Fit for duty


Fit for duty Ethical BoardroomBy Arthur B. Crozier – Chairman of Innisfree M&A Incorporated and Lake Isle M&A Incorporated



Directors’ roles and responsibilities at publicly traded companies have changed dramatically over the last decade, largely fuelled by the rise in shareholder activism across the globe and, especially in the United States, the sharp increase in share ownership by passive investors, particularly the ‘Big Three’ index funds: Vanguard, BlackRock and State Street.

Directors must now take on an active role in engaging with institutional investors and considering those investors’ viewpoints as part of the board’s deliberations, even if a shareholder activist is not seeking change.

This article will trace the history of these developments and discuss the types of actions and concerns that directors should consider when undertaking their evolving roles and responsibilities.

Until recently, it was very rare for directors to engage directly with shareholders. At virtually all publicly traded companies, the investor relations programme, if there even was one, focussed exclusively on actively managed institutional investors, which generally made up the bulk of the shareholdings.[1]

Those active managers necessarily have in-depth knowledge of the company and considered views on its strategy and management team. They rarely saw the need to engage directly with board members, even in contested director elections. If there was a proxy contest, directors’ involvement with third parties was limited to participation in meetings with proxy advisory services. Directors, in effect, stood for election; they did not run.

Compensation challenge

The requirement for shareholder votes on executive compensation programmes (say-on-pay), which began in 2011, started to change that dynamic. While say-on-pay proposals incorporate all forms of executive compensation, it has been viewed as a referendum on CEO compensation in particular. As such, it was generally considered inappropriate for the CEO to lobby shareholders to support the proposal if there was controversy. Consequently, it often fell to the chair of the compensation committee, along with other members of senior management, other than the CEO, to meet directly with institutional investors, although such participation was, at least initially, often controversial.[2]

At approximately the same time, shareholder activism exploded. Aggressive hedge funds, often referred to as ‘value investors on steroids’, targeted board members and management teams at companies that they viewed as underperformers, seeking significant and often short-term share price improvement. Tactics included the development of extensive white papers, detailing the supposed failings, causing inferior shareholder returns, demands to present the activists’ findings and alternative strategies directly to the board and implicitly and, sometimes explicitly, threatening the targeted company with the dissidents’ ultimate hammer – a proxy contest to replace incumbent directors. Companies of all sizes and their directors, including mega-caps that were once thought invulnerable due to their size, were targeted. Even companies generally considered well-managed and well-performing came under activist attack.

This aggressive model of activism has continued to grow and is increasingly attracting new types of activists, beyond hedge funds, including so-called ‘reluctivists’, or traditional institutional investors (including mutual funds, investment advisers and pension funds) using customary activist tactics and assertiveness to force change at lagging portfolio companies. According to recent statistics compiled by Activist Insight, 949 companies globally were targeted by 851 activists in 2018, compared to 611 companies targeted by 452 activists in 2013. Activism in 2019 may even exceed those levels with 555 companies targeted by 449 activists as of 11 June.’

As index investors, the Big Three are focussed on long-term sustainable shareholder value creation — as long as a company is in an index, they will be investors’

While activist approaches were causing targeted directors to be more directly involved with shareholders in order to rebut the activists’ challenges, the dynamics of companies’ shareholder bases were changing in ways that would also result in more director involvement, even in the absence of a shareholder activist.

Passive investing

Passive investors have seen huge increases in AUM as the result of the extraordinary bull market following the 2008 market correction. Total inflows to passive managers far exceeded inflows to all types of active managers. Vanguard, BlackRock and State Street, in particular, have been outsized beneficiaries of this development. During the period 2009 to 2018, the Big Three received 82 per cent of total asset inflows to all active and passive investment funds.[3]

As index investors, the Big Three are focussed on long-term sustainable shareholder value creation – as long as a company is in an index, they will be investors. Consequently, they consider themselves to be permanent capital.

As such, they tend to support boards and managements who enunciate a credible long-term value creation strategy as opposed to an activist shareholder whose strategy is more short-term or, if long-term, is less credible. In fact, at recent contested director elections, Vanguard supported management 70 per cent of the time, BlackRock 66 per cent and State Street 76 per cent.[4]

This strong record of management support, combined with the Big Three’s significant ownership at most US public companies, demonstrates that the Big Three can be the deciding factor in a proxy fight, the ultimate and most powerful activist tactic.

As of 2017, the Big Three in the aggregate owned on average 20.5 per cent of the outstanding shares at S&P 500 companies, and, unlike other retail and institutional investors, they vote all of their shares, resulting in a disproportionate portion of shares actually voted. In 2017, the Big Three represented on average 24 per cent of shares voted at S&P 500 companies. If current trends continue, in 10 years, the Big Three would own on average 27 per cent of the shares at S&P 500, which could represent 34 per cent of shares voted at those companies.[5]  By contrast, institutions that are directly influenced by ISS now generally represent 20 per cent or less of a company’s shares. As a result of this shift in the shareholder base at US public companies, the management-friendly Big Three effectively counterbalance (and, in the future, will almost always overpower) investors who subscribe to ISS’ dissident-friendly recommendations.[6]

Ensuring effectiveness

The participation of independent directors is critical in obtaining support from the Big Three. Although the funds have been adding investment professionals with expertise in a variety of sectors, these investors necessarily do not have in-depth knowledge and understanding of every company in their portfolios, given the vast number of companies in which they must invest in order to accurately track their chosen indices. Consequently, the funds must ultimately rely on the quality of directors to ensure that the board is effectively working with management in developing a strategy that will deliver long-term value, has taken into account the critical factors that could impact that strategy, are effectively overseeing management’s execution of that plan and holding management accountable for any shortcomings.

“Recent shifting dynamics in the markets have caused directors to assume a new, more out-front role, particularly with respect to shareholders”

Those qualities cannot be demonstrated only on paper or through videos on the company’s website. Direct engagement is critical, ideally in person. Further, the board cannot view such engagement as a one-and-done activity. In essence, engagement is about building credibility. Credibility is not built in a day, particularly if that day is shortly before a contested election.

Outreach efforts to the Big Three need to be a regular part of every company’s overall investor relations programme. Many companies schedule annual engagements in the Fall, when there are fewer shareholder meetings occupying the funds and the company has time to take into account the funds’ views in planning for the following year’s annual meeting.

The funds will often not take up subsequent requests for engagement but will track such requests and appreciate the outreach effort. In many cases, the declination of an engagement request is a sign that the fund does not have any significant concerns with the issuer.

Before undertaking an engagement programme, there are several things directors and management need to consider carefully.

Careful preparation is essential. First impressions are lasting. An initial bad impression by a director can taint the fund’s view of the entire board, can take a long time to dissipate and will distract from key messages.

Directors who participate in meetings or calls need to appear active, knowledgeable and engaged. Typically, the independent chairman or lead independent director should participate. Any other participating directors should be carefully chosen to ensure they have the right expertise and experience on the board to address likely concerns, as well as a shareholder-friendly attitude.

Understanding strategy

As noted above, the funds’ concerns now go beyond isolated corporate governance issues. Directors must be able to demonstrate understanding of the business strategy, the particular challenges confronting that strategy, explain the processes the board follows in ensuring that the strategy continues to be effective and illustrate that the board holds management accountable for successfully executing the strategy.

While directors need to be knowledgeable, they do not need to be able to get into the weeds on every particular topic. Senior management will also be present and can address details. In doing so, however, the directors should not appear to be overly reliant on, or deferential to, management.

In addition to being prepared with respect to the company’s affairs, it is vital to review in advance the fund’s voting guidelines and policies and be prepared to address likely areas of concern. The nature of ESG concerns as they impact long-term value creation continue to evolve and each fund has different topics it focusses on.

It is important to remember that the purpose of the meeting is not to win an argument, but to cause the fund to believe: that the board is a careful steward of the shareholder’s investment; that it is committed exclusively to the shareholders’ best interests; is open to suggestions and alternatives; and has knowledgeably and thoughtfully analysed the important drivers of shareholder value creation.

In most instances, the board does not need to simply agree with any suggestions made by a fund. It is important, however, to appear open to suggestions and willing to bring the fund’s concerns to the full board. In doing so, even if it is unlikely that the board will ultimately adopt the fund’s suggestion, it is important to validate the fund’s concern. The directors should indicate that the board understands the fund’s concern is legitimate as a general matter; but, while leaving open further discussions on the topic, there are particular reasons that dictate the company’s current policies on the topic and then discuss those reasons.

Finally, perhaps the most important pointer is to listen as much as to talk. While it is vitally important to ensure that the funds understand the company’s strategy and the board’s bona fides, it is equally important for the funds to come away with the view that the board has listened to their concerns and is prepared to carefully consider them and to continue a meaningful dialogue, as appropriate.

Recent shifting dynamics in the markets have caused directors to assume a new, more out-front role, particularly with respect to shareholders. That new role, however, also opens up opportunities to communicate more effectively with key shareholders, thereby enhancing a company’s ability to continue to pursue long-term, sustainable shareholder value strategies for the benefit of all shareholders. The potential dangers can be easily addressed through careful preparation.


About the Author:

Arthur B. Crozier is Chairman of Innisfree M&A Incorporated of New York and of Lake Isle M&A Incorporated, Innisfree’s wholly-owned UK subsidiary. Mr. Crozier’s practice includes the representation of U.S. and international clients in a wide variety of transactions and proxy contests, as well as annual and special meetings. In addition, he counsels an international roster of clients on corporate governance, shareholder engagement and executive compensation issues.


1. Depending upon a company’s business sector, individual holders can own up to as much as 30 per cent of a company’s shares in the aggregate, although such high levels are now rare – 10 to 15 per cent ownership by individuals is more typical. Most investor relations efforts directed to individuals now consist of a brief Chairman’s letter bound into the annual meeting proxy statement.  Glossy annual reports, which used to be the primary means of communicating with individual holders, are largely a thing of the past, due to concerns that the high cost of producing and mailing such materials are not justified in light of the reduced levels of ownership by individuals.

2. Early on, more than one General Counsel asked me if ‘I was out of my [expletive deleted] mind’ to suggest that a director should meet with a shareholder.  Indeed, not every director is ready for the ‘prime time’—directors should be prepared to ensure their meetings with stockholders effectively transmit the company’s key messages. Also, this development capped the fulfillment one of the original goals of the executive compensation reform movement in the early 1990s: to use compensation as a mechanism to force boards to maintain accountability for management.

3. Bebchuk & Hirst, ‘The Specter of the Giant Three’, John M. Olin Center for Law,  Economics and Business, Discussion Paper 1004, May, 2019, 

4. Source, Innisfree M&A Incorporated

5. See, Bebchuk & Hirst, supra.

6. Over the past several years, ISS supported dissidents approximately 66 per cent of the time in proxy contests at companies with a market cap of $1billion or more.