Corporate boards are finding that offense may be the best defense when it comes to dealing with shareholder activism.
Historically, boards have spent little more than a few hours one day a year in the same room as shareholders—at the annual meeting.
Yet boards taking that approach today can risk being out of touch when it comes to activism, according to leading shareholder activist defense advisory bankers at Morgan Stanley. Increasing numbers of institutional investors who would never have called themselves “activists” are now entering the fray.
Of the 758 companies that globally received public demands from activist investors last year, 311 came from so-called occasional activists —a.k.a. “disgruntled shareholders” or “reluctivists.”1 These are mostly long-term investors who might have made the occasional public criticism of a company at some point, but certainly don’t consider activism as part of their core investment strategy.
As activism soars to record levels,1 shareholders are increasingly bypassing the traditional avenue of going no further than lodging their complaints with a company’s Investor Relations department. These institutional shareholders are forcing companies to take notice of them, by supporting or joining with activist hedge funds, or even launching their own proxy battles.
Their arrival on the scene is one of the reasons why boards are shifting their mindset. “Boards have become increasingly aware that shareholders no longer come solely with a 'vote with their feet' attitude where they would sell in the event the investment isn’t performing as hoped—instead, they are increasingly willing to stick around, make their voices heard and push for change,” says David Rosewater, Managing Director and Global Head of the Shareholder Activism and Corporate Defense Group at Morgan Stanley.
“Preparation and Shareholder Engagement” is steadily becoming part of regular activities within boardrooms. Bankers like Rosewater are advising corporate clients on how to make offense their best defense. “The best way to avoid activism—or at least to be fully prepared in the event an activist appears—is for the board of a company to be its own activist and foresee what changes may be needed", says Rosewater.
The best way to avoid activism...is for the board of a company to be its own activist...
Last year Morgan Stanley advised more companies on activism and hostile takeovers than any other investment bank3. Rosewater and Jan Weber, Managing Director responsible for Corporate Defense and Shareholder Activism Advisory for Morgan Stanley in Europe, advise their clients to think of activist defense as a fact of corporate life that can affect companies of all sizes, and in a variety of circumstances, rather than as a break-glass-in-emergency plan that goes into action only after an activist shows up.
“The best way to fend off an attack is to prove to institutional investors, before an activist hedge fund comes along, that the management and the board are doing everything they can to think through all the value-creating alternatives to maximize shareholder value,” says Rosewater. “Boards and management teams need to have a credible explanation as to why shareholders should permit the company to pursue long-term value creation in lieu of short-term gains.”
Activist hedge funds typically seek to generate returns by taking minority stakes in a company and then pushing for divestments, acquisitions, share-buybacks or any other strategy that will increase the value of their stock holding. They will often get the views of institutional investors regarding their potential plan before they launch it.
Corporate boards need to get ahead of this by engaging shareholders first. “How companies manage their relations with institutional investors has become a critical part of defense strategies" says Weber. “Companies need to be proactive with institutional investors, rather than the other way around, and show they are willing to listen and act where it makes sense on their concerns.”
The glue that should bind investors and the board together is that they both want basically the same thing: long-term sustainable growth for the company. “Whether they are active fund managers or large passive index funds, institutional investors should be the natural ally of an involved board focused on long-term shareholder value creation,” says Weber.
The larger corporations that have been practicing shareholder engagement are finding that it reaps benefits. “With continued macro challenges to growth, pressure for consolidation and many sectors being disrupted by technological changes, getting feedback and backing from shareholders with a vested interest in the long-term success of the company can be very useful in driving strategic change that looks beyond near-term quarterly results performance," says Weber.
Companies outside of the Americas are increasingly being targeted, now that competition among activists and other investors using activist tactics has risen in the U.S. In recent months, activists in the UK, who have traditionally shown preference for engaging companies behind closed doors rather than making their campaigns public, appear to be using a broader range of strategies.
“We’ve seen activist shareholders run U.S.-style campaigns, such as Elliott and Active Ownership Capital with respect to Alliance Trust and Stada, respectively, but we’ve also seen shareholders seek a middle ground between the shorter-term activist investment strategy and the private-equity strategy” says Weber. “In certain circumstances, they’ll take a three- to five-year perspective and pursue long-term value-creation strategies. These campaigns typically unfold behind closed doors and aim to generate informed and consensus-based support for the right cause.”
The next step, hopes Weber, is a move by passive index fund managers to become more engaged in conversations about corporate strategy, rather than focusing primarily on governance issues, such as the make-up of a company’s board. “Companies should want to see index funds have a seat at the table,” says Weber. “After all, these funds by definition are the embodiment of long-term investing.”