They’re a rising, but natural target for the shareholder activist. CEOs are catching the eyes of activists because, in simple terms, activists are recognizing that they’re sometimes an easy target.
We spoke with Richard Grossman, a partner at Skadden, who focuses his practice on proxy contests, responses to shareholder activists, corporate governance matters, mergers & acquisitions and leveraged buyouts.
Christopher P. Skroupa: Why have shareholder activists been targeting CEOs?
Rich Grossman: CEOs are something of a natural target in an activist campaign. If a company is being targeted, the activist is likely unhappy with the performance of the company and, as the face and voice of the company, the CEO potentially becomes a natural target. What we’re now seeing, with increasing frequency, is the targeting of CEOs as part of a proxy contest to remove a minority of a company’s board of directors. Activists often seek minority seats on a board, in part because it’s somewhat easier to do under a bifurcated ISS standard for how they view and make recommendations in election contests.
Under the current ISS analytical framework, recommendations are made depending on whether the dissident is seeking a minority or a majority position on the board, with the standard for a dissident seeking minority representation being significantly easier to meet than if control is sought. The ISS minority contest standard — what I’ll call the “what’s the harm” standard — for replacing directors seems to apply regardless of whether the CEO is targeted. I think activists have realized that, and are pursuing minority contests, under the lower framework, to target CEOs.
While the shareholders pride themselves on making their own decisions, and a lot of the index funds have their own governance groups and their own processes for determining a vote in a contest, the fact remains that ISS still wields influence in election contests. ISS has said that it does factor in whether a CEO is part of the short slate of targeted directors in a proxy contest, but their current formal policies don’t make that distinction.
Skroupa: What is the impact of removing the CEO?
Grossman: I think most practitioners and governance experts would agree that one of the most important responsibilities of a board is the selection of the CEO, and the removal of the CEO from the board sends a very strong message, especially a board made up of a majority of independent directors.
While shareholders do not have the right to directly remove board-selected officers, if a CEO gets removed from the board in a contest, it’s a vote of no confidence. In those circumstances, I can’t imagine a board not looking at the situation and saying, “should we rethink our decision regarding the CEO?” It certainly makes for an awkward situation.
In the event of a CEO’s removal, the board obviously would still need to invite the CEO and management to board meetings in order to obtain any pertinent company information. It doesn’t, and won’t, totally eliminate the flow of information, but it’s a less than ideal situation if the CEO is not on the board.
For this reason, it’s very rare to see a public company for which the CEO is not on the board. Even when you have situations where the company replaces a CEO, they almost universally place the new CEO on the board even if they don’t make him or her the chairman immediately.
Skroupa: How did CEOs originally catch the eye of the activist? Why is this trend rising?
Grossman: I think the trend is rising because activists are discovering that it’s not entirely difficult under the ISS framework to throw out the CEO. They also realize that if the shareholders don’t necessarily agree with this tactic, they can vote for other candidates, or maybe not vote for all of the activists’ candidates.
There are different situations where this arises. Sometimes the activist will have a CEO in waiting, someone they’ve identified, and sometimes they won’t. So each situation is different in that regard. I do think that the activists have realized that if they’re challenging the company and their performance, it’s just a natural outgrowth to challenge the CEO.
If you look at the data, it shows that companies that have been subject to an activist campaign have an inordinate amount of CEOs who end up being replaced, regardless of whether the board or the activists won the original campaign, or if there was a settlement. It may not be an immediate change in leadership, but many of these companies are making changes not long after being targeted by an activist. I think CEOs certainly are vulnerable, and are going to continue to be vulnerable, if activists are targeting companies over their performance.
Skroupa: How do you see this trend evolving in the next three to five years?
Grossman: I think activists’ targeting of CEOs is a trend that is not going away. I do believe we may see fewer attempts if ISS adopts an intermediate standard for minority campaigns that target CEOs, but I do not think they would ever be completely eliminated. ISS should require a higher hurdle for the activist when they are going after the heart of the company. The CEO can’t be viewed as just another director at the company.
Skroupa: Since your article Queen of Hearts or Ace in the Hole was published, we saw that ISS released a research note talking about its approach to CEOs as activist targets. Has this response changed your viewpoint at all?
Grossman: I appreciate that ISS has made clear that it takes into consideration CEOs as dissident targets regardless of whether it is as part of a minority or majority position on the board. I still believe companies, shareholders and activists would benefit from further transparency from ISS concerning how it evaluates short-slate campaigns targeting CEOs for board removal. I continue to believe that a more formal intermediate framework requiring an activist to lay out, at least in large part, its rationale for change from the status quo and vision for the company’s future would be appropriate.