When Tanks Arrive on the Lawn
Boards must build relationships with shareholders if they want to fend off activist investors eager to shake things up.
The desperate efforts of Alliance Trust to see off an activist investor’s campaign to put three new non-executive directors on the board will come to a head on Wednesday.
The investment funds manager’s chairwoman Karin Forseke and chief executive Katherine Garrett-Cox have accused the New York hedge fund Elliott Advisors of trying to make a quick buck, but the odds are not in the women’s favour.
According to research by the headhunter Russell Reynolds — which is, coincidentally, looking on behalf of the Alliance Trust board for one new non-executive — three-quarters of the demands made by activists globally last year were at least partly successful.
This was largely because they are gaining the support of mainstream investors. “Pension funds, in particular, have sought to improve returns by investing with activists,” says the report from Russell Reynolds, titled Engaging the Activists: Guidance for Boards in Responding to the New Reality of Shareholder Activism.
“In turn, activist funds have been successful in attracting these investors by championing governance reforms that resonate with all shareholders.”
Financial results also work in activists’ favour. Analysis by eVestment, a global database of fund manager performance, indicates that activist strategies outperformed the aggregate of the hedge fund industry last year. Also, the law firm Macfarlanes said that corporate activism was the best-performing hedge fund strategy in 2013. A recent study reported in Harvard Business Review found five-year improvements in the performance of companies targeted by activists.
It is unsurprising, then, that the first line of defence against activists is financial success. Companies that lag their peers are vulnerable, said Simon Wong, former partner at Governance for Owners, an activist firm, and a visiting fellow at the London School of Economics. “The business needs to be well run at the core. If it is not, that will be the primary reason that it is targeted,” he said.
Next is the development of good relationships with institutional investors. This should allow the board to tackle any potential sources of discontent before an activist takes advantage of them.
“One reason that activist campaigns get traction is that mainstream shareholders feel ignored or not listened to, so boards can get on the front foot by building healthy relationships,” said Wong.
“If you have an activist arriving on the scene, it has to convince not just the board but the other investors of the merits of its case. A board with good relationships will be able to buy time because it will have credibility.”
If a challenger does appear, the next task is to understand just what sort of activism is on the table: positive engagement of the sort encouraged by the Financial Reporting Council’s stewardship code, or agitation designed with short-term profits in mind.
“Where activism is helping to build resilient, successful businesses over the long term, it is healthy,” said Tony Manwaring, director of external affairs at the Chartered Institute of Management Accountants. “Where it distracts companies from that, it is not.”
Every board should expect a degree of “lower-level activism” if investors are unhappy with the company’s performance or governance, added Kit Bingham, a partner at the headhunter Odgers Berndtson. “The board needs to be clear about who it is talking to and what their objective is. Are you being presented with an idea that is genuinely in the long-term interest of the company [in which case] you should engage on those terms . . . or should you say these people are locusts?”
Whatever the board does, it must act fast. “Meet the activist immediately,” said one director quoted in Engaging the Activists. “You have a short window of time before it takes the issues public.”
The company must also present a united front, the report says: “It is critical that the board and management work hand in hand to determine the appropriate course of action. Activists could use any sign of conflict to their advantage.”
Nick Stephens, head of the search firm RSA, argues that it is not quite that simple: the chairman’s responsibility is to the company and its shareholders, not the chief executive. “A good one will seek to fulfil his or her duty to the long-term success of the business by supporting or counselling the chief executive appropriately . . . but he or she also has to remain independent in the face of what looks like a common enemy.”
It is worth remembering that the chief executive may be under financial pressures, potentially positive ones, said Stephens. “If there is an activist who could move the share price in such a way that it could trigger a bonus for the chief executive, who could then bow out with 10 years’ salary, you might have a job of thinking about how to approach that question.”
Rachel Atkins, a partner at the law firm Schillings, recommends that directors work together to prepare for the difficult questions raised by an activist — and how to answer them in public. “The chairman needs media training and needs to know how to handle difficult questions, but the whole board has to be informed because any of them could be faced with a left-field question,” she said. Such a question may not come in a formal setting, but when they are buttonholed at a function or quizzed by a journalist they thought was interested in another topic.
Preparation and foresight are also valuable when it comes to board composition — another frequent concern of activists. Nearly two-thirds of last year’s campaigns involved seeking a seat on the board, according to Engaging the Activists. An inappropriate mix of skills or a perception that non-executives are too cosy with management tend to be the main concerns, said Wong, also former head of corporate governance at Barclays Global Investors.
An effective board evaluation regimen should allow the chair–man to nip in the bud any potential problems, but it is also worth listening to activists’ complaints. “The chairman needs to be brutally honest with the board [if] there is merit to an activist proposal.”
Things get trickier when, as has happened at Alliance Trust, both the company and the activist propose new non-executives. Many candidates are rightly wary of becoming involved in such situations, said one headhunter, as their reputation could be damaged if they pick the wrong side.
Successful candidates are likely to face a difficult path when they join the board, added Stephens at RSA. “If you have two rival factions proposing two rival groups of people, the first question [for candidates] is, ‘Am I being manipulated or am I creating a conflict of interest for myself in putting myself forward?’ ” he said.
“It does mean you need to do your due diligence more carefully and be more aware that, when you step into the role, you will have a group of investors who already think you are not independent. It is a no-win situation. If A wins, B thinks A’s Neds are not independent, and vice versa.”
Nobody at Russell Reynolds was available to comment on the report while it searches for a director for Alliance Trust. Elliott Advisors used the recruiter Spencer Stuart to identify three potential non- executives for the trust’s board.