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Preparing for activist investors

Corporate governance is becoming more and more complex. Amid an increase in rules and regulations, the broader availability of information about company activities has enabled stakeholders to become more active in expressing opinions and suggesting changes they feel appropriate.

This environment has also created a wider platform for opportunistic activist shareholders. Estimates put the number of activist campaigns launched in the US last year at approximately one per day and, according to Davis Polk, aggregate assets under management for activist investors range from $120billion to more than $200billion.1 In other words, these campaigns can’t be considered small special interests looking to make big noise.

Though the intent of many of the rules and regulations has been to increase corporate transparency and shareholder rights – undoubtedly a positive thing for all constituents – some are concerned that this has upset the balance of power. The changes over the past few years have put high demands on boards and management not only to perform well in the face of added scrutiny, but also to appropriately predict and communicate proactively how company performance will play out in both the short- and the long-term.

Activist investors who are interested in short-term gains and disrupt long-term strategic plans at issuing companies get most of the media coverage and it is tempting for companies to give in to their demands. But this creates tension with institutional investors who hold funds aimed at long-term returns. While traditionally passive with their portfolio management, these shareholders own massive stakes in the corporate world and are increasingly active in their engagement. For example, according to a Conference Board report, institutional investors owned 73 per cent of the 1,000 largest US public companies in 2013.2

The rise of engagement

In the US, where Equilar collects a majority of its data on public company executives and boards, the rise in shareholder engagement is highly correlated to the Securities and Exchange Commission’s (SEC) say-on-pay ruling in 2011.3 Following the creation of this mandatory shareholder vote for approval on executive compensation, the number of companies explicitly detailing shareholder outreach efforts in their annual proxy statements has grown significantly. In 2011, just two per cent of the S&P 100 – which comprises the largest and most established US companies – disclosed shareholder engagement, which increased to 55 per cent in 2015, according to Equilar research. In the S&P 500, the number of companies disclosing shareholder outreach has doubled, reaching about one-third of that larger index. The trend line is striking and it clearly illustrates that we are in an age of growing shareholder engagement.

On paper, the solution to the tension among companies and their various constituents seems simple: carefully assess and address all potential shareholder concerns. The application, obviously, is not so straightforward and outreach means very little if it doesn’t produce better results and investor relations. Companies must address issues and make changes in order to show shareholders a true return on their investment.

That process starts by engaging with shareholders proactively to understand the hot-button issues and potential trouble spots. Here are seven ways that companies should be prepared for shareholder outreach in today’s environment.

  1. Be prepared to show how pay and performance align

As more regulations and requirements about pay disclosures become mandatory, companies will have to be prepared to answer more questions about any nuances in their compensation practices.

In 2015, the SEC introduced a proposal that would require companies to detail information about how executive pay aligns to company performance in their annual proxy statements.4 The proposal says that companies must include information on what executives actually earned in a given fiscal year versus total shareholder return (TSR) in comparison to peer groups. While ideally this would make pay for performance universally understandable and easily digestible, it creates further challenges for companies who want to show other definitions of pay and performance, of which there many, in relation to their specific strategies and goals.

According to Equilar research, 252 companies failed their say-on-pay votes at least once within the last five years and among those, nearly 25 per cent (63 companies) saw their CEOs resign – the average time frame being within a year of the shareholder meeting.

  1. Be prepared to discuss pay equality

Because CEO to employee pay ratios shine a spotlight on income inequality, companies must be prepared to contend with the media and the general public.

In August 2015, the SEC passed a rule that will require companies to disclose CEO pay in comparison to a median employee.5 Aside from the logistical and cost challenges that this will incur – some estimates have the put the cost to corporate America at $1.3billion in the first year and an estimated $526million each year thereafter – the concept of a uniform figure applying to all companies complicates this issue when it comes to communicating the reasoning.

The degree to which the CEO pay ratio will influence investors remains to be seen, however. There’s a lack of comparability across companies in terms of what’s being calculated, and it’s difficult to say what an appropriate ratio should be. Down the road, CEO pay ratios could be valuable to investors who want to examine why or how the ratio changes within a company from year to year, rather than looking across companies in a comparative analysis.

The intended consequences would bring more equitable and transparent pay practices at the executive level and from board compensation committees. However, there will also be a ripple effect to corporate communications strategies both internally and externally, which could distract them from shareholder engagement.

  1. Be prepared for board elections

With board elections becoming more hotly contested on a regular basis, companies must be prepared to respond to shareholder concerns well in advance of their annual meetings.

Say-on-pay brought executive compensation to the forefront as a shareholder concern, but as time passes, effective board governance is coming more strongly into view. As activists continue to seek a stronger influence in the boardroom, the movement among shareholders to push for the ability to nominate directors for annual elections – also known as proxy access – is on the rise. In 2011, there were zero proxy access proposals for S&P 500 companies and that number increased to 66 in 2015, according to an Equilar study from November of last year.

More telling than the number of proxy access proposals is the rate of acceptance. In 2014, less than half of the proposals that came up passed, while two-thirds of the 2015 proposals were accepted.

The decline of classified boards could also foreshadow increasing turnover in the boardroom. Just 11 per cent of the S&P 500 had such a board for their most recent fiscal year, down from nearly one-third in 2010. A classified board creates different classes of directors, who are each elected for a term of more than one year. Each year one class of directors faces re-election, allowing a majority of the board to remain in place. Proponents of classified boards say that this system creates continuity on the board and allows directors to focus on long-term goals absent the risk of not being re-elected as well as deterring hostile takeovers, since a majority of a classified board cannot be overturned in one year. On the other hand, supporters of non-classified boards claim there is increased accountability to shareholders as incumbent directors face an annual evaluation of their performance in the form of a shareholder vote.

  1. Be prepared for diversity initiatives

Boards need to be prepared to effectively communicate how they are assessing, recruiting and refreshing their boards on an annual basis, down to the specific candidates they are bringing to the ballot.

As the potential for board turnover increases, companies are under pressure not only to replace directors, but also to replace directors with the right people. The SEC has weighed in on gender and racial diversity, calling it “a priority for 2016”.6 Boards can expect to see more and more calls from their stakeholders and the public at large to add diversity to their ranks as a signal of better corporate governance.

“As more regulations and requirements about pay disclosures become mandatory, companies will have to be prepared to answer more questions about any nuances in their compensation practices”

Diversity in the boardroom is not limited to gender and ethnicity, and it’s not about increasing numbers for the sake of doing so. The concept of ‘cognitive diversity’ is gaining traction, as companies require new skillsets and professional trade skills in order to meet the changing demands of today’s corporate environment. In 2015, six per cent of S&P 500 companies included board skills matrices in their annual filings, or a visual representation of their directors’ experience.7 These visuals help shareholders easily understand the diversity of backgrounds and experience on boards as they go to vote and may become the expectation rather than just nice to have.

  1. Be prepared for executive and board succession

If boards aren’t prepared with the right executive and director candidates when a succession situation arises – whether due to an emergency, directors forced out through a proxy fight or for a strategic reason – they will be facing significant challenges as the pool of qualified director candidates comes in for higher demand over time.

There’s no way around the fact that many individuals in the current generation of executives and board members are on the cusp of retirement. The case of Sumner Redstone at Viacom was unique, but it shined a light on the emphasis activist investors place on active board management and also on the age and tenure of some members at high-profile companies.8 Among S&P 500 companies that have a mandatory board retirement age, the most common is 72. A recent Equilar study found that 45 per cent of all S&P 500 directors are over the age of 61 and another 15 per cent are older than 70.

Preparedness for succession extends to the CEO’s office as well and data shows that many companies are either unprepared, or at least are unclear about how they anticipate executive succession. Just one in five S&P 500 companies specifically included some sort of shareholder communication around CEO succession in their most recent proxy statements, according to Equilar research.

Meanwhile, 10 per cent to 15 per cent of companies change their CEO every year, but more than one-third of directors told PwC’s annual corporate directors survey that they don’t identify potential successors as soon as a CEO is hired.(9) Just 45 per cent of directors in PwC’s survey said that their company is very prepared to deal with an unplanned CEO succession emergency.

  1. Be prepared for more shareholder proposals

Boards need to be prepared not only for immediate risks and threats, but also to address ongoing issues impacting their companies that continue to gain steady momentum.

“Straightforward, clear and consistent communication with respect to company goals and expectations among all stakeholders is more critical than ever”

Activists get a lot of the ink for being instrumental in driving changes to executive compensation and board composition. And though we’ve seen more proposals come to the forefront as a result of activist campaigns, the most common issues remain social and environmental issues, more typically brought forth by investors with longer term interests. At S&P 500 companies in 2015, there were 175 such proposals on the table, up from 133 in 2011.

  1. Be prepared to fight for shareholders’ attention

Companies need to be prepared for a competitive shareholder outreach environment, adding fuel to an already expanding fire. The uptick in shareholder engagement amid the increase in shareholder activism is a fine balance for companies, who may want to avoid extended exposure to calls for quick decisions on short-term strategic planning. The irony is that in order to avoid this, they have to go out proactively and make sure that their strategic vision is clearly communicated to all their shareholders, especially those that have long-term interests. Even though activism is on the rise, many if not most investors are aligned with companies in seeking long-term gains, not just quick returns, and partnering with allied shareholders can help mitigate disruptive forces.

The challenge is finding time with those allied shareholders, many of whom are busy being engaged by other portfolio companies. The upshot of shareholder engagement is more communication with the individuals that care about the well-being of the company, but the downside is that most other companies are seeking the same thing at the same time.

Companies face a perpetual challenge in reaching out to investors that all have different needs and interests, and they need tools to prepare for outreach and response to these multi-faceted issues outlined above. There’s risk in waiting for a problem to occur to talk to shareholders, but as engagement increases from all companies, these constituents have limited bandwidth and availability. As a result, identifying a defined process that involves strategically addressing a planning, outreach and a feedback loop is crucial.

In coordination with a defined process, companies need the appropriate information and use the same tools that proxy advisors and investors use in evaluating these issues. Whether that’s modeling pay versus performance to ensure understanding of shareholder needs and proxy advisor recommendations; consistently and regularly assessing board and executive talent for succession planning; or analysing peer groups on a regular basis to ensure they accurately represent the company’s current strategy in alignment with shareholder expectations, shareholder engagement platforms bring together these constituents in a central place where all parties can communicate on a level playing field. Before proposals get heated and go to a proxy fight or even the courtroom, governance stakeholders have the opportunity meet in the middle and actively address issues on an ongoing basis through technology platforms.

Corporations consistently prepare to deal with unpredictable elements in the economy and boards are attuned to managing risk for a host of issues. The case of shareholder outreach is no different. The era of activism may represent a shift in process, but it doesn’t have to mean a change of strategy. Straightforward, clear and consistent communication with respect to company goals and expectations among all stakeholders – directors, executives, investors and employees – is more critical than ever.


1 https://alerts.davispolk.com/62/1860/uploads/2016-03-03-shareholder-activism-engagement-trends-developments.pdf?sid=99abe96f-cc0a-492d-a5d3-fd0641f61f5f
2 https://www.sec.gov/News/Speech/Detail/Speech/1365171515808
3 https://www.sec.gov/news/press/2011/2011-25.htm
4 https://www.sec.gov/news/pressrelease/2015-78.html
5mhttps://www.sec.gov/news/statement/statement-at-open-meeting-on-sbs-and-pay-ratio-disclosure.html  6http://www.wsj.com/articles/sec-chief-board-diversity-is-a-priority-for-agency-in-2016-1453853477  http://d-scholarship.pitt.edu/22422
8 https://assets.documentcloud.org/documents/2693288/Activist-Investor-s-Report-on-Viacom.pdf  9Ken Favaro, Per-Ola Karlsson and Gary Nielson, CEO Succession Report, Booz & Co. (2012)


Ethical Boardroom is a premier website dedicated to providing the latest news, insights, and analyses on corporate governance, sustainability, and boardroom practices.

Ethical Boardroom is a premier website dedicated to providing the latest news, insights, and analyses on corporate governance, sustainability, and boardroom practices.


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