Strategic Shareholder Management—Directors' Best Answer to Shareholder Activism

By Katarina SikavicaJanuary 27, 2015 | Print
Commentators sing it from the same hymn sheet: Shareholder activism is on the rise, and more is expected to come, particularly from institutional investors (hedge funds, union funds, and pension funds), who have more muscle, interest, and expertise to challenge executives and the board. The effectiveness of traditional defense mechanisms such as poison pills, dual-class shares, and staggered boards is decreasing and regulatory forces keep shifting the balance of power toward shareholders—at the expense of the directors.

While how the battle is fought largely depends on the dynamics between activists and the board, boards—especially in continental Europe—still seem to overlook, downplay, or simply ignore shareholder activism. Throughout my academic work and in my role as practitioner, I've had conversations with numerous board members, executives, corporate secretaries, investor relations professionals, proxy advisory representatives, and the activist community. The message is clear: The approach that directors adopt toward shareholder activism is not strategic, not proactive, and based on hastily made ad hoc decisions. Companies consider themselves safe from activists' attacks when, in fact, they are not. What they overlook is that neither a large blockholder nor good financial or social performance shields them from becoming a target. And companies often misjudge the perils of peripheral players who, while small in terms of shareholdings or assets under management, are exceptionally well networked, knowledgeable, and highly motivated to realize their goals sometimes up to the point of personal sacrifice and foregone financial wealth.

This may lead to high financial and reputational losses from which companies recover only slowly, if at all. Indeed, an interview-based study by McKinsey & Company1 estimates that each contested campaign costs a company between $10 million and $20 million. A related recent survey of activist shareholders by Schulte, Roth, & Zabel2 unveils that activists view active dialogue as their most effective strategy and, at the same time, as the most effective defense mechanism that directors can use when it comes to preventing contentious public attacks. Clearly, directors need a more strategic, more preventative, and more engaging approach. In other words, they need to implement strategic shareholder management.

Strategic shareholder management refers to all actions taken to analyze activist shareholders and their identities, plan for appropriate answers to their likely questions, and implement procedures aimed at achieving long-term cooperation and interest alignment with activist shareholders. Strategic shareholder management is a tailored approach, tailored to the needs of each individual organization and its unique situation. As a result, ready-made instructions are difficult to provide. Nonetheless, the following elaborations contain a high-level and hopefully helpful road map for implementing a strategic approach to engaging with shareholder activism.

Inside-Out Analysis

The first step in adopting a strategic approach to shareholder management consists of gaining an understanding of one's identity. An answer to the question of “who are we as an organization” almost always entails an answer to the question of what we deem as rightful and appropriate behavior and what we consider to be outside the realm of legitimate actions. In other words, it entails a statement of the company's own motives and objectives. However, most importantly, seeking to understand one's identity inevitably involves considering whose interests the company exists to pursue.

Companies may adopt a stakeholder or a shareholder approach and may thus make decisions so as to prioritize the interests of all stakeholders or only those of shareholders. Boards can go further, for example, as suggested by the Policy Governance approach, distinguishing between the interests of different groups of legal owners (shareholders), moral owners, and remaining stakeholders. In any case, finding one's place in the stakeholder versus shareholder space is important because it provides a rough guideline on how to engage with shareholder activists—social and financial alike.

Managing one's interface with shareholders almost always means having an appropriate answer ready for an activist's question. While companies may choose to lean more toward one or the other end of the continuum, adopting a stakeholder versus a shareholder orientation is not mutually exclusive. In fact, companies may choose to place equal emphasis on both orientations and adopt a shared-value approach (see Figure 1). The Swiss-based Nestlé is a case in point. Nestlé prides itself on creating shared value for all its stakeholders, including shareholders, equally. Such an approach has a plethora of implications, ranging from the design of incentive systems (who and what to reward) to financial reporting (how frequently to report). As a result of their shared-value approach, Nestlé, for example, renounced quarterly earnings statements and chose to publish its earning statements biannually. Whatever the orientation and objectives, companies are well advised to find their place in the stakeholder-shareholder matrix and formulate ways to convincingly defend it.

Figure 1.

Figure 1. Inside-Out Analysis

    Activist Analysis

    Once the company has gained clarity over who it is as an organization, the next step consists of analyzing its shareholders and potential activists. Before potential activists can be identified, any organization is well advised to identify its current shareholders. Such engagement provides them with useful insight on who their key shareholders are and what these shareholders' exit versus voice strategy might be. In fact, a study of 50 large European and US companies found that a maximum of only 100 current and potential investors significantly influence the share price of most large companies.3 Identifying these critical shareholders and understanding what motivates them may help in making accurate predictions of their behavior and, consequently, the direction of the stock price.

    Shareholder identification builds a sound basis for identifying potential activists among one's current and prospective investors. To understand how shareholder activists make their targeting decisions about which companies they should seek to influence, my colleagues and I investigated the mission statements of 120 US institutional investors who used the proxy process in 2009 and 2010 and filed a resolution against their organizations.4 Our qualitative analysis of these mission statements yielded seven distinct types of activists that can be arranged on a continuum depending on whether they pursue single, unidimensional objectives (i.e., financial performance) or complex multidimensional objectives (i.e., social performance or education/raising awareness objectives on top of financial objectives). We then performed a series of regression analyses to predict the targeting choice of each type of activist. As Figure 2 demonstrates, shareholder activists' objectives vary systematically with their identities—the definition of who they are as activists—as described in their mission statements.

    Figure 2.

    Figure 2. Activist Analysis

      We find that, in general, activists' objectives differ in scope: The first three types of activists on the left-hand side of the continuum emphasized service to their clients as their primary raison d'être as activists. The last three types of activists on the right-hand side of the continuum view their mission as activists more broadly to serve special stakeholder groups (e.g., employees) or the society at large with socially responsible investors being somewhere in the middle. Because identities shape objectives and define success, they also shape targeting decisions. As a result, when engaging in activism, shareholders on the left-hand side of the continuum typically pursue changes in single firms; those on the right-hand side of the continuum, by contrast, often single out those firms most likely to change the entire industry or market. As the Teachers Insurance and Annuity Association–College Retirement Equities Fund (TIAA-CREF) CEO once put it: “The significance is not the three or four laggards you catch—it's that you get the herd to run. We need to scare all the animals.” It follows that hardly any company is safe from activists' attacks. Even well-performing companies that score high in terms of both social and financial performance can become targets of activist shareholders if they are large and visible so as to attract a lot of attention. In analyzing activists, companies can use our typology to map their current and prospective investors and assess these activists' targeting decisions.

      Vulnerability Assessment

      Once key shareholders are identified, the next step consists of estimating one's likelihood of becoming a target. A vulnerability assessment refers to the process of identification and weighting of factors that make a company susceptible to activists' attacks. Vulnerability assessments are becoming more popular in recent times. As a BusinessDay online article informed earlier this year, investment banks have started offering vulnerability assessment to their clients and advising them on how to anticipate and thwart vocal investors. It is reported that Deutsche Bank offers what it calls a “vulnerability assessment,” while Barclays has developed a “proprietary model” that identifies companies most at risk from activism. Other banks including Goldman Sachs, Morgan Stanley, and JPMorgan Chase have followed suit and pitch similar services to head off activists.5 Vulnerability assessments are becoming an essential tool in dealing with activism.

      Because vulnerability assessments will vary from company to company due to the companies' unique shareholder and activist makeup, it is rather difficult to provide an off-the-shelf, ready-to-use template. That said, the set of factors that should enter the vulnerability assessment are more or less finite. They refer to those issues that might catch an activist's eye given their investment strategy and targeting objectives. As hinted above, shareholders' investment strategy and their targeting decisions are related: Financial activists (i.e., those on the left-hand side of the Figure 2 continuum) engage in activism in order to realize their investment objectives. Social activists (i.e., those on the right-hand side of the Figure 2 continuum), by contrast, (also) invest in order to realize their targeting objectives. In extreme cases, social activists buy stock just for the purpose of activism. In other words, in these extreme instances investments are means to ends and activists use their ownership rights to push through their personal, educational, and/or political interests. Admittedly, these extreme cases are rare, but they exist.

      Most commentators and advisors on shareholder activism focus on financial activists and those issues that make companies vulnerable to financial activists' attacks. In their Harvard Business Review article, Coyne and Witter6 categorize investors into financial addicts, strategy junkies, and organizational mavens. Financial addicts, on the one hand, engage in what can be termed balance-sheet or financial activism. The set of factors that makes companies vulnerable to these activists' attacks are related to the company's financial condition, core assets, and results. Consequently, to assess their company's vulnerability to become a target of balance-sheet activism, directors should scrutinize things like earnings estimates, operating margins, and capital deployment decisions, including stock repurchases and dividends.

      Strategy junkies, on the other hand, engage in a type of activism that is commonly referred to as income-statement or operational activism. Income-statement activists focus on issues that affect a company's income statement or cash flow. They are particularly wary of the company's cost structure, technology, and products and services. Targeting is triggered when companies accumulate high cash flow reserves; when they have an unfavorable cost structure, high research and development (R&D) expenses, high restructuring costs, or when they are on the verge of losing market share or competitive advantage to their competitors. A vulnerability assessment evaluating the possibility of becoming a target of income-statement activism thus includes investigating whether the company can be accused of hoarding cash or to have a bad business strategy or poor operational execution.

      Organizational mavens, finally, investigate a company's leadership structure and governance. Organizational mavens engage in what some have termed governance activism. Governance activists target companies that they believe have a poor executive team, CEO, or board. They also become active when dissatisfied with the design of executive compensation or when they don't see the link between executive pay and company performance. Poor governance in general, such as the appointment of directors that they believe lack sufficient independence, or the implementation of takeover defense mechanisms (such as dual-class shares or poison pills) are also among the factors that make a company vulnerable to governance activists attacks. In assessing their vulnerability, companies should examine to what extent they abide by principles (and codices) of good governance, and if they don't what kind of explanation they can reasonably provide for their noncompliance.

      Often neglected, yet no less important, is social activism. Because social activists often hold only few shares, companies tend to underestimate their impact. However, when their cause finds the ear of a broader audience, they can become a source of almost irreparable losses to company and director reputation. A prominent case in point is Daniel Vasella, the former CEO and chairman of Novartis, the Swiss-based pharmaceutical company, who was accused of receiving a fat-cat salary and surrendered to public pressure, renouncing his “noncompete” pay-out of $78 million.

      Social activists thus are well-informed, well-networked, and very persistent and can become very powerful. As a result, companies are well advised to include social, environmental, and spiritual factors into their vulnerability assessment. A good way to do this is to include their social rating scores into their analysis. A number of organizations, such as Risk Metrics, provide such scores. Companies can then use the movements in these scores as an early warning system and brace themselves with answers should activists come knocking on their doors.

      A final step necessary in the vulnerability assessment is the weighting of factors that found their way to the list. Be it due to a different shareholder makeup, company size or visibility, or different industry or sector, the factors discussed above will not be equally important for all companies. Instead, directors should additionally assess each factor according to the impact it has commensurate with its potential to hurt the company's financial and reputations capital. The factors can then be mapped in a vulnerability scorecard (see Figure 3), providing a quick insight into the vulnerability level at a given point in time. Needless to say, the vulnerability assessment should be periodically repeated. Again, movements of factors in the scorecard provide a convenient early-warning system.

      Figure 3.

      Figure 3. Vulnerability Scorecard

        Action Plan

        Within the realm of strategic shareholder management, the inside-out analysis, the analysis of activists and the vulnerability assessment are, essentially, pieces of an integrated action plan. A strategic approach to shareholder management requires the establishment of a working group, a flexibly composed team that counts the CEO and one or two nonexecutive directors (e.g., the chairman of the audit and the governance committees) among its members. C-suite and board-level representation assures that the topic obtains the attention that it deserves and signals to internal stakeholders the commitment by the highest organizational ranks. It also assures that enough financial and other resources will be devoted and that the right processes will be put into place. These include a clear assignment of duties and responsibilities and a sleek information flow inside and outside the organization (see Figure 4).

        Figure 4.

        Figure 4. Action Plan

          Among the team members, in large organizations, are cross-functional internal and external experts, including corporate secretaries, legal counsels, investor and public relations officers, and compensation and corporate governance consultants who are assigned the tasks of identifying shareholders, performing shareholder and activist analyses, and conducting vulnerability assessments. The team should also be staffed with communications specialists who take care of informing and engaging internal and external stakeholders and nurturing the relationship with the investors' and activists' community, proxy advisory services, analysis, regulators, and the press. The team should also design a task force entrusted with the evaluation of any issues or decisions taken that could increase the company's vulnerability. This task force may use a number of means to assess and predict activists' reactions. They may, for example use the five-hats riddle whereby members of the team put themselves in the shoes of different types of activists and comment on an identified issue or a future decision to be announced. In any case, what is important is that the insights of all analysis are synthesized and utilized for formulating the right message, to the right audience in a language that shareholders understand. In any case, each procedure should aim to equip the company for the establishment of a constructive relationship and interest alignment with its current and prospective shareholders. This is, in a nutshell, the key objective of strategic shareholder management.

          Prior to joining Korn Ferry, Dr. Katarina Sikavica, spent ten years in academia where she specialized in corporate governance, and particularly organizational ownership and shareholder activism. She holds a PhD from the University of St. Gallen, Switzerland, and an MA from the University of Zurich, Switzerland. For more information, see

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