The Governance Leadership Centre speaks with leading governance researcher David Beatty on how shareholder activism is transforming traditional governance models.
Part of the challenge is defining activism. As tens of billions of dollars flow into activist investing, a continuum of activist investment styles is developing.
Activists range from opportunistic hedge funds seeking to destabilise companies and exploit quick gains through short selling; to long-term “constructivists” who seek positive change and value creation through strategy recommendations to the board; to active investors who apply an Environment, Social and Governance (ESG) filter to their investment portfolio.
Some activists focus purely on commercial gain. Others seek to create social value by pressuring companies to adopt environmental changes, for example. The upshot for boards is a wider range of activists on share registers with competing interests.
“The challenge for boards is to weigh up the different interests of activists,” says Beatty. “Boards will need to identify activists who seek short-term ‘slash and burn’ gains and consider their interests against the needs of long-term shareholders. There is not a one-size-fits-all model for activism; assessing their proposals requires a lot of board judgement.”
Boards that ignore activism do so at their peril, says Beatty. “This is not a trend that will happen or something where boards can hold their breath and hope the wave passes. Activism is sweeping through public markets in America and Europe and spreading to others. It’s rapidly gaining support from the world’s largest investment funds.”
The Governance Leadership Centre asked Beatty about activism and its implications for Australian boards. Here is an edited extract of that interview:
Governance Leadership Centre: David, activism has been around for a long time. What’s changed to make it such a key governance issues for listed companies?
David Beatty: In the ’80s and ’90s, activist investors were thought of as corporate raiders and generally had a bad name. They would bang on doors to force change, often acted alone and controlled only a tiny percentage of stock. Today, the activist fund that has 1 per cent of the share register might have mobilised support from funds that control 40 per cent of the stock.
The world’s largest institutional investors, such as BlackRock and Vanguard, have directly supported activist campaigns, where they are seen to create value. Activists have never had as much support from institutions as they do today.
GLC: Are boards prepared for this trend?
DB: No. An entire industry is emerging overseas where specialist firms and global consultants are advising boards on how to identify, communicate and respond to activists. Good boards are sourcing advice on how to get in front of activists, understand their views and respond if an activist targets the company.
GLC: There is a perception that activists only target companies with weak governance or performance issues. How widespread is this trend?
DB: It’s true that companies performing in the bottom quartile of their peer group will attract earlier interest from activists. But every Fortune 500 company in the US now has at least a few activist firms having a close look at its strategy and performance. The activists are coming; it’s a question of when, not if, for most large public companies.
GLC: You write that boards will have to take ownership of their organisation’s investor relation function. What do you mean by that?
DB: Boards will have to understand and communicate with shareholders, including those who have negative views on the stock, like never before. It won’t be enough to delegate investor relations to management or to meet with key shareholders once or twice a year, or at the annual meeting. Andy Bryant (Intel chairman), for example, meets with four of the company’s largest shareholders each quarter. That’s a significant time investment and something that more boards will have to consider.
I believe investor relations will become a central board function and be a much bigger part of director workloads. In some respects, boards will have to get to know shareholders in a whole new way because of activism.
GLC: Why should boards consider alternative strategies for their organisations, proposed by activists?
DB: Traditionally, management presents a strategy to the board and directors try to coach or shape that strategy where needed, and improve it along the way. But boards are still only considering one source of strategy: that from management. Having two or three activist firms looking at a corporate means there are, in essence, several ‘management teams’ out there trying to develop strategies that create short-term or long-term shareholder value.
Boards need to be open-minded about external strategies, listen to them and compare them to the strategy devised by the internal management team. Boards might find that the external strategy is better than the internal one, or that a combination of these strategies creates extra shareholder value.
GLC: Wouldn’t that create tension with management if boards source outside opinions on strategy and use them to challenge the executive team?
DB: For sure. It comes back to transparency and boards working with management on this issue. But boards must consider alternative opinions on corporate strategy, especially when they come from well-informed groups who have good ideas. At the very least, they can use these ideas to test the current strategy and to help shape the best strategy. It’s foolish to reject alternative views on strategy simply because they did not come from management.
GLC: You argue that boards should open their organisation’s strategy to outsiders. How can boards do this and aren’t there risks in this approach?
DB: Many corporates still have an annual offsite where directors and the executive engage in strategy. There’s no reason why boards cannot source external views at such events by inviting subject experts or even activists to their offsite. Why not get activists to share their views on alternative strategies and challenge corporate thinking, in a section during the offsite? Why not listen to competing strategies from external group rather than hear only management’s strategy?
Another approach is boards spending more time with activists and understanding their views on the organisation’s strategy and performance. Boards must show they are open to different perspectives on strategy from different shareholder groups. That doesn’t mean the board must listen to every activist and analyse what is proposed. But it does recognise that activists often speak on behalf of a much larger group of shareholders these days, so they warrant more communication and consideration from boards.
GLC: Your view suggests an evolving relationship between directors and management, as boards rely less on the executive team for information and consider a wider range of external opinions.
DB: The days of management spoon-feeding information and data to boards are long gone. Good boards constantly look for outside information and opinions to test strategy and corporate performance. They do not rely only on what management tells them. The executive team knows the board is sourcing external opinions, in a transparent way, to test what management is giving them. Strategy is no longer only the preserve of management.
Boards and the executive teams should work together to understand if activists are targeting the organisation and, if so, why. In some cases, that means analysing the activists’ strategy to see if it has merit and its outcomes are aligned with the needs of the broader shareholder base. If the proposed strategy is wrong, companies need to mount a defence and communicate it to activists. If the proposed strategy is a winning one for shareholders, companies and boards need to be willing to accept the alternative view.
Rejecting an outside opinion simply because it comes from an activist is dangerous. Boards should accept that activists are here to stay and that the trend is ultimately about shareholder democracy in action. Going on the offensive against all activists will only leave organisations more vulnerable to attack and boards more exposed to risk.
GLC: Your paper argues that more boards should appoint the chief financial officer (CFO) as a director, in response to activism. Why do you favour that approach?
DB: It’s certainly one of the paper’s more controversial suggestions. Because the CFO does not ‘own’ capital investments in the way the CEO or other executives might, they can take a more dispassionate, third-party evaluation of alternative investment strategies presented by activists. The CFO could be charged with discerning activist strategies and representing any alternative asset-deployment strategies to the board, through his or her directorship.
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