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Boards of Directors, Hedge Fund Activism and Strategic Decision Making
by Professor Margarethe Wiersema
An activist investor campaign is an unsolicited and unwelcome attempt by one of the company’s shareholders to influence the governance, financial, and/or strategic direction of the company in order to enhance shareholder value. Flush with cash, activist investors are rattling CEOs and boardrooms of companies globally. In 2020 activist investors deployed more than $40 billion in capital globally and initiated approximately 180 campaigns against publicly traded companies (Lazard, 2021). Activist investors target companies and take an ownership position with the intent to make a gain on their investment by making demands of management and the board to improve shareholder value.
Before launching a campaign, activist investors conduct extensive research on the company, including consulting with industry experts and former executives. They express their concerns and demands in their letters to the board and management as indicated in Elliott’s letter to GSK: “Despite possessing strong businesses in attractive markets, GSK has failed to capture business opportunities due to years of under-management. GSK has a substantial value creation opportunity: We believe there is significantly more value to be realized at GSK with superior execution”. They can also be highly critical of the firm’s governance, as in Daniel Loeb’s scathing remarks about Intel’s board: “… we cannot fathom how the boards who presided over Intel’s decline could have permitted management to fritter away the Company’s leading market position while simultaneously rewarding them handsomely with extravagant compensation packages; stakeholders will no longer tolerate such apparent abdications of duty”. Clearly, activist campaigns raise not only concerns regarding the performance of the CEO but also render a critical assessment of the board as an internal monitor of management.
Given their small ownership stakes and lacking control, activist investors must rely on communication and persuasion to convince the boards and management of the companies they target that their proposals are valid and at the same time they must obtain support from the company’s institutional investors. They can make a compelling case they are shareholder focused, as illustrated in Third Point’s letter to investors: “Nestlé, with an over $250 billion market capitalization, is the largest food business in the world and home to some of the world’s greatest brands. However, despite having arguably the best positioned portfolio in the consumer-packaged goods industry, Nestlé shares have significantly underperformed most of their peers on a three-year, five-year, and ten-year total shareholder return basis. Third Point intends to play a constructive role to encourage management to pursue change with a greater sense of urgency”. Activism has changed the relationship between companies and their shareholders in that management can no longer rely on the unconditional support of their institutional investors. Despite voting with management on most shareholder proposals, institutional investors are increasingly willing to side with activist investors. For example, with just a 0.02% share position, Engine No. 1 launched a proxy fight for board representation at ExxonMobil and succeeded at gaining board seats due to the support of the company’s investors including the Big 3 index funds (e.g., BlackRock, State Street, and Vanguard). Institutional investors may also instigate an activist campaign by issuing a request for activist, known as an RFA, a sure sign they also have concerns over shareholder value. In addition to the company’s shareholders, activist investors may engage in discussions with specific board directors to elicit support for their campaigns. Ultimately, an activist campaign is a negotiation between the activist investor and management and the board, but its outcome is highly dependent on the perception of the company’s shareholders towards the campaign.
Activist investors have approached more than 45% of the S&P 500 and are increasingly targeting companies in Europe and Asia. This is a wake-up call for boards in that activists’ primary concerns are whether the governance and strategy of the company is optimizing shareholder value or destroying it. Boards must become more pro-active and realize that sooner or later they are likely to get an activist “knocking” on the door. The best defense is for boards to focus on the company’s strategy and to ask the same hard questions about shareholder value as activists do. What are the key resources/capabilities that drive performance in the industry and is management making the requisite investments to be competitive in the marketplace? This is clearly an issue in many of the campaigns initiated by activist investors, where companies were targeted because of their deteriorating competitive position.
A thorough examination of the company’s business portfolio is also called for to avoid value destroying acquisitions and to be more proactive in divesting business units. Many activist campaigns have targeted companies where value can be unlocked by splitting up business or divesting business units. This is a classic case where the sum of the parts is worth more than the company as a whole. These re-assessments of competitive and corporate strategy call for boards with the requisite talent in strategic thinking to incorporate the demands and challenges posed by foreign competition, global supply chains, digital technologies, and environmental concerns. Boards must be more critical of their own skill set and whether, in total, they possess the necessary competencies to provide the guidance and oversight that activist investors look for. Thus, activist campaigns have placed intense pressure on boards to raise their game when it comes to engaging strategically with management on value creation. Anything less invites an unwelcome visitor.
Margarethe Wiersema
Dean’s Professorship in Strategic Management
University of California, Irvine
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*Prof. Margarethe Wiersema spoke at the last IESE - ECGI Corporate Governance Conference celebrated in October 2021.
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