According to Korn Ferry, last year, activist investors launched 929 campaigns worldwide, a 6% year-over-year increase. In the United States, activist campaigns sought to change board composition and focused on specific corporate governance concerns like board tenure, executive compensation, shareholder rights and ESG-related risk. Shareholder activism is expected to rise, driven in part by the SEC's new universal proxy rule, which enables investors to target individual directors for removal.
Although traditional asset managers and hedge funds account for most activist activity, advocacy organizations also use the tools of shareholder activism, most notably shareholder proposals, to encourage companies to change. Investor coalitions formed with a focus on specific issues, such as climate or corporate social responsibility, are also growing in size and influence. While it may take different forms, the goal of all shareholder activism is the same: to push management and boards to change some facet of the way their companies are run.
Both Risk and Opportunity
Many directors view shareholder activism as a risk to be managed, but it also presents a strategic opportunity if addressed proactively, says Michael Montelongo, former assistant secretary of the Air Force and director of Conduent Inc. and Civeo Corporation.
“Shareholder pressure can serve as a valuable wake-up call for companies that are underperforming — if it isn't ignored,” says Montelongo. “It can work well if an activist is motivated to work with a management team and board to address serious strategic, operational and financial challenges, and if management and boards leverage the benefits and insights activists can provide. Activist investors may have sound ideas about how management can use the company's assets better, improve its operations or enhance shareholder value.”
Patrick A. Cozza, executive in residence at Fairleigh Dickinson University's Silberman College of Business and a director of Franchise Group Inc., agrees. “Activism overall has more of a negative connotation to it, but [activists] can play a valuable role when they come in truly looking to help the management team and the board turn the company around. If you have a company that's undervalued in some way, shape or form because of either a flaw in strategy or an issue with the leadership team, or potentially with the board, an activist can bring new thinking and disrupt the culture positively.'”
Andrew Shapiro is founder and CEO of Lawndale Capital Management, which manages the longest-running activist fund in the small and microcap space. He says a healthy boardroom culture is one in which the board is empowered with the right information to push back on management when necessary, and that lack of empowerment is one of the biggest signs that a more activist posture should be assumed.
“A big red flag for me is when I ask a question that relates to the board's purview, and I'm referred to the CEO, or I hear of management promulgating, whether it's through a few really close cronies or directly, limitations on the board from availing themselves of what I view as an essential component of the duty of due care, and that is the duty to be informed,” says Shapiro. “When undue restrictions are placed on board members, to the point that they cannot satisfy my broader interpretation of the duty to be informed, that is a prime indicator of an insecure CEO, especially when the board adheres to those views and policies rather than pushing back.”
Does Every Board Need an Activist?
Having an activist point of view on the board can guard against both groupthink and the kind of asymmetric information risk that can spell trouble for a company's long-term strategy. This shifting perspective on the role and value of shareholder activism has more boards rethinking a central question: Does every board need someone who thinks like an activist?
The answer hinges in part on defining the term. Just as the phrase “public company” is broad and encompasses everything from complex multinational organizations like IBM and Coca-Cola to micro-cap companies with very different governance and capital allocation needs, activist shareholders are not a monolith. Some activists are focused on the long-term success of the company and improving corporate governance. Others have a more self-serving goal, such as taking a significant position, running a campaign on a short-term measure or collecting quick profits and making an exit. Regardless, says Montelongo, successfully engaging with an activist starts with communication.
“I think of activist tactics as a continuum that begins with routine shareholder engagement. Keeping shareholders in the loop is good governance. It's what CEOs and boards should be doing. More aggressive shareholder activism is usually prompted by companies not listening to or engaging with their shareholders.”
Alex Zyngier, a long-time investor and board member for companies like Atari, EVO Transportation (where he is chair) and Schmitt Industries Inc., sees a fundamental flaw in using the word “activist” at all.
“A shareholder is a shareholder. Good governance would tell you that you represent everyone equally, regardless of whether they own one share or 99% of the shares,” says Zyngier. “I work for the money, so when the money comes and says something, I have to listen. Is it easy? Not necessarily. But that's the job. Now, you might look at [an activist's] feedback and say ‘That's way out there. We don't have the resources to spend on this. It's just not relevant, and we're going to move forward.' But I think you take it as input, and then the board just decides how much needs to be developed.”
The open-minded approach to differing perspectives Zyngier describes is one key hallmark of what it means to think like an activist. Another is the willingness to question assumptions and ask management to do the same, says Nancy Reardon, who served in executive leadership roles at Campbell Soup Company and now serves on the boards of Big Lots Stores Inc. and Signet Jewelers.
“An activist usually has a thesis. Maybe it's that the company is underleveraged. Maybe it's that [the company] has assets that can be monetized in a different way,” says Reardon. “It could be selling a division off. It could be financing all their distribution centers differently. Or it could be they see that the board is tolerant of poor performance and should make changes by unseating management. So, thinking like an activist means looking at the business strategy, the business results, the goals for the next year, and the risks and the opportunities from the outside in. In other words, being cognizant of what the competition is doing, recognizing opportunities and vulnerabilities from a big-picture standpoint, and not just assuming that the management team has it down cold, because sometimes they don't.”
For many directors, it's fundamental to how boards should approach their role. “Usually when you see activists jump in, it's because they believe they see untapped value and they're buying in to try to transform, make change and raise shareholder value,” says Cozza. “A key is to not put yourself in that position and to do your job as a board member.”
The Difference Between Public and Private
Part of the tension between boards and activists, say some investors, is a disconnect in what “doing the job” means as a practical matter. When Glenn Kaufman joined his first public company board, he noticed a fundamental difference from his private company board work.
“It was an incredibly capable and talented board, but as I studied it and other public boards, I was surprised by the degree of difference in how directors engaged in their jobs,” says Kaufman, who has served more than 15 boards in the private equity space and today is managing director of D Cubed Group; chair of KPS Global LLC, Trading Company Holdings and KEH Camera; and a director of Red Robin Gourmet Burgers.
“I recall asking at a corporate governance event why directors at public companies can't have options in the company, and the answer was, ‘Because they need to maintain their independence.' I thought how incredibly different a mindset that is at a private company, where the board is not focused first and foremost on its independence, but on the company's success.”
Zyngier agrees. “If I think very conceptually about what a director is, a director is representing all of the shareholders. You're supposed to be the voice of those shareholders. You're supposed to be asking the hard questions, and you're supposed to be guiding the company toward what an investor wants, which is, ultimately, how do we maximize the returns, and how do we get that money back to them? To me, that's crystal clear. There isn't a difference between what a shareholder wants and what a board member wants.”
Another way to frame this owner mindset, says Shapiro, is “Follow the money.”
“As activists, we follow the cash flow, we follow capital deployment, and we ask, ‘Are you deploying your capital into its highest and best use?' For example, are acquisitions being made in an uneconomic manner for purposes of empire building, which tends to be the CEO's rationale to support a higher-compensation structure?” says Shapiro. “We ask, ‘Can the capital be better used in some other way? Do you build internally versus buy? Do you divest of something rather than keeping it just to maintain size? If the company owns a bunch of real estate assets, do you know the value of those assets and are they undervalued?' It doesn't take an activist to understand the inherent conflict of interest that management could have during the process of selling a company once the decision has been made to sell it. Or to understand how to align interests in structuring compensation policy long-term, balancing equity compensation versus fixed compensation and determining the right triggers for cash bonuses. It's that kind of thinking that comes into play and is important.”
Activist Experience and the Nom/Gov Process
Acknowledgment of both the increasing prevalence of shareholder activism and the potential benefit of constructive scrutiny has led more directors to reconsider not only how they approach their role, but also whether nom/gov committees should consider adding activist investor experience to the board's skill set matrix.
“It can be invaluable having at least one director who understands the resources, the steps in the process and how you respond,” says Reardon. “They can identify whether there is a threat, who has current holdings and the resources needed if it gets to that stage. Who do you draw on? Do we go back to the banker and say, ‘Could you give us a current deck on who else is out there and who's going after us and their deals?'”
Shapiro also points to the new SEC rules that make it easier and less costly for activists to target individual directors for replacement as another reason boards should seriously consider adding activist experience to the roster. “It raises the importance for expedited and recurring internal scrutiny of the board's composition and the relevancy of each board member's skills and experience for the company's future needs. More than ever, boards will need to have the right skills and experience to address the issues that are on the minds of shareholders before an activist forces such change with their own candidate. There's no better board member to spearhead such efforts internally on a board than a board member with activist experience and skills.”
Think Like an Activist
Even as boards consider more focused expertise in this area, thinking like an activist means being fit for purpose in a changing economy, and that requires full board engagement, says Montelongo.
“As a board, do what the activists do. Take a candid look at your company, focus on common triggers for activist engagement and, if there are issues, take proactive steps to address them. Stay on top of performance. Monitor and identify the company's strengths and weaknesses, ownership, disclosures and governance practices. Assess board composition, skills, executive compensation, expertise and diversity for strategic, fit-for-purpose alignment. Keep a watchful eye on the macro environment because rapidly evolving sentiment can create opportunity for activists. Know your shareholders and closely follow changing shareholder expectations. Finally, keep shareholders informed. Monitor shareholder sentiment frequently to understand investor concerns, preferences and potential triggers. Develop contingency and communication plans. And, if an activist does come calling, help the company find constructive ways to respond and leverage the interaction.”
Many board members point out that activist firms have the upper hand in discussions because they are deeply resourced to generate detailed analysis of the company, industry and overall marketplace. Kaufman acknowledges this factor but says there are concrete steps every director can — and should — take to help even the playing field.
“Much of what external parties do is ask for information, and then they process it. The information can be processed internally at a company if directors are asking for the right information. You need to leverage the resources of the company. You need to ask proactively for the right information and not assume that what you're given is the information you need. You need to be inquisitive with that information so you can assess what's really going on, and know where the real opportunities and risks are. If you do that, you can get 90% of the way toward what an external investor would have available to them.”
While the views on activism vary, there is widespread agreement that the uptick in activist activity has one big upside: fostering more constructive dialogue that benefits all key stakeholders.
“The good news is companies have gotten better at shareholder outreach and investor relations, which has created more alignment on key issues,” says Montelongo. “As a result, companies are proactively cutting costs, pursuing mergers and acquisitions, reinstating dividends, instituting ESG metrics and so forth. Companies are finding ways to work with activists, building consensus and adapting proactively before the activism comes.”