Shareholder activism will undergo a global evolution in 2017. A steady increase in public proxy fights and activist campaigns, combined with a volatile political atmosphere are creating a new world of investment strategy and investor-issuer relations, with particular emphasis on a heightened level of shareholder influence on companies.
U.S. companies, along with Canada, Australia and the U.K., remain at the highest level of activism threat, according to FTI Consulting. This is unsurprising, considering the U.S. has remained at the forefront of shareholder activism since the corporate raider era.
The beginnings of shareholder activism can be traced to the 1926 exposure of Northern Pipeline’s holdings. Professional investor Benjamin Graham realized that the company had the capacity to make a one-off payment of $90 per share to its shareholders (stock was trading at $65 at the time) without affecting its ongoing earnings. Northern Pipeline strategically held the annual shareholder meetings at an obscure off-site location and appointed an entirely employee-based board. Graham collaborated with other stakeholders to earn their proxy votes and the rest, as they say, is history. The full story is detailed in Jeff Gramm’s book, Chairman: Boardroom Battles and the Rise of Shareholder Activism.
“Shareholder activism is not a recent phenomenon,” Gramm writes. “But the last hundred years in America have been the most turbulent period for corporate oversight, marked by power struggles between management teams and shareholders that have culminated in an era of unprecedented shareholder power.”
As President Trump settles into his new role as Commander in Chief and continues developing relationships with his chosen advisors, the country with the highest number of activist campaigns may experience a shift in power away from the C-Suite and into the hands of investors. A shift in engagement standards and regulations are expected to further establish the U.S. as the frontrunner of activist activity.
Carl Icahn, one of the most prominent names in activism as the billionaire investor and chairman of Icahn Enterprises, has been named special adviser on overhauling regulations to Trump in an unofficial capacity. As an instrumental player in a variety of major industries, the number of potential conflicts of interest may be high, but it is his primary role as famed activist investor that draws wary eyes from major public companies.
“While Mr. Icahn was initially tapped by President Trump to advise him on the scaling back of excessive government regulation, there is always the possibility that the ‘grandfather’ of shareholder activism will also have the President’s ear when it comes to policies that could have an impact on activism,” Steve Wolosky, partner of Olshan Frome Wolosky LLP warns.
The SEC is also revisiting previous legislation, with the pending universal proxy proposal being “the most significant regulatory development relating to shareholder activism that we have seen in quite some time,” Wolosky says. The proposal would allow shareholders to “mix and match” their votes among all candidates proposed by either investors or management. “This is somewhat speculative,” Wolosky says, “but Carl Icahn could be the wild card in determining the fate of universal proxies as he is a staunch proponent of a universal proxy system.”
David A. Katz, partner at Wachtell, Lipton, Rosen & Katz, a firm specializing in M&A and takeover/activism defense, believes Icahn’s appointment will allow the environment to remain “largely pro-activist.”
“Unfortunately, with Carl Icahn as President Trump’s regulatory czar, there is likely to be little additional SEC regulation on activists,” he explains. “However, given the recent statements by important institutional investors such as Blackrock and State Street, companies should be less inclined to settle quickly with an activist; institutional investors appear to be pushing back on the number of settlements, especially where the settlement results in the activist going on the board.”
Considering Icahn’s career thus far being centered around aggressive investment tactics, we may bear witness to a changing of hands. He has spoken against overregulation and shareholders are going to quite literally begin controlling the board, deviating power from management directly to investors.
Issues for Issuers: What Management Can Expect
Trump’s transition team has focused on reducing federal regulation on the private sector, stating on the official White House website that they would like to maximize job growth and retention. “It is estimated that current overregulation is costing our economy as much as $2 trillion dollars a year,” Trump said in an August speech at the Detroit Economic Club during his campaign, citing a 2014 study by the National Association of Manufacturers.
One feared consequence of Trump’s incoming regulatory reform plans would be the possible repeal of the Dodd-Frank Wall Street Reform and Consumer Protection Act. This would undo the greater level of transparency for stakeholders initially enforced by President Barack Obama following the 2008 financial crisis. The enactment of Dodd-Frank may have given investors and boards a wealth of tools to create effective engagement, as I discussed in my October 2016 piece on the future of shareholder engagement, but there’s a delicate balance between exhaustive reporting and effective engagement.
Some would contend that heightened engagement practices may be deemed ineffective. Katz believes shareholder engagement is “important,” but “overemphasized.”
“If every public company insisted on engagement with their institutional shareholders, the institutions do not have sufficient resources to engage in a meaningful manner,” he says. “Instead, companies need to pursue targeted, focused engagement and use disclosure effectively to relieve the burden on both company and investor from overly (and unnecessarily) ambitious shareholder engagement programs.”
Paula Loop, leader of PwC’s Governance Insights Center, explains how companies may encourage interactive discussion so investors can raise any concern of perceived risk. “The true measure of a successful engagement effort is to gain valuable insights from your most influential investors and develop an effective plan to address their concerns.”
A study published in the Columbia Law Review states they found “no evidence” in activist targeted companies that the initial spike in stock prices were followed by abnormal negative returns in the long term. “To the contrary,” the report states, “the evidence is consistent with the initial spike reflecting correctly the intervention’s long-term consequences.”
While a report by SharkRepellent.net shows that 72% of activist targeted stocked increased in value three years after campaigns, Robert Jackson, Professor of Law and Director of the Program on Corporate Law & Policy at Columbia Law School, doesn’t see a definitive answer on the effectiveness of activist campaigns.
“While the weight of the evidence suggests that activism enhances, rather than destroys, long-term value, the question is far from resolved,” he says. “One recent study found that the short-term value increases associated with activists’ 13D filings are sustained over a period of several years. Another paper, however, has indicated that those findings may simply be the product of a selection effect—that is, that hedge funds are simply good at finding firms that will soon improve their operations and hence their value.”
According to Elliot Sloane, founder and advisor of Sloane & Company, while 2016 was considered a relatively challenging year for activists, there is still a significant number of activists who believe they may improve returns given the right targets. “We may even see several situations where an activist was willing to settle for a board seat or two last year or in 2015, but this season targets the company again if the performance hasn’t been there and they think more change is needed.”
While the second-round approach to activist campaigns may seem aggressive, Sloane’s colleague Dan Zacchei, managing director of Sloane & Company, believes we will also continue to see activists move toward more “constructive” engagement going into 2017. “That has been the trend for some time now, particularly when you talk about the largest, most well-known activists,” he explains. “But as dissidents continue to go down-market for low and mid-cap opportunities, you will still see a decent number of proxy fights that are publicly aggressive and far from friendly.”
Power Shift: What Investors Can Expect
What can passive shareholders expect from an activist infiltration in the coming year? That depends on several factors, some of which may be directly affected by the looming atmospheric shift for financial markets in the coming year, given the incoming presidency and Trump’s business-oriented cabinet.
There has been a long-running increase in the influence of large institutional investors, and going into 2017, that pattern is expected to continue. According to Katz, we can expect to see a loss of proxy advisory firm influence—gone are the days of shareholders “blindly following proxy advisory firms’ recommendations.
“The increasing concentration of share ownership in institutions is not a new phenomenon but one that has been steadily increasing over the last 20 years,” he explains. “What is new, however, is that many of these funds have taken the corporate governance and voting decisions back in-house instead of simply outsourcing their proxy voting decisions to proxy advisory firms such as ISS and Glass Lewis.”
The relative ease with which management and investors reach settlement has vastly increased between 2015 and 2016, according to Sullivan & Cromwell LLP’s 2016 U.S. Shareholder Activism Review and Analysis. Only 4% of 2016 activist campaigns took 6 months or more to reach settlement, a significantly lower number than 21% in 2015.
“I believe that activism, as practiced by experienced investors, has changed little over the past ten years,” James A. Mitarotonda, Chairman and CEO of Barington Capital Group says. “What I believe has changed is that institutional investors, as well as the marketplace as a whole, have become more receptive to the proposals of thoughtful activists and the positive contributions they can make.”
January 2017 has already seen a number of potential activist campaigns in the works. Earlier this month, animal rights campaign PETA bought shares in LVMH, owner of Louis Vuitton, Fendi, Christian Dior, Givenchy and other notable brands. They aim to put pressure on the luxury market conglomerate to stop production of exotic skin products.
Ethically motivated activist campaigns may see an increase in 2017—the emerging conscious consumer brought about by the Information Age, in which a company’s CSR statistics are merely a click away, continues to pick up speed. A 2015 report by Mintel shows that 56% of U.S. consumers stopped buying from companies they believed were unethical.
A number of companies have seen pressure from investors to curb excessive and/or irresponsible product use that may have a negative impact on the environment and consumer health. Green Century Capital Management, for example, incited Tyson Foods to invest in plant-based protein producer, Beyond Meat, and acted to have both Darden Restaurants, Inc. (owner of Olive Garden and LongHorn Steakhouse) and Jack in the Box, Inc. (owner of Jack in the Box and Qdoba Mexican Eats) curb their use of antibiotics in their meat supply chains.
While there’s been an increase in ethical investing, environmental concerns are still low on the agenda. Of the 354 proxy proposals filed in 2016 through the end of September, in Russell 3000 companies, 20 were calls for reports on climate change (earning only 27.9% average support). Only 17 proposals involved GHG emissions (averaging 26.1% support), and 14 called for reports on sustainability (averaging 32% support).
Catching a Glimpse: The Future of Shareholder Activism
Will we continue to see a rise in shareholder activism on a global scale? Wolosky believes so.
“While it is difficult to cite empirical evidence, it is becoming apparent that a steadily growing number of activists and other hedge funds are crowding the space and competing for the same perceived undervalued targets in the U.S.,” he explains. “As a result, activists are taking a closer look at potential activist plays in foreign jurisdictions.”
In the summer of 2016, 37 economic activist funds with combined assets under management of $153 billion participated in a survey commenting on predicted trends they expected to see develop over the next 12 months. According to the report, 97% of respondents believe that the U.S. will remain at the forefront of activist campaign activity. However, there was mixed opinion on whether activism is becoming crowded and targets increasingly hard to find.
Respondents were also asked to what extent they agreed with the following statement:
“Activism is becoming crowded in the U.S. and targets are becoming increasingly hard to find.” While 33% agreed to some extent, 39% disagreed or strongly disagreed.
When asked whether they expected to see any change in volume of activist campaigns going into 2017, almost three times as many activist investors believed campaigns would “somewhat increase” than those that believe campaigns will “somewhat decrease” (12% of those surveyed voted the latter).
As far as settlement patterns are concerned, we may see an ease between activist investor and management relations. Compared to previous years, the majority of activists (54%) believe it will be somewhat less difficult for activist investors to reach settlements with managements teams.
The outcomes of future campaigns will ride on the intent of the activist, Katz says—whether they’re disruptive short-term oriented or constructive investors looking to produce long-term returns.
“Activists who join boards simply to provide a disruptive influence are often successful at being disruptive, but it is far from clear that this approach ultimately benefits all shareholders,” he says. “Constructive activists are active, engaged board members who work within the current system and challenge their fellow board members and management to do better than the status quo. They are also willing to be long-term investors, which tends to better align their interests with those of other stockholders.”
Christopher P. Skroupa is the founder and CEO of Skytop Strategies, a global organizer of conferences.