No Fox in the Henhouse: Direct Shareholder Board Representation Matters
By Peter Carlin, Contributing Author/ April 17, 2023
Peter Carlin is a Senior Analyst with Saddle Point Management, L.P., a private investment firm. Prior to joining Saddle Point, Peter was a professional investor and served as Managing Director at Blue Harbor Group from 2014 to 2020.
Prior to Blue Harbor Group, he was a Managing Member of Estekene Capital from 2009 to 2013. Carlin was also a Deputy Portfolio Manager at Alson Capital, where he worked from 2002 to 2009, and at Sanford Bernstein & Co., where he was a Buyside Research Analyst from 2000 to 2002. Peter began his career at Morgan Stanley in the Mergers & Acquisitions Group.
Peter also served as a director and a member of the Audit Committee, Nominating and Governance Committee and Risk Oversight Committee of Investors Bancorp, Inc., from 2017 to 2019.
Peter currently serves as a member of the Board of Directors at Adient, PLC where he is on the Human Capital and Compensation Committee and the Governance Committee.
He earned his MBA from Columbia Business School, a JD from Columbia Law School, and a BA from the University of Pennsylvania.
Professional, Experienced Investors
It is time for America’s corporate boards to invite professional investors into the boardroom. This collaboration will provide a wide variety of benefits for American corporations, workers and investors. Investors bring different skill sets and perspectives relative to the predominantly corporate executives, academics and retired government officials that, today, constitute the overwhelming majority of US corporate directors. Thus far most professional investors have joined corporate boards through activism, pre-IPO investments or private equity buyouts.
It’s time that boards themselves take steps to actively recruit experienced investors for corporate boards, thus bringing the voice of shareholders directly into the room where it happens.
Loss of Shareholder Voice
In 2022 only 5% of new S&P 500 directors were professional investors.
This category encompasses venture investors, private equity professionals and retired executives now turned to investing as a profession. What this suggests is that actual investors focused on public markets occupy an even smaller percentage of seats. The current situation has resulted in the near total loss of the shareholder voice in corporate boardrooms.
While the presence of experienced corporate executives and operators is of great utility to companies and boards, the pendulum has swung too far at the expense of the shareholder voice. According to PwC’s 2022 Annual Corporate Directors survey, 42% of board members don’t believe there should be contact between shareholders and non-management directors. Boards’ primary duty is to represent the interests of shareholders with a dedication to employee, customer and community well-being.
Why then are members of the primary constituency only a small fraction of board members and why do boards of directors shun the idea of putting investors on their boards?
Cultural Calcification: Challenging the Status Quo
Some of it just comes down to sticking with what you know. Most corporate executives spend most of their professional careers working their way up corporate ranks until they reach business unit or c-suite executive level positions. Sometimes they become CEOs or CFOs whose jobs require them to interface regularly with shareholders. But the vast majority of corporate executives rarely spend time with shareholders and infrequently hear candid feedback or investor perspectives other than through the capable lens of investor relations departments.
Most corporate executives thus have few relationships with professional investors and little experience with the shareholder perspective.
Investor relations executives are great conduits and can convey some of the shareholder perspectives, but it must be noted that these IR executives are still part of corporate management and report to senior level executives, not the board. It is natural that executives would choose to surround themselves with those individuals whose experience most closely resembles their own, and whose skills seem most useful to them in the context of running a company.
Boards and CEOs who choose new director nominees naturally gravitate to other corporate executives out of habit.
Boards Are Missing Important Perspectives
Investors however have a lot to offer to boards. Professional investors research companies and industries for a living. They regularly compare companies to their peers from a financial, operational and strategic perspective. Investors generally have deep knowledge of multiple industries and do extensive primary research on competitive strengths and weaknesses, industry outlooks and macroeconomic conditions.
Capital allocation is a crucial board responsibility.
This is what professional shareholders do for a living. Most investors have significant experience analyzing corporate capital allocation decisions. Most importantly they often interface with other investors and can funnel the perspective of the shareholder community back to management and the board, while maintaining the confidentiality of the company’s information. Professional investors provide a perspective on company operations and strategy additive to that conveyed by management. Many of these skills are accretive to those resident amongst board members with corporate management backgrounds.
Professional investors know how to read and analyze publicly reported financial information and are often versed in many components of ESG. Professional investors can share with boards the fruits of the resources investors use that are typically not available to retired corporate executives.
A Seat at the Table
At my former firm, Blue Harbour Group, we frequently collaborated with boards and management teams to drive increases in enterprise value. We did this by heavily researching the companies and industries where we invested and frequently shared with boards and management teams what we learned. We found many executives and board members who were open to these dialogues and accepted the notion that shareholders deserve a seat at the table.
Finally, we offered the tangible benefit to boards of assuring other investors that their voice would be heard in the boardroom, thus often obviating the need for hostile activism and increasing the level of communication between boards and shareholders. By demonstrating that we could add value and that our interests were aligned we were able to add constructive shareholder perspective and resources to the boardroom.
My current firm, Saddle Point Management, along with many other institutional investment firms, follow a similar strategy of partnering with management teams and boards to drive improved performance. But we frequently run into boards and management teams that have no interest in bringing us into the tent.
Why do most boards and management teams resist our efforts to participate in the conversation and what is the downside of adding professional investors to the boardroom?
Diversity of Thought and Experience
Sometimes they don’t like our ideas. Based on my experience in boardrooms, consensus isn’t immediately reached on any topic. Healthy boards should entertain ideas from shareholders, board members, managers and other constituencies, and engage in healthy debate on their merits as a group.
Often there isn’t universal agreement.
That doesn’t mean that boards should reject the advocates of ideas they don’t immediately like. Instead they should seek out a diversity of thought and experience to enhance the debate and let the group decide what’s best for the corporation. Boards would benefit from having those shareholders at the table to advocate for their ideas. Shareholders and other investors actually do sometimes have good ideas that can create value if adopted in whole or in part. This is particularly true for the 50% of companies that underperform their peers.
Bull and Bear Cases
Many opponents of shareholders in the boardroom will say that individual professional investors don’t perfectly represent the diverse set of ideas and opinions held by all of their shareholders. This is true, though investors are typically well versed in understanding both bull and bear cases for industries and companies and can partner with investor relations professionals to hear all investor perspectives. Professional investors talk to and read research from professional equity research analysts with diverse opinions and who maintain relationships with a variety of institutional investors.
Investors on boards may also be able to garner more open feedback from shareholders frequently reluctant to voice their true opinions to management teams for fear of losing access.
Another Voice to the Mix
I am not advocating for replacing the entire makeup of corporate boards.
Experienced and qualified managers, lawyers, accountants, academics and bankers bring a lot to the board table. However, doubling the number of professional investors on corporate boards still implies only 10% of directors. One or two shareholder representatives on corporate boards will only add another voice to the mix, not radically change the current profile.
Difficulty of Recruiting
Another objection to investors as board members may be the difficulty of recruiting shareholders and professional investors to public company boards due to time commitment, liquidity restrictions and information constraints. Ultimately it will be up to investors to decide if these restrictions are too onerous at companies where they are currently invested or where they contemplate investing. The best alternative where no existing shareholder steps up is to choose investors who aren’t current shareholders and therefore won’t be making the same sacrifices.
The Same Alignment of Interests
An interested investor/board member can rapidly apply the resources of investment management to benefit the board even if their employer isn’t a shareholder. This outcome also solves one of the other challenges that boards and management teams frequently use to reject investors as board members; time horizon.
Boards and management teams frequently use a broad brush to paint all shareholders as short term oriented. There are many investors with long time horizons who would love nothing better than finding a company with great prospects that they could invest with for years. Even if shareholder/board members eventually sell some or all of their stakes, does this make them any less qualified to serve on boards? Executives and board members frequently sell large portions of their ownership interests in the companies where they serve. Are they no longer qualified to serve on the board? Most boards today have ownership requirements for their directors and officers. This would naturally apply to investor/board members, thus maintaining the same alignment of interests with shareholders.
Legal Protections
Finally, many legal protections exist to protect shareholders from the interests of one.
Aside from the fact that the vast majority of board members will not hail from one investment firm, other legal protections include the many prohibitions on trading on inside information and self-dealing codified in federal securities and state corporate laws as well as the many legal opinions exploring the topic. Instructively many current investors on boards hail from VC or PE firms with ownership stakes. In most cases these firms have successfully navigated share ownership and board membership without problems.
Time for Change
According to Willis Towers Watson’s 2022 Board Index, out of 395 new directors appointed to S&P 500 boards in 2022, 5.5%, or 22 were professional investors. 284 of 395 (72%) new S&P500 directors were active or retired corporate executives.
It’s time to tilt these numbers towards more shareholder representation. Increased shareholder representation in boardrooms achieved through a collaborative mentality and at the behest of boards themselves will reduce the often discussed agency problem endemic to the governance structure of public companies.
Adding more investor perspective to boards will diversify board skill sets and perspective, increase shareholder representation at the board level and will help companies achieve optimal performance.