As more types of funds make their voices heard in corporate boardrooms, companies of all sizes are being forced to prepare for the possibility of an activist approach. New factors, such as calls for a greater emphasis on environmental, social and governance (ESG) issues, are changing the game as well. How will these and other trends shape shareholder activism in 2019?
Mergermarket on behalf of Toppan Merrill spoke with four experts on how shareholder activism will impact dealmaking in 2019.
Toppan Merrill question: How are the tactics used by companies to defend against activists evolving? Are there new techniques that are proving to be effective? Leading industry experts weigh in...
Jack “Rusty” O’Kelley III, Russell Reynolds says: There are three things we're hearing more about on the defense side. One is that companies are engaging more frequently with their regular set of advisors on all sorts of scenarios. They're more focused on what could happen and who could enter the picture, realizing that no one is safe anymore from activist investors. Your size and scale don’t matter, and you can even be a good performer. So I think there's just a greater awareness that no one is safe from an activist campaign.
The second action we’re seeing companies take is proactive director vulnerability analysis. So a company will come to us and say, "If you were an activist, how would you attack our board? Who is strongest and who is weakest?" The boards don't like to do that, but they realize they need to be smart and have the answers to these questions before a proxy campaign begins.
The third thing we see is that I'm being retained to look at the activist's proposed board members, to provide our opinions on the strengths and weaknesses of that slate and to help articulate the argument about why their slate is weaker and ours is better. Traditionally, PR firms would do that, but they’re not experts in talent and board composition. As a search firm whose job it is to put people on boards and evaluate people for boards, we have the ability to take a deeper and more nuanced view. So we can look at an activist slate and identify their strengths, their weaknesses, and articulate how to make the argument against them – or, on the other side of the coin, communicate how to make the argument that your client’s board slate is stronger.
Professor Minor Myers, Brooklyn Law School adds: The activist world seems to be evolving in ways that echo the takeover market of a generation ago. Boards, now as then, are nothing if not well-advised. There are battalions of corporate lawyers who help incumbents avoid the disciplining pressure of an activist campaign. And the tools of the M&A market are, not surprisingly, being adapted to defend against activists. So companies have created triggers in poison pill provisions that specifically target activists, as Sotheby’s did a few years ago. Bond indentures can include put provisions that are triggered upon a proxy contest.
In other words, a credit agreement can deliver a put right to the bondholder not just in the more conventional context where the ownership of the company changes but also now when the composition of the board changes – precisely the thing that activists seek to change. The effect of these developments is to make activism less financially attractive. Things like the activist poison pill limit the activist’s upside potential, while the put provisions will drain away the financial benefits of any activist- induced change.
Beyond these efforts, it will be important to see how the rules of the game develop. This means how, for example, the SEC handles issues like the 13D reporting rules. And how states like Delaware apply the basic fiduciary rules that govern director behavior. The combined effect of these forces will determine what tactics are fair game and what may cross the line.
Aneliya Crawford, Schulte Roth & Zabel weighs in: The tactics used by companies are constantly evolving, and they are somewhat customizable in the sense that the type of defense tactic that would make sense depends on the individual situation. One thing that tends to change the momentum and thought process behind a campaign is when a company decides to proactively make changes on its board of directors, because typically, a change on the board is what the activists are looking for. What we often see companies do is they make the change themselves and then argue that because they have refreshed their composition on their own, any change requested by the shareholder is moot.
From the perspective of activists, that's almost never really the case. This has been deployed many, many times by various companies, and I'm yet to see a situation where the board proactively made board changes and the activist thought to themselves, "Well, that's great. That's what we wanted. The people they now have on the board will solve all our problems."
Usually, what happens is that the activist thinks the whole idea of changing the composition of the board was to have someone who is not picked by the board to be able to ask hard questions and fight for the interest of shareholders. They usually don't want the same cast of characters whom they think have done wrong by the company to pick friends and connections to step in and help them out in this situation. They wanted someone picked by them and by shareholders, not picked by those very same, compromised directors.
But this defensive strategy is often effective. It's harder to convince proxy advisory firms and other shareholders, because they are both inclined to give the new set of directors a chance. So it very much changes the rhetoric and strategy of the campaign.
Professor Claire Hill, University of Minnesota Law School says: The main thing I would stress here is preparation, by means of anticipating vulnerabilities and possible activist strategies and also by means of a broader and more continuous focus on shareholder engagement, so that shareholders know more about what the company is doing and why. As the activist business matures, more companies can anticipate being targeted. And for many reasons, including the say on pay votes required since Dodd-Frank, increasing and continuous shareholder engagement has made a lot of sense. The final thing I would note is that activism and engagement are to some extent on a continuum. An aggressive activist campaign seeking to make significant changes to the board is on one end, but listening to shareholders who present ideas that the company decides are good ones and then adopts is closer to the other end.