Understanding what’s on the minds of shareholders is critical for today’s board members, as is knowing the rules of engagement, particularly with shareholder activists.
One of the dilemmas facing board members today is to what extent should they engage with shareholders, particularly activist shareholders. Some observers maintain that the board has a responsibility to engage with shareholders as their representative, while others believe the board should rely on management to engage with shareholders. Whichever course is taken, it’s important to establish clear guidelines regarding how and when the board engages with shareholders, and to understand potential risks of engagement.
The primary points of contact for investors should generally be investor relations (IR) personnel and management. If shareholders bring a concern to the board’s attention, it may be appropriate in some cases for the board to engage with those shareholders in concert with the IR group. However, encouraging shareholders to approach the chair or board members directly could call into question the value of the IR function, and perhaps of the management team. Direct chair or board engagement with shareholders in the normal course of business also could risk blurring the lines between overseeing management and actually managing the organization, especially if there are no protocols in place for the board’s involvement.
If a decision is made to have a board member engage with a shareholder, he or she should be an independent director rather than an executive director in order to add objectivity to the discussion and insulate management. After all, if a shareholder approaches the board, most likely it will be due to dissatisfaction with the organization’s performance or its handling of an issue.
The board should be open to not only listening to shareholders, but also to collecting input from them to understand what’s on investors’ minds. That said, some investors will have activist agendas from the outset, and others may develop activist tendencies if it’s in their interest and, usually, in the interest of the company. The board has a duty to see that the company is prepared for activists and responds to them effectively.
Actions to Consider in Light of Shareholder Activism
In a Deloitte survey of CFOs of North American public companies conducted in 2015, finance chiefs were asked how companies are changing their approach to investor relations in response to activism. About half indicated they had made substantial changes, and most cited increased monitoring of activist activity, enhanced planning in response to activists’ concerns, and more proactive communication with investors.
Shareholder activism should encourage boards to step up their investor engagement oversight efforts, recognizing that different boards and different directors will take different approaches. For example, some obtain updates from their IR teams at every board meeting, while others do so once a year. In some cases, directors even meet directly with investors. Yet very few omit shareholder engagement from the board agenda, and those that do act at their peril.
When authorizing corporate actions, the board should consider the views and priorities of key shareholders and shareholder segments. For example, if the company is going to undertake a share repurchase program in lieu of reinvesting that capital in the company, the board should consider the potential effects of that decision on shareholders. Decisions that involve either raising or allocating capital always warrant close scrutiny and an understanding of shareholders’ views and expectations.
In that context, the board should also:
Exercise strong risk oversight and organizational governance. True understanding requires sound governance of the processes by which decisions are made and initiatives are undertaken. Sound governance involves gauging the long-term impact of management decisions on the organization’s performance and value and the effects on investors, employees, and environments in which the organization operates. The board needs clear lines of sight into decision-making processes, reliable assurance regarding the risks implicit in management’s assumptions and decisions, and the willingness and ability to challenge management when needed.
Monitor the company’s shareholders and their goals. Through surveys, discussions with management, and external perspectives, the board should monitor the makeup of the shareholder base and understand the reasons for its composition. For example, industry factors may influence the diversity of shareholder institutions and objectives. Although it is outside the board’s control, the makeup of the shareholder base will reflect investors’ views of the organization and management’s strategy and performance, and the board must be aware of those views. The board should also be cognizant of issues such as a misalignment between compensation and performance, large and long-standing cash holdings, and activists targeting peer organizations.
Ensure that the company’s IR team performs well. The IR function should articulate a fact-based investment proposition that makes a clear case for why management’s strategy and decisions are better than alternatives. The function should stay in front of developments that could prompt activist activity, such as industry reversals, poor performance, or negative media coverage.
The IR team should also respond quickly to shareholder demands for information and cultivate good relationships with major shareholders, who can be invaluable in mounting an activist defense. An adequate staff of well-qualified people should work closely with the CEO and the CFO to communicate a compelling value proposition and strategy. Boards also need to receive periodic reports from the IR group; some receive them at every meeting and others only annually. Regular updates are imperative.
Request an activist vulnerability assessment. Companies should periodically commission an activist vulnerability assessment, which takes an objective, outside-in look at the company. These assessments consider factors such as market capitalization relative to the sum of the company’s parts, financial performance versus that of peers, and the stock’s trading range relative to that of similar companies. An assessment identifies underperforming lines of business as well as nonoperating assets, such as real estate, that could be monetized. The composition, skills, tenure, and performance of the board is also considered. This kind of assessment not only helps the company prepare for an activist event, but also identifies opportunities to lower the organization’s vulnerability to such an event.
Review management’s activist-campaign response plan. The plan should include protocols for responding to friendly activists and those taking a confrontational approach. The plan should identify the members of the response team and their responsibilities and provide guidelines on who should be informed (including the board), when they should be informed, and who formulates and delivers which types of responses. The first rule of activist response is to never ignore or stonewall, either of which can elicit frustration and aggressiveness. Management needs to prepare an internal communications program to keep employees informed and focused in situations where activists go public.
Failing to communicate internally will only foster rumors and distraction. Consider including financial, legal, public relations, and accounting advisers in the response team. Also designate specific members of the board, such as the chair of the compensation, governance, and other relevant committees to be involved in specific issues and communications. Shareholder communications should be structured to make higher levels of executives available if an issue escalates.
Engage and Embrace
Shareholder activism has advantages as well as drawbacks. On the down side, confrontational activists can launch highly public campaigns that can distract management and cost millions. They can also disrupt customer and supplier relations, create openings for competitors, generate uncertainty, and discourage potential employees.
On a more optimistic note, many companies have benefited from activists who have directed management’s attention to opportunities to accelerate growth, improve the bottom line, monetize assets, or return capital to investors. The management team and the board must be prepared for either constructive or aggressive activism both in the immediate future and for the long term.