Shareholder activism has increased significantly over the past several years, and many companies who once believed they were too small to attract the attention of activist shareholders more and more frequently find themselves in the middle of a proxy contest or responding to shareholder proposals, among other things.
Staying out in front of activist investors and disgruntled shareholders is most important. To this end, companies should be aware of the events that may trigger a reaction, such as lower than market returns on equity, a low stock trading price, and higher than average board or executive compensation. Understanding who your shareholders are is also imperative, for this will guide management in determining what triggering events could spark a shareholder dispute and with whom. For example, a hedge fund shareholder may be more sensitive to certain events than, say, a wealthy individual whose family has an emotional stake in the success of the company. Similarly, a shareholder more interested in short-term gains may react differently to certain events than a long-term investor in the company.
In order to better understand shareholders, companies should seek to maintain an open dialogue with its shareholders, and in particular those owning great than 5% of the companies’ voting securities (all while remaining in compliance with Regulation FD, of course), including groups of shareholders that are known to side with each other, or whose interests are aligned, and who, collectively, could influence shareholder votes. It will be important to reach out to these shareholders on a regular basis, research their activities relative to other companies, and speak to boards of directors of other companies in which they invest. For example, other boards can tell you what experience has taught them about the shareholders' hot button issues and how aggressively they have acted toward other companies.
Once you engage the activist investor or disgruntled shareholder, don’t assume that they are the enemy. Both the shareholder and the board of directors want to increase shareholder value, they may just have different ideas about how to do it. At the same time, don’t be naïve; if the company’s goal is long-term value creation but the investor’s goal is short-term profits, the divergence will ultimately need to be addressed. Despite these differences, engaging in candid, ongoing conversations—in which executives listen carefully to shareholders’ views of the company’s key value-creation opportunities—is an excellent preventive measure for three reasons: (1) professional investors often have good ideas, (2) activists are more likely to be patient if they believe management and the board are listening to their concerns and not stonewalling them, and (3) activists are less likely to intervene and to succeed if they lack the support of major institutional shareholders.
In the event dialogue breaks down, the next steps of the activist investors or disgruntled shareholders may range from private and moderate to public and hostile. For example, the shareholder may quietly negotiate with the company to obtain governance or other changes or they could, more publicly, leak ideas to the analyst community, file a Schedule 13D with the SEC, submit a shareholder proposal, or even conduct a negative public relations campaign.
So what can the board of directors and management do in the event they are faced with activist investors or disgruntled shareholders that appear to have already made up their mind? In the event the company believes a protracted battle with the shareholder is not in its best interest, the company should critically examine its financial performance and governance in much the same way that an activist investor would, and then preemptively make necessary changes. Alternatively, the company could seek to make it less attractive to activists by making it more attractive to long-term shareholders. To this end, the company must make sure the board's long- term strategic plan is communicated clearly and regularly to shareholders. Companies should also evaluate their corporate governance documents to ensure they are not making it easier for activist or disgruntled shareholders to force corporate actions that may not otherwise be supported by the majority of the other shareholders. For example, a company could amend its bylaws to require advance notice of nominations and other shareholder proposals, permit the board to set the date for the annual meeting (rather than a fixed date in the bylaws), prescribe qualifications for all director nominees, limit the ability of shareholders to call a special meeting, prohibit shareholders from privately compensating a director for serving on the board, and provide directors with the exclusive right to fill board vacancies.
The way in which a company addresses its first meeting with an activist investor or a disgruntled shareholder is of paramount importance. By demonstrating an interest in open and frank dialogue with shareholders, a company may find that the shareholder is more willing to work with the company rather than publicly challenge or criticize it.
Reprinted with permission from Focus, a publication of the Association of Corporate Counsel S.C. Chapter