Shareholder activism & engagement
June 2020 | ROUNDTABLE | BOARDROOM INTELLIGENCE
Financier Worldwide Magazine
June 2020 Issue
Although historically a topic of interest in the US, shareholder activism is continuing its outward spread, with the number of activist campaigns steadily increasing across the globe. While there has been a shift toward engagement between issuers and activists and away from confrontation in recent years, generally speaking shareholder activism remains largely aggressive in nature. Moreover, the disruption, financial pressure and new legislation arising from the COVID-19 pandemic is likely to be a major driver for shareholder activism in the year ahead.
FW: What do you consider to be the most significant developments in shareholder activism over the past 12 months or so?
Ryan: Prior to the pandemic, I would have pointed to the rise of ‘handshake’ agreements whereby activists and companies make peace without formal settlements, the continued convergence of private equity and hedge fund activism as each side borrows tactics from the other, and the increasing prominence of environmental and social themes in activist campaigns. Several coronavirus (COVID-19)-related developments, however, are significantly impacting the activism landscape. Declining valuations are fueling a revival of takeover defence mechanisms like poison pills that had fallen out of favour. Balance sheet activism has largely disappeared as companies prioritise preserving cash, and executive compensation is receiving renewed scrutiny. How long-lasting these trends will be is unclear and depends partly on the scale and duration of the pandemic’s economic consequences. We feel confident, however, that we will see a surge in activism as we did in 2009 once lockdowns lift and markets stabilise. Corrections tend to highlight underperformance and expose structurally deficient companies.
Mehrbrey: For many years, shareholder activism was a topic of interest predominantly in the US, but recently it has become increasingly popular in Europe too, particularly in Germany. The number of activist shareholders in Germany has steadily increased. The same applies to public campaigns run by activist shareholders. It can be seen that the focus to some extent shifts to non-financial shareholder activism. In these kinds of campaigns, the activist shareholder is not primarily motivated by financial objectives. Rather, the investor intends to make an impact on environmental or social issues. It is likely that the COVID-19 pandemic will also have a substantial influence on shareholder activism.
Bieber: Shareholder activism continues its outward spread. Geographically, US activists have made their mark in Europe and Asia, while local activists also bring campaigns. In the US, actors not historically perceived to be activists, such as active managers, continue to emerge with increasingly activist-style tactics. Ideologically, there has been significant overlap between issues raised by activists and interests of other investors, including institutional investors, pension funds, single-issue investors and even so-called governance ‘gadflies’. As expansion continues, there is indicia that activists may be moving beyond dabbling in environmental, social and governance (ESG) issues as levers for institutional investor concordance. This overlap increases the dependence of activists on the governance ecosystem to achieve their goals. While we believe that a cohesive, board reviewed and approved strategy continues to be one of the most significant pieces of defence preparation, the inputs to what the board must consider in its strategy also continues to expand beyond financial considerations.
“Generally, it can be seen that recent activist shareholder campaigns have become more aggressive. In particular, they often make use of public campaigns in an effort to put the management in a bad light.”
FW: What are some of the common factors driving activist campaigns?
Mehrbrey: The main driver for activist shareholders, be it investment funds, hedge funds or private equity funds, still is to make the company more profitable. But there are different ways to pursue this goal. Generally, this depends on the investment strategy of the activist shareholder. In particular, a distinction can be made between short-term and long-term investors. While short-term investors often try to yield higher dividend payments, long-term investors put their focus on strategic aims, such as divestment of certain business units, the expansion of business areas, and the restructuring of group structures, and so on. And there are groups of activist shareholders pursuing non-financial aims.
Bieber: Activists do not operate in a vacuum. By the time a company recognises that an activist has taken a position in its stock, the activist has done significant work behind the scenes engaging with company shareholders, including those the company considers to be company-friendly. The activist has generally received indications of support for its thesis and has identified areas that other investors perceive to be weaknesses that will be helpful to provide a broad range of appeal among investors in campaigns. It is also common for activists to use a variety of methods to build their stakes, including certain derivatives which may not be required to be reported in some instances. It can be difficult, as a result, to determine true levels of ownership at the outset of a campaign.
Ryan: Active managers are continuing to adopt activist tactics as they feel pressure from outflows to index funds. This has driven the increase in campaigns by first-time and occasional activists in recent years, and we believe this trend will continue. As far as macro trends, a need for consolidation in certain industries, such as energy, was fuelling M&A activism prior to the COVID-19 outbreak. Given depressed valuations, we expect this to continue and even accelerate as the economy reopens. When looking at individual companies, undervaluation relative to peers will remain a top driver of activism. Undervalued companies with operating performance in line with those of peers are particularly appealing targets for activists, as the reason for their undervaluation, such as poor capital allocation, may appear relatively easy for an activist to fix.
FW: Have any recent campaigns caught your eye? What insights can we draw from their outcome?
Ryan: Recent campaigns in Japan have been fascinating to watch. For years we have heard about the opportunities for activists in the country – companies there are generally undervalued relative to their international peers, conglomerates and pseudo-conglomerates proliferate, and prime minister Shinzo Abe has pushed reforms aimed at making Japanese companies more shareholder friendly, though less so in recent years. Significant obstacles nonetheless remain for activists in Japan. Japanese institutional investors, for instance, appear less likely to support dissident shareholders than their Western counterparts. It has been interesting to see these competing dynamics play out. Last year Olympus became the first major Japanese company to add a US activist, ValueAct’s Robert Hale, to its board. Elliott Management’s success in pushing SoftBank to repurchase shares is also notable. More recently, however, issuer victories in proxy contests at Kirin Holdings and Toshiba Machine contribute to a mixed record for activists in Japan. In evaluating these campaigns, one clear lesson is the need for activists to take a soft-touch, collaborative approach to campaigns in the country, as Japanese shareholders are particularly put off by combative rhetoric and tactics.
Bieber: Three campaigns have underscored key themes. At a large oil and gas exploration company, a merger financially engineered to bypass shareholder approval ended up being a more significant long-term shareholder relations issue that attracted Icahn and ultimately cost the company provisions in its defence structure, board seats and leadership and executive jobs and compensation. Recently, Elliott sent a regional utility company a letter urging the company to consider its capital expenditures and allocation to facilitate renewable energy and reduction of the company’s carbon footprint. The letter was one of the first significant campaigns that featured ESG as central to the activist thesis. Meanwhile, Elliott also was recently fined €20m by French regulators in connection with inaccurate or late filed reports in connection with a campaign, which underscores one of the areas in which companies often have an edge over activists: understanding their regulatory landscape.
Mehrbrey: Generally, it can be seen that recent activist shareholder campaigns have become more aggressive. In particular, they often make use of public campaigns in an effort to put the management in a bad light. In many cases, from the perspective of the activist shareholder, a public campaign proved to be more efficient than exercising statutory minority rights. Thus, it has become more and more important for companies to develop and implement a sophisticated PR strategy. In many recent cases activist shareholders succeeded in achieving their goals – whether by bringing about a change of the business strategy or in achieving a change in the composition of the board of directors as well as the supervisory board. In some cases, it is apparent to all that the change was caused by activist shareholders. However, in many cases it is not.
“Settlements have become a significant part of the activism business model, with only a handful of full-fledged proxy fights each year.”
FW: How have activist tactics evolved in recent years? What are some of the approaches they are taking to exert their influence and effect change?
Bieber: Settlements have become a significant part of the activism business model, with only a handful of full-fledged proxy fights each year. In part, settlements are attractive to activists because they can leverage lower percentages of ownership into less expensive, but still impactful agreements. Through settlement, an activist generally obtains one to three board seats, which is within spitting distance of winning a short-slate proxy contest. Settlements have also opened the door for a variety of other options for activists to demand, including commitments to alter the mix of capital expenditures, governance changes, creation of special committees to review strategy, commitments for operating and financial goals, and interestingly, the influx of other professionals, such as consultants, into the boardroom. While activists in many campaigns have not included their own employees as directors, their ability to nonetheless direct companies to particular consultants can still maintain a level of connectivity to the boardroom.
Mehrbrey: The main forum for shareholders in Germany to exert influence is the annual general meeting (AGM). As a general concept of German law, the AGM is the only forum where shareholders of a publicly listed company can exercise their shareholder rights. Even long before the general meeting, public campaigns are launched to win votes. Here, proxy advisers increasingly play an important role. However, even though the AGM is still a centerpiece for activist tactics, and is still used to extensively question management, there are many other approaches besides. For instance, activist shareholders often exert pressure on management by other means. This includes letters which are often leaked to the public, and press campaigns which have become more professional in recent years. Another activist tactic which has become more prevalent in recent years is to commission investigations, mostly into allegations of compliance issues or other breaches of duty attributable to management.
Ryan: The last decade has seen a marked shift toward collaboration between issuers and activists and away from confrontation. Both sides recognise the potential costs and distractions of proxy fights and will often make a good faith effort to resolve disagreements and reach settlements behind the scenes. As perhaps an extension of this trend, in the past year we have seen a rise in handshake agreements which typically involve concessions from companies, such as buybacks or board seats, but with no formal settlement or standstill provisions. Unsurprisingly, activists including Elliott Management are increasingly seeking such agreements with issuers. However, we find these informal arrangements are only in companies’ best interests in a narrow set of circumstances, including when they have a close working relationship with the activist and there is significant common ground.
FW: How are legal and regulatory developments affecting this space? To what extent do shareholder-friendly laws, for example, facilitate activism and make campaigns more likely to succeed?
Mehrbrey: The legal framework under German law for exercising shareholder rights is largely confined to the AGM. In the general meeting, however, shareholders have extensive rights and a variety of options to exert influence. In these general meetings they can hold speeches, vote on resolutions, make counterproposals and request information. The legal framework is quite formal. It is not unusual for German courts to declare resolutions void as a result of the violation of minority rights. The legislator attempts to restrict the ability to abuse formal rights as a means of exerting undue pressure on companies. However, professional advisers are constantly looking for loopholes in the legal framework. On the other hand, there are rules that make shareholder activism more difficult. For example, while activist shareholders often request additional information, the prohibition of insider information pursuant to the European Market Abuse Regulation leaves little room for disclosures requested by individual shareholders.
Ryan: Several legislative proposals in the news lately in the US – such as tight restrictions on M&A – appear politically unfeasible. More significant for the US activism landscape are the Securities and Exchange Commission’s (SEC’s) proposed rules for proxy advisers, which, among other things, would give companies an opportunity to comment on proxy adviser recommendations before those recommendations are shared with the proxy adviser’s clients. This, of course, would benefit companies at the expense of dissident shareholders. More broadly, government or regulatory action can significantly impact proxy fight dynamics but can only go so far. Returning to the example of Japan, prime minister Abe’s push toward a more shareholder-friendly environment has met with mixed results thus far, indicating that governments can only do so much to tip the power balance between shareholders and issuers. Other factors – such as cultural norms – play an important role in contested situations as well.
Bieber: Over the last two decades, some significant defences against activists have been pared back, as many companies moved to annually elected directors with majority vote and mandatory resignations, while proxy advisory firms and institutional investors have increased the criteria under which a director may not receive a ‘for’ vote in annual elections. Decreased activist levels of stock ownership, the ability to acquire derivatives that legally skirt regulatory reporting regimes, and the acquisition of economic-only derivatives, have rendered other defences, such as poison pills, less effective. This confluence of events has left companies vulnerable. Even companies willing to see out a proxy fight find that they win the battle only to lose the war, having expended shareholder goodwill on a costly, distracting fight that, for close elections, lacks a solid mechanism to even determine the outcome. This landscape has made settlements a de facto winner in many campaigns.
“No company is immune to activism, but issuers can take certain measures to make themselves less appealing targets. Closing a valuation gap, while easier said than done, remains the best defence against activists.”
FW: What strategies should companies consider to reduce the likelihood of becoming embroiled in an activist campaign? What shareholder engagement methods might be deployed, for example?
Bieber: Well-executed shareholder engagement is key. First, companies need an active and engaged board that has reviewed the standalone plan, sets and believes in the company’s strategic vision, engages with management on its views and puts forward a public and united front. Together, management and the board develop a cohesive story and the company works to incorporate this narrative in corporate communications, as well as proactive shareholder outreach to key investors. It is important to develop those relationships on ‘clear days’ and ensure the buy-in from the stockholder base regarding the company’s long-term plans. In addition, companies need to think broadly about what the strategic vision encompasses – more investors want to hear about how sustainability, human capital management and other ‘soft’ issues play into the long-term strategy of the company.
Ryan: No company is immune to activism, but issuers can take certain measures to make themselves less appealing targets. Closing a valuation gap, while easier said than done, remains the best defence against activists. Removing governance deficiencies to better align practices with a company’s peers and industry likewise may help an issuer avoid being targeted, or at least put them in a better position in the event of an activist approach. Strong shareholder communications – including robust disclosures relative to peers and clear capital allocation plans and priorities – are also advisable. Relatedly, companies should ensure they have the most compelling articulation of their investment proposition possible, and then make sure they are executing in accordance with that proposition. Traditional, reactive investor relations is now insufficient. Proactive investor engagement to stay close to a company’s shareholder base – including passives – is critical if a company hopes to avoid, or more realistically prepare for, an activist engagement. This means both ensuring shareholders adequately understand the company’s investment narrative and strategy, and that the company is gathering and synthesising substantive investor feedback. On a tactical level, investor perception audits conducted by third parties can help here.
Mehrbrey: Companies should continuously monitor their shareholder structure and encourage the representation of a large portion of the share capital at the AGM. This can reduce the risk of activist shareholders obtaining a greater influence as a result of their voting rights and of proxy advisers cooperating with the activist shareholders. The general meeting should be carefully prepared to avoid procedural mistakes that activist shareholders can take advantage of. In addition, companies should monitor the shareholder activism scene and new developments closely. Companies should coordinate communication with the public in a professional manner. It is important that companies always seek an open dialogue with activist shareholders in order to resolve disputes in advance. And sometimes the biggest threat is within the company – for example board members who cooperate with activist shareholders.
FW: Looking ahead, how do you expect shareholder activism to evolve? Are campaigns set to ramp up the pressure on boards, challenge corporate strategy and transform company culture?
Ryan: The extent of COVID-19’s long-term impact on the economy and activism remains to be seen. At least in the near future, shareholders will largely avoid balance sheet activism, and takeover defences such as poison pills, with reasonable terms, will enjoy increased acceptance from investors and proxy advisers. As the economy begins to reopen, dissident shareholders will also likely look to hold boards and management teams accountable for perceived mismanagement or failed oversight during the pandemic. Longer term, we expect certain pre-COVID-19 trends to continue. Environmental and social issues that now comprise a significant part of shareholder discourse will play an increasingly prominent role in activist campaigns. With several industries ripe for consolidation, we also expect M&A activism to remain strong.
Mehrbrey: We will probably see more shareholder activism in the coming years. Activist shareholders will continue to conduct public campaigns to pressurise boards to achieve their objectives in order to influence the company’s strategic approach. Companies should expect an increasing number of activist shareholders pursuing non-financial objectives in the future. Finally, I expect the disruption and new legislation caused by the COVID-19 pandemic to be a major driver for shareholder activism in the coming years. Not only is there an increased economic pressure on companies due to the pandemic, but there is also an increased pressure on shareholder activists as well. They will now, more than ever, feel the need to do everything they can to make their investment more profitable.
Bieber: In the near-term, companies are dealing with COVID-19 impacts, so campaigns are more likely to be seen as a distraction and cost, assuming an activist is able to build a model in these uncertain times. However, activists, strategics and private equity firms are likely taking advantage of opportunities to build quiet accumulations while stock prices are low and will be poised to emerge as winners and losers develop. Campaigns emerging at that time are likely to continue with typical tactics – M&A, strategy and governance considerations and director refreshment – but are also likely to include attention to sustainability and human capital management issues, particularly framed against compensation considerations. Activists will be watching the increased attention from large institutional investors on these issues, as well as tracking companies that had poor records in these areas and diverging interests between shareholders and executives and are struggling to regain market traction as a result.
Patrick Ryan is the shareholder activism director in Edelman’s financial communications group. Based in New York, he advises management teams and boards, focusing on shareholder activism defence, contested and hostile M&A, litigation communications and crisis management in the face of intense shareholder scrutiny. He is a former US marine officer and holds an undergraduate degree from Princeton University. He can be contacted on +1 (212) 819 4880 or by email: patrick.ryan@edelman.com.
Elizabeth K. Bieber is counsel with Freshfield Bruckhaus Deringer’s global transactions group, based in New York. She focuses on activism and takeover defence preparedness and plays a leadership role on corporate governance issues. She regularly works with executive management teams, boards and their committees charged with governance and defence preparedness and is a recognised thought leader on governance matters. She can be contacted on +1 (212) 508 8884 or by email: elizabeth.bieber@freshfields.com.
Dr Kim L. Mehrbrey, a Dusseldorf-based partner in Hogan Lovells’ litigation and arbitration practice, combines the experience and knowledge of being a former corporate and M&A lawyer with the skills of a professional litigator and arbitration counsel. He has 20 years of relevant work experience in this field, including numerous representations of large corporates and national and international investors in corporate disputes. He can be contacted on +49 211 13 68 473 or by email: kim.mehrbrey@hoganlovells.com.
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