recent years, unless you go back 15 or 20 years, when there was a series of corporate scandals, starting with Enron.”
Activism is now ubiquitous, says Scott W. Bell, a fellow at Nashville-based law firm Bass, Berry & Sims. Large-cap companies “used to be like a giant Jurassic sauropod dinosaur,” notes Bell, whose practice includes defending shareholder activism. Given the vast sums of money required to build ownership, such companies were once too big for activists, he adds. Not anymore: “Such large-cap campaigns have increased in recent years.”
Activist investors, who own maybe 1% or 2% of a company’s stock, are seeing institutional owners join with them to pressure companies, Useem explains. “The big institutional holders and the equity analysts they work with have become part of the high-octane fuel that has powered activist investors, who are typically much smaller.”
Useem cites the successful attempt by Engine No. 1, an activist hedge fund, last year to name three directors of Exxon Mobil. “The big non-activist investors said, ‘You’re right.'”
Bell also points to the “democratization” of activist investing. It used to be dominated by the usual suspect hedge funds like Elliott Investment Management, Starboard Value and Third Point Management. “In recent years we have seen a tremendous growth in first-time or relatively inexperienced activists or moves from private equity into the activism space.”
The result for boards? “It doesn’t matter how big your company is, and there’s an unlimited number of potential activists out there,” says Bell. “Any company can be tagged with one of these engagements at any time.”
Useem’s advice: think like an activist and don’t bury your head in the sand. “The activist might have some great ideas, might have some terrible ideas,” he says. “But sit down with the activist — or at least your CEO should, and your CEO — and find out what his analysis says.”
Boards need to think about activists on a continuum, says Moats, noting that PwC addresses this approach in its new one Director’s Guide to Shareholder Activism. For example, one activist might be an institutional investor wanting to learn more about the company, while another might be a hedge fund asking tough questions about strategy.
“As a director, management has to think through all the different types of activists and questions you might get from them,” says Moats. “As a director, you need to understand who owns the stock and why they own the stock – and therefore what types of questions you’re going to get in terms of strategy and execution.”
The real reason to brace yourself for potential questions is to focus on risk factors, Moats claims. “Underperformance is something that will be questioned. And why? And what’s the plan? And how are you going to turn that around? All of these questions should be asked in the boardroom with management.”
Boards should also be honest about governance weaknesses, suggests Moats. “First, look at the composition of the board,” she says. Shareholder rights – or lack thereof – are another potential vulnerability.
Something else to consider: executive compensation, which has added non-financial metrics like diversity, equity and inclusion, Moats notes. “At the end of the day, the shareholders vote,” she says. “There is a say in the payment.”
Farkas has always preferred dialogue with shareholder activists. “Being hostile towards you will only make them angry, and then they will pursue their own agenda,” he says. Farkas also encourages panels to learn about an activist’s past behavior and track record — a task less rewarding for beginners.
The committee’s role is to separate an activist’s bona fide, well-informed arguments from the rest, Bell says. Directors should avoid becoming fixated on defense, he advises. “It’s important not to get too involved in the ti-for-tat with an activist,” says Bell. “Shareholders like to see their board’s responsiveness, but they don’t want to feel like the board is obsessing over the struggle or taking it too personally.”
This is also the advice Bell offers on defending against activists: “Maintain and maintain good relationships with your investor base as a normal business.”
That takes discipline, but it can pay off when an activist criticizes the company, Bell says. “Your credibility with investors, for example if you’re trying to make your case in an actual voting contest, will be much greater if they know the company well, they feel like they already have a voice in the boardroom, and you have their concerns.” heard and perhaps involved in what you do.”
What should bodies on the activism front be looking to for the future?
Moats highlights the environmental and social aspects of ESG. The Securities and Exchange Commission has proposed new rules that will lead to more disclosures related to climate change, it notes. Moats also recommends focusing on the second element of diversity, equity and inclusion. “If I’m a director, what are we doing as a company in terms of everything we do with our talent, in terms of vendor collaboration and stuff like that, on the equity side?”
Bell agrees that companies continue to face environmental and other ESG-related arguments from activists, legitimate and otherwise. “Again, the best defense is to reduce your vulnerability by maintaining good ESG practices and reporting, and having a good dialogue with shareholders about these things before an activist comes up.”
He and others also point to the SEC’s new universal proxy rules for director contests, which went into effect in September. “These new rules will likely increase the number of potential contests by reducing the cost for activists to run them,” Bell says, “and likely also increase activists’ ability to win board seats in certain circumstances.”
Boards should remember that “activists are always finding new ways to attack companies and push for new things,” Bell warns. The line has now blurred between traditional activist hedge funds and private equity firms, with the latter backing hedge fund takeover bids and buying their own stakes in public companies. “It all reinforces the feeling that it could come from anywhere at any time.”