Activist Investors’ Approaches to Targeting Boards
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August 21, 2017
Leadership StrategiesLeadershipBoard and CEO AdvisoryBoard Effectiveness
Reynolds Associates Consultant Jack "Rusty" O'Kelley III writes this article about how activist investors approach targeting boards.
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Harvard Law School Forum on Corporate Governance and Financial Regulation

The Harvard Law School Forum article, “Activist Investors’ Approaches to Targeting Boards,” was authored by Russell Reynolds Associates Consultant Jack "Rusty" O'Kelley III about the firm's study, "Clear Eyes Provide Boards with Better Vision." The article is excerpted below. 

Clients who are anticipating or early in the process of an activist situation, and a potential proxy contest, often ask us two questions: 

How do you know if an activist is going to seek to expand the board or target specific directors for replacement (and potentially escalate the situation to a proxy contest)? 

If an activist chooses a board member replacement strategy, how can you predict which directors an activist may target? 

Based on our experience working with corporate boards defending against activists (as well as our broader board search and effectiveness expertise), we have gathered insights regarding how activists analyze and target boards of directors. In response to client requests, we have developed this guide to help our clients proactively think through defensive measures regarding board composition and governance issues. 

Activists generally will utilize against individual directors all current and historical negative press, statistics, and data that is publicly available, whether or not it is accurate, comprehensive, or fair. Boards should be ready for this tactic and be ready to take back control of the narrative about the board. 

Russell Reynolds only works on behalf of corporations and their existing board and management teams. We urge our clients to take a proactive, “clear-eyed” activist view of their board to understand how an activist may attack their board. We have prepared this overview based on our experience and on the insights of several activist defense lawyers, investment bankers, and proxy advisors with whom we have worked. Additionally, we have talked with activist investors who were willing to share their approaches. 

Expansion vs. Replacement 

Anticipating an activist’s approach to targeting board seats 

Activists target a board to influence decision-making and increase value creation. While activists may take different approaches and specific tactics vary by activist and situation, key indicators can help identify their potential path. 

Two of the most common activist approaches to maximizing influence on a board are either pressuring the company’s board to expand the number of board members or targeting specific incumbent directors to be replaced. Both may be done by way of a proxy contest or by using the threat of such a contest to pressure the target board into a settlement that places activist-backed directors on the board. There is no strict methodology for predicting which tactic an activist will pursue, and activists’ decisions are frequently determined by how companies react to the activists’ ideas. 

We have identified some key indicators that determine if activists are likely to look to expand a board or target specific board members. 

Expansion 

Activists often seek to expand a board in less contentious activist situations 

We have observed that the earlier a company is in the process of engaging with an activist, the more likely it is that the activist will encourage the board to expand its size by adding activist-backed directors. The longer and more public the process, the more likely it is that the activist will target specific incumbent directors and consider conducting a proxy fight. 

Board expansion usually occurs in several situations based on several factors, which include: 

The board has accepted the activist’s investment thesis and acknowledges the validity of its recommendations 

The activist wants to monitor a situation or progress 

There is specific insight or expertise the activist and board feel is missing based on business strategy 

The board has classified terms (to get around limitations of a replacement strategy with staggered terms) 

The first procedural step is for the board to look at its size in relation to its bylaws and peer benchmarks. As a general rule, relatively large boards make expansion less desirable. If the board is already at the maximum membership allowed by its bylaws, expansion is less attractive as the board may not want to change the bylaws to increase the number of directors. Board expansion will dilute the magnitude of activist influence (compared to replacement), but may face less resistance from the target board in a settlement. 

For example, if an activist seeks to add 2 directors to a 10-member board, a board agreeing to expand the membership will net the activist 16% representation (2 of 12), as opposed to the 20% representation by replacing 2 sitting directors (2 of 10). 

To read the full article, click here.