No public company is immune from becoming an activist target. The good news is that in today’s environment, being approached does not signal that the company is on the brink of disaster. The bad news is that anticipating an activist threat is more challenging than ever. That is especially true because the dissidents are constantly exploring new tools for proxy fights, including leveraging shareholders’ ability to “mix and match” competing director slates and using social and environmental performance as wedge issues that can swing shareholder sentiment.
Fortunately, companies and directors can take proactive steps to help protect themselves from future activist endeavors—and to avoid being caught by surprise if an activist does come calling. Understanding these issues can help directors protect the company and its strategy from disruptive short-term interests.
Current Activism Environment & Impact of Universal Proxy Card Rules
Who Are the Activists?
“Shareholder activism” is a broad term without a consistent definition. It encompasses activities that range from submitting a precatory shareholder proposal to suggest a course of action on a discrete issue, to private letters, to public campaigns for change, to launching a hostile tender offer to take control of a company. Often, activists raise issues that are worthwhile to consider. However, their attention can be costly and distracting.
Although shareholder proposals, which are typically submitted by either pension funds or a handful of prolific retail shareholders, play into control contests in the sense that they can put a company on an activist’s radar and highlight vulnerabilities that an alert activist can exploit, they are not the focus of this article. That said, a company will be much better positioned for both shareholder proposals and a control contest if management and select directors regularly engage with key shareholders and demonstrate consideration and responsiveness to issues that they raise.
When it comes to “traditional” activism that seeks to influence the company’s overall strategy, obtain one or more board seats, or take control of the company, hedge funds pose the greatest threat for most companies. Individuals—such as ousted directors or executives—have also seen a few recent successes.
Is Your Company Vulnerable?
Most activists continue to center their campaigns around fundamental financial performance and M&A alternatives. Companies that lag their peers are most vulnerable, especially if there are signals of waning shareholder support—such as mediocre director election results, low say-on-pay results, or high support for shareholder proposals and perceived inadequate company responses over multiple years.
Here are some key trends according to recent Goldman Sachs data:
We identify four metrics relative to the sector median that are associated with an increased likelihood of becoming an activist target: (1) slower trailing sales growth, (2) lower trailing EV/sales multiple, (3) weaker trailing net margin, and (4) trailing two-year underperformance. Note that low realized sales growth relative to the sector median is the metric most associated with a target company’s share price outperformance following the launch of an activist campaign.
…The most frequent activist investor demand involved in 28% of campaigns since 2006 has been for companies to separate its business. Other common demands include (1) review strategic alternatives (19%), (2) return cash to shareholders (12%), (3) block a proposed merger or acquisition (12%), (4) become a target of a potential acquisition (10%), and (5) increase or decrease leverage (7%).
How Do Universal Proxy Cards Change the Landscape?
In 2022, a new SEC rule went into effect that requires the proxy cards in any contested director election to include the names of all nominees, in a specific format. Previously, each side’s proxy card listed only its own nominees. Shareholders could only vote for directors from one slate because they had to choose which card to fill out and return. Now, shareholders can “mix and match.”
In addition, since dissident nominees are listed on the company’s proxy card alongside incumbents, activists may have less incentive to conduct a significant mailing of their own. The rule requires the dissident to solicit at least 67% of the voting power for the election. At some companies, holdings may be so concentrated that a small mailing will reach that threshold.
It is too early to draw definitive conclusions about the impact of universal proxy. In the first year that the rules were in effect, the number of activist campaigns—and their success rates—have been in line with pre-UPC levels. However, both companies and activists are continuing to analyze how to use the new rules to their advantage. Overall, activists will likely gain an edge with these new rules because they lower the barriers to entry for launching a proxy contest. They raise the likelihood that at least one activist nominee will be elected to the board, but they lower the likelihood that an activist’s full slate will be elected.
For these reasons, the biggest impact of universal proxy to date has occurred “behind the scenes.” Universal proxy may have contributed to companies acting more quickly to make concessions and strike cooperation agreements with activists, to avoid a drawn-out public campaign.
In addition, proxy advisors and other institutions have signaled that they will be taking a closer look at individual director nominees, rather than slates as a whole. That may eventually affect how nominating committees approach director evaluations and the renomination process. It is also causing some companies to place renewed emphasis on their investor relations pages and the electability of each individual director.
What Directors Can (& Should) Do
Activism defense is very company-specific and requires close consultation with legal counsel, financial advisors, the communications team, proxy solicitors, and—in some cases—specialty advisors. However, there are common themes that can serve as a starting point for discussions. Directors have an important role in anticipating whether the company may be vulnerable to activist attacks, who the activists might be and in overseeing a defense playbook.
Proactive Ways to Protect Your Company
Assess your financial vulnerabilities. Boards should encourage management and advisors to take a candid look at company performance on at least an annual basis. This includes assessing whether the company is effectively accomplishing its big-picture mission and strategy, as well as details that could attract an activist looking to unlock financial gains. For example, does the company have what would be considered excessive cash on hand or other semi-liquid assets to monetize? Is the company falling short on metrics that tend to attract activist attention?
If this assessment identifies outsized risks, it is appropriate for the board to be apprised so that it can identify priorities and direct steps to address them. Conducting the assessment can be a difficult process, but if those involved have a trust level with each other to allow for objective evaluation, the company can not only protect itself from activists, but likely also improve performance.
Assess your non-financial vulnerabilities. Activists are much more likely to win if they are also able to leverage non-financial issues that are important to institutional investors—such as shortcomings in corporate governance structures, a weak correlation between executive pay and performance, or lack of progress on environmental and social initiatives compared to peers. Directors must help the company strike the right balance between keeping up with “best practices” and doing what is best for the company’s long-term strategy and be able to communicate and stand behind those decisions.
Review governance documents. Your corporate charter and bylaws are more than just compliance documents. They define the rights of the board, company, and shareholders that apply to whether and when activists can initiate campaigns and how the company can respond. Because legal issues, activist playbooks and company practices are constantly evolving, it is important to devote attention to an annual review. In approving amendments, boards must consider the difficult balance between defensive measures that are in the company’s best interest, versus provisions that could be interpreted by existing investors as entrenchment provisions that erode shareholder rights. Management and advisors can provide reminders on how these decisions will be evaluated—by current investors and by courts, if challenged.
According to research from White & Case, 200 companies in the S&P 500 have amended their bylaws since the universal proxy rules were finalized. Amendments range from housekeeping matters that eliminate potential conflicts between the company’s governing documents and the new rules, to imposing additional disclosure requirements on dissident shareholders and enhancing advance notice provisions.
Some companies are also proactively stating that the company has the right to use the “white card” in a proxy contest. It is important to consider changes before any specific activist threat arises and to show that the board carefully considers the interest of the company when taking action, because amendments that have been viewed as too aggressive have been challenged in court.
Consider putting a poison pill on the shelf. A shareholder rights plan, or “poison pill,” protects a company from hostile takeover bids by creating a cap on maximum share ownership. The basic objective of a rights plan is to encourage potential bidders to negotiate with the board. However, because institutional investors and proxy advisors may vote against directors if a company adopts a poison pill without good reason, companies that may be vulnerable to hostile takeover attempts but are not currently facing a specific threat typically keep an up-to-date poison pill “on the shelf.” This way, the board can move quickly to activate the plan when needed.
When adopted in response to a specific threat, Delaware courts will evaluate the board’s decision to adopt a poison pill under the “enhanced scrutiny” standard rather than the more deferential “business judgment rule.” This enhanced scrutiny will also apply when the board decides to redeem the pill. For that reason, it is important to carefully consider the parameters of the shareholder rights plan and the process for adopting and activating it.
Monitor your trading environment & shareholder base. This is important for all companies, but particularly relevant for companies that may be viewed as underperforming. Activists are skilled at launching campaigns before a target company even realizes that the fund has a stake, but thorough surveillance techniques can improve a company’s ability to anticipate threats. Directors can ask the investor relations team how they monitor the trading environment for the company and its peers to ensure that the appropriate level of surveillance is in place for the company’s circumstances and that the board is getting the information necessary for its decisions. If a company is vulnerable, surveillance is particularly important leading up to and during the director nomination window that precedes the annual meeting. Having familiarity with the company’s shareholder base and whether and how it changes over time will also help the board to oversee shareholder engagement.
Thoughtfully engage with key shareholders. Having strong support from institutional investors can help insulate a company from activist threats. Moreover, that support is essential if an attack breaks through. It is important to nurture these relationships and build trust over time. It is also important for the board to receive regular reports from management about any shareholder feedback or significant policy changes, and what the company may be doing in response.
Institutions are increasingly requesting that board chairs, or chairs of key committees, participate in engagement meetings. To prepare for these meetings, directors should attempt to get a sense for the investor’s voting and engagement policies. If possible, it helps to understand if there are specific topics that the investor may want to better understand, or that the company believes are necessary to discuss to support voting outcomes at the next annual meeting. Directors should also be prepared to listen and accept feedback. Although the corporate secretary typically also participates in the engagements, it is helpful to also meet with them beforehand to get clarity on the boundaries of what the company has shared publicly and what can be discussed.
Investors vary in how they approach engagements, but many of them are run by stewardship teams who are monitoring governance and other issues more than the financial performance that the portfolio manager cares about. The stewardship teams are often also responsible for the eventual voting decision at the company’s annual meeting.
Show your work – engagement programs. Companies and directors can get an even greater return on their efforts by publicly disclosing high-level engagement activities and responsiveness. Again, this can help support strong voting results from year to year, which may reduce the activism threat level, and can build investor trust over time.
Show your work – board meetings. Shareholder plaintiffs, including activists, are increasingly using books and records demands as an entry point to investigate corporate wrongdoing. In the activism context, that information may be used to highlight perceived shortcomings during a proxy contest. For these reasons, it is important for the records of board meetings to demonstrate that the board is getting adequate information and acting with due care. Directors should ensure that the record reflects that they are regularly meeting and regularly considering “mission critical” risks.
Consider enhancing your director evaluation and re-nomination process and talking about it. While the overall composition and function of the board as a whole will always be important, over time, the universal proxy card rule may also make it more important to consider the skillsets of individual directors and to clearly communicate the qualities that each person brings to the table. From a process standpoint, that means that nominating committees may enhance the director evaluation and renomination process to consider individual skills more thoroughly and assess how each person’s skills align with the current needs of the board and the company. Many companies are enhancing proxy statement disclosures about the nominating committee’s role, individual director backgrounds and skills, and director tenure considerations. Some are also updating investor relations pages to showcase directors and emphasize their electability in a more modern way (e.g., with video interviews and director-specific URLs).
Know who you will call. Like any risk, advance preparation makes it more likely that a company will be able to respond to real-time threats in a timely and well-considered manner. In addition to the steps above, directors of companies that may be especially vulnerable should consider encouraging management to create an internal working group to track the activism landscape and learnings from vulnerability assessments, create communication guidelines, and identify when a response playbook is triggered. Members of this group can provide regular activism preparedness updates to the board.
Regardless of whether the company formally maintains a working group, there should be an understanding of who needs to be involved if a threat arises and who will lead the response. This includes identifying key outside resources, their contact information and the order in which they should be brought into the process. Generally, all overtures initially should be referred to the CEO or board chair.
How to Respond if an Activist Situation Arises
Responding to a specific activist threat is a very delicate situation that requires careful counsel from legal, communication and financial advisors. An ineffective response can make things worse by making the board seem misaligned with any or all of each other, management or shareholders. Steps include:
- Assemble your working group and outside advisors. Put your plan into action by assembling the internal and external resources that will be involved with your response. Make sure that specialists know their respective roles and responsibilities in the process, as there may be overlap in services. Also make sure that everyone knows who is leading the process and who needs to be included on communications. Although there is no need to rush a response, keep in mind that the situation can evolve very quickly.
- Objectively consider the activist’s recommendations. Although it can be difficult, try to keep an open mind about the activist’s recommendations and be willing to cooperate and give them credit. Before approaching the company, they have researched the company and formed a value thesis. They may have even talked with other shareholders—who will expect the board and management to give due consideration to the activist’s ideas.
- Speak with one voice. A company’s response to a traditional activist will depend on the type of contact that they have made. It may make sense to respond to private letters and work to keep the campaign private for as long as possible, whereas in public campaigns it can be better to stay above the fray and focus on communicating with other shareholders. In any event, it is very important that the company communicate consistently and presents a united front. Activists can leverage signs of internal disagreement to create a perception that the company is lacking strong leadership and needs a change.
- Engage with other shareholders. When facing an activist threat, it is essential for the company to communicate with other shareholders about the value of the long-term strategy, the topics that the activist has raised, and changes that the company is considering in response. Take the opportunity to gather and process the views of key shareholders. Hopefully, these conversations build on existing long-term relationships, in which case the company can also emphasize its record of engagement and responsiveness.
- Find agreement, if possible. Proxy contests and hostile takeover attempts are costly to both companies and activists, time consuming for everyone involved, and may involve unwanted personal attacks on directors’ reputations. To the extent that an activist’s suggestions do not derail the company’s long-term strategy, it often is worth looking for ways to meet the activist in achieving at least some of their goals. In many cases, a standstill agreement can placate an activist and give the board more time to respond to the activist’s ideas—although it remains important to carefully review and negotiate the terms of those agreements so that the board does not face additional difficulties during the term of the standstill. With positive cooperation, activist nominees may end up becoming valuable board colleagues.
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Keep fiduciary duties in mind. The same principles apply to an activism response as to other business decisions, at least initially. Throughout the activism response process, the board should ensure that meetings are appropriately documented to show that the board is acting with due care and loyalty and in the best interest of the company and its shareholders.
If the board responds to a specific threat with defensive measures, those may trigger a higher level of scrutiny. In addition, if the board takes steps that would put the company into the sales process, its duty becomes getting the best price for shareholders.
As directors, review minutes to ensure that they clearly reflect the board’s intent and considerations during the response process, so that decisions can be defended if necessary. Experienced legal counsel can assist the board with navigating the process and maintaining appropriate documentation.
