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Boards, corporate strategy and activist investors
by Professor Jordi Canals
Activist investors are back. Many boards are expressing concerns about this new wave of activism. After a slowdown in activity at the beginning of the pandemic, activist investment is picking up again. Recent growth in the number and volume of operations and the entry of activists as shareholders of well-known European companies such as Shell, Unilever and Vodafone, offer evidence of a broader phenomenon.
A major driver of activists’ investment decisions is the potential to improve the target firm’s operational profitability in a short period of time. Very often, activists also push the board to take decisions involving spin-offs, divestments and M&A. Activists often target conglomerates or very diversified companies made up of unrelated businesses. These moves can help unlock value in the target company by highlighting the unique potential of some individual businesses; or by combining those businesses with others through M&A deals to become larger and create scale economies.
Despite the increasing focus among investors and boards of directors on keeping companies simple and avoiding excessive diversification, the fact is that diversified groups exist. Some of them are true conglomerate groups: a combination of business units or different companies with very limited or zero synergies among them. General Electric, Siemens, ABB, and Sony, among many others, were examples of conglomerates whose boards and top management seemed at some point capable of managing different businesses effectively under the same umbrella. Most of those companies invested significantly in technology and were great innovators. Unfortunately, the magic was lost, innovation and profitability declined, and conglomerates fell out of fashion. The recent breakups of General Electric, Siemens and Thyssenkrupp provide good examples of investors shifting away from conglomerates.
But investors still love some conglomerates. It is relevant to bring to this discussion the fact that some of the new tech giants, such as Amazon, Facebook and Google, among others, are also conglomerates. It’s true that these are platforms that use digital technology extensively, which is the glue that keeps them together. But the nature of their different business units is quite diverse: online sales, digital advertising, search engines and cloud computing, among other business. Thus, it is not conglomerates themselves that are out of fashion among investors, but certain types of conglomerates, in particular, those associated with industries that have lost their shine, such as traditional capital goods, or oil and gas.
Boards of directors of companies with a certain level of diversification should have a clear understanding of why different business units are kept together and how the group’s structure really can help each business unit create value. Moreover, boards should engage in discussions about strategy, and own the strategy, in order to help develop the company in the long term. At the same time, boards should keep questioning themselves and the top management team about the basic principles of the firm’s strategy and business model: Why does this company exist? Which customers' needs is the firm trying to serve? What is the firm’s value proposition? How unique is this company? What is the business model and the organization of different activities? Does it have the capabilities and resources to execute the strategy? Is the leadership pipeline strong and the firm attractive for top professionals? Do the top management team and the board regularly explore new business ideas and initiatives?
Including debate about the firm’s strategy on the board’s agenda is not an easy process. Boards often lack the internal organization needed to do this effectively. And when they are able to do it, senior managers may think that the board is overstepping senior managers’ duties. Collaboration between the board and the top management team is indispensable for effective governance and, in particular, for constructive debate about the company’s strategy.
In this new wave of activism, boards would do well to examine how deep and meaningful their understanding and debate of the firm’s strategy is. Boards may signal that they are not doing their job well when outsiders – activist investors – discover better ways of creating long-term value than insiders, specifically, the board of directors and top management teams. Companies are vital social institutions and boards should help develop them for the long term through an effective strategy.
Jordi Canals
President, IESE Center for Corporate Governance
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