When it comes to corporate governance, board members and shareholder activists are usually on opposite ends of the spectrum. But at separate conferences in New York and Boston this month, the two camps expressed a surprisingly similar view about the most effective way to deal with the anticipated increase in shareholder activism in 2011: better communication.
According to a study by law firm Schulte Roth & Zabel (SRZ), 76% of activists surveyed identified “dialogue/negotiations with management” as the most effective activist strategy to achieve desired results. None of the other proposed strategies – shareholder resolutions, publicity campaigns, proxy contests or litigation – received more than 16% of the vote.
Results of the study were highlighted at SRZ’s Shareholder Activism Conference in New York, which I attended as part of an invited group comprised mainly of hedge fund and private equity fund managers.
In response to the question of the most effective activist strategy, one activist summed up his answer this way: “Open communication is critical, and it is less contentious than other options. It is our experience that fruitful dialogue works best when you are trying to achieve a settlement.”
On the same day I attended the SRZ conference, I moderated a panel on board-shareholder communications at the New England Chapter of the National Association of Corporate Directors (NACD) meeting in Boston. Panelists agreed that – when faced with an activist shareholder – a proactive dialogue between the board and the investor is integral to a mutually beneficial outcome.
One director recounted his company’s response to an activist shareholder’s decision to accumulate shares in the company. Rather than retrench, the company’s management engaged in a dialogue that included personal visits to the investor’s offices by the CEO and CFO, corresponding visits by the investor to the company’s headquarters and operating locations and intensive, face-to-face meetings between the investor and the company’s directors.
The interaction gave management and the board invaluable insight into how the investor perceived the company and its performance. It also clarified the investor’s agenda, which included board declassification, separation of the chairman and CEO roles, the addition of new board members with industry experience, conversion of multi-class shares and a stock repurchase program.
The company, which had been considering some of these changes prior to the investor’s decision to boost its stake, proposed a number of these initiatives to its shareholders, who approved them at the company’s annual meeting. Within several months the company’s valuation had increased significantly and the investor liquidated its position in the company.
Score one for open and honest communications.
Which leads me to a key point from this month’s two events: Activism is on the rise because it’s working. Numerous studies indicate that, in aggregate, companies targeted by activist investors deliver abnormally high market returns. A second reason, as articulated by Damien J. Park, a managing partner for Hedge Fund Solutions, LLC, is that we’re in a “fertile environment” for activist investing. Park and others at both events pointed to a confluence of forces that promise to create favorable conditions for activism in the months ahead.
Capital inflows to funds have been growing recently, so shareholders with a propensity for activism have the resources and motivation to seek more involvement in corporate governance. For the first time, we could even see sovereign wealth funds entering the fray. Meanwhile, corporate balance sheets are the strongest they’ve been in years. This strength is giving rise to questions about whether companies are deploying their cash effectively and whether their returns on invested capital are reasonable.
In addition, current market conditions are unusually conducive to mergers and acquisitions, which tends to increase the level of shareholder activism. Louis A. Goodman, a partner at Skadden, Arps, Slate, Meagher & Flom LLP, observed that financial activists such as hedge funds and private equity funds become more interested in pushing for control when companies are, or could be, in strategic transactions.
At the same time, corporate governance has become politicized. In the aftermath of the 2008 financial crisis, the Dodd-Frank Act and recent SEC rulemakings have created a positive environment for social-issue investors such as pension funds that target executive compensation and other hot buttons.
Whether financially or socially motivated, the behaviors of dissident shareholders have never been easy for boards and management teams to deal with. Contending with activism is even more challenging today, now that many companies have adopted shareholder-friendly provisions, such as those instituting majority voting or eliminating staggered boards and poison pills.
As we approach the 2011 proxy season, boards and activists may find that communication is a bridge linking divergent perspectives. Actually engaging with dissident shareholders seems to be leading an increasing number of boards to the realization that dialogue is preferable to confrontation. At the same time, interacting with boards and management teams – and gaining an appreciation for the constituencies they have to serve – could be drawing activists to the same conclusion.
Maureen Wolff is president and partner at Sharon Merrill. The Boston-based firm develops critical communications for public and private companies that need to inform, engage and persuade shareholders, employees, customers and other key constituents. Since 1985, the firm has served as a strategic advisor to management teams and boards. Sharon Merrill’s award-winning programs focus on investor relations, crisis communications, transaction communications and reputation management.
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