What CFOs may consider “bullying” by activist shareholders could also be viewed as helpful advice for improving a company.
Says who? Admittedly, it’s an interested party: Christopher Davis, head of the investor activism group at law firm Kleinberg Kaplan. He exclusively represents activists, mostly hedge funds but also some wealthy individual investors.
Company executives may be understandably defensive or otherwise react emotionally when their business models, strategies, or plans are questioned or criticized. Such a reaction intensifies when there’s a threat, or a perceived one, that an activist may try to wrest board seats or even control over the company from the incumbents.
But, says Davis, keeping a cool head can only help officials of a company targeted by an activist.
He recalls, for example, during a first call with an activist, a CFO charging that the activist was “sort of a nobody.”
“That’s really not a good strategy,” says Davis, “especially because [the CFO] didn’t understand that he was hearing a viewpoint that other, much larger shareholders shared.”
It works both ways, he acknowledges, noting that lawyers who represent companies commonly lament that the first approach from activists is often unfriendly and nonconstructive.
Still, according to Davis, it’s important for CFOs and CEOs to understand, when dealing with activists, that they “can’t just go through the motions.” He says, “An investor can tell quickly whether an executive he or she is talking to is open-minded and doesn’t care where a good idea is coming from.”
Instead, executives may be “wound up by PR folks, lawyers, and bankers to create a perfect record, even though there’s no intention to engage in change,” Davis says.
By “a perfect record,” he means establishing a record of engagement and repeated contacts with the investor so that those outside advisers can tout that record in any subsequent proxy campaign by the investor.
“It comes down to a matter of intent,” says Davis. “Sometimes an activist gets the unmistakable impression of being subjected to a messaging exercise. On the other hand, when company representatives enter discussions committed to doing what is best for shareholders regardless of the source of the ideas, the outcome is usually more positive than where there is deep distrust of the investor or an inflexible commitment to the status quo.”
Such talk, though, underscores why relations between activist shareholders and company executives often feature a contest of wills. Is it up to the company to be unilaterally flexible, or is flexibility a virtue for an activist as well? Is it possible for a company to be rightfully protective of its strategies and plans, or is the activist always right?
Indeed, it’s not hard to understand why company executives may find activists to be annoying at best, and dangerously threatening at worst.
Explaining why he thinks activist shareholders can be helpful to companies and CFOs, Davis notes that “just as a matter of human nature, it’s typical for people to be more accountable when someone is watching over their shoulder.”
Unquestionably true. At the same time, companies are subject to a litany of securities laws and regulations that are designed to protect investors’ interests. What level of additional oversight is practical?
Davis also notes that “a sophisticated activist may have resources, information, and data in their quiver that may not be immediately available to a CFO and may help to provide some insight.”
Also true. Companies generally don’t know everything about everything that could affect their business. But talk about human nature — “We know more about your business than you do” is typically received with about the same warmth as being told how to raise your kids.
Notwithstanding such counter-perspectives, companies are, of course, owned by shareholders. If an activist can drum up enough support from other shareholders, a company can be effectively forced into an alternative course of action.
What activist shareholders push for is changing, according to Davis. Requests to return more excess cash to shareholders are waning, while activism is more often aimed at influencing operational or strategic issues. Such efforts often take a long-term view, winning strong support from index-fund investors.
Indeed, the increasing popularity of index funds is part of what’s driving the change in mix of activist campaigns. Index-fund investors tend to disfavor activism that results in the return of capital to investors. Because the funds have to hold a position in an index stock as long as the stock remains publicly held, they can’t take the money, show a spike in returns for the position, and sell out.
“The fact that such activity may result in a positive effect on the stock for several years matters little when you think in indefinite time horizons,” Davis says.
Instead, index investors look favorably on operational activism that can lead to business and financial improvements of extended duration, he notes.
They also favor activism that results in a company being sold and delisted, as that both helps the fund’s performance and allows an index fund to exit its position in the company’s stock.
Activist shareholders are also highly focused these days on diversity on boards of directors — gender, racial, and to a lesser extent age diversity. It’s an important issue for many institutional investors, and different viewpoints and experiences are increasingly seen as catalysts for fresh ideas, notes Davis.
Companies also become targets when they announce deals that activists may think are undervalued or poorly thought-out from a strategic standpoint. Conversely, activists may favor deals involving good companies that would benefit from being acquired or forming key strategic partnerships.
Davis says companies that are bringing in a new CFO stand to benefit if they add experience in engaging with activist shareholders to their list of criteria for the job.
“A CFO who has flourished in previous activist situations can effectively deliver an instant shot of credibility for a company during a period when a misstep could stress the relationship with an activist,” he says.