Activist investors have learned that pressure tactics sometimes work. That’s just one reason for the increased pressure on corporate executives and board directors, which is compounded by scrutiny by regulatory authorities. According to the Harvard Law School Forum on Corporate Governance and Financial Regulation, there were 268 activist campaigns in 2018, which was a 5.5% increase from the prior year, as reported by the law firm Wachtell, Lipton, Rosen & Katz. The firm also reported that assets under management at activist funds were 50% higher. While these numbers represent a fraction of the total US value of stocks, it demonstrates the power of investor pressure.
Failures of the recent past have shifted the focus from long-term results in favor of proving short-term gains. As the economy begins to improve, corporations are on a mission to demonstrate that they can produce long-term returns.
Signs of a Shift in the Indicators of Good Corporate Performance
Research points to the notion that getting back to the basics of good governance is more of an indicator of long-term performance than experimenting with financial moves that yield good short-term results with little or no accounting for long-term results. A recent Business Roundtable discussion yielded a groundbreaking public statement that concurs with research that indicates that positive long-term performance is a result of good governance.
The statement highlighted five principles of good governance that commit to the best interests of all shareholders and stakeholders. The five principles include:
- Delivering value to customers
- Investing in employees
- Dealing fairly and ethically with suppliers
- Supporting the communities where companies work
- Generating long-term value for shareholders
While the marketplace is gaining clarity as to the connection between good governance and profitability, boards may need to shift their focus on creating transparency to shareholders around their approach to board effectiveness and their commitment to good governance practices.
Examples from the Markets on Demonstrating Board Effectiveness
As detailed in a Harvard Business Review article, former IBM CEO Sam Palmisano explained how he was able to gain the trust of major investors with his plan for a new strategic model that was tied to long-term gains. Palmisano now spends his time coaching CEOs and is the founder of a nonprofit called the Center for Global Enterprise, which is devoted to the study of the contemporary corporation. Palmisano also serves on the board of directors for Exxon Mobil.
During the interview, Palmisano expressed his annoyance about the heavy focus on quarterly earnings, which he felt weren’t a true indication of the company’s performance. He also expressed frustration with the fact that missing a target by a fraction could unfairly cause stocks to drop by 4–8%.
Rather than wait for an activist attack, Palmisano engages with investors to better understand how to give them transparency. He came up with a new strategy that brought in all the units of the company and released results only once a year. His strategy eventually proved successful, ultimately increasing earnings from $6 to $10 per share by 2010. The shareholders were initially skeptical, but by tying the model to long-term compensation, the strategy worked.
Palmisano coaches CEOs to listen to shareholders, come to an agreement on what they can measure your performance against, and then deliver. He notes that it takes time and communication to figure that out.
PepsiCo’s CEO Indra Nooyi’s approach is to decide on a clear strategic focus and stick to it. After her appointment to the company, she became concerned about PepsiCo’s products and the impact of their connection to long-term health trends like obesity and Type 2 diabetes. She set a new strategy to shift consumer demand to more healthful foods and beverages like Quaker Oats and Gatorade. That approach, combined with product innovations and emerging markets, became the company’s new strategy. PepsiCo subsequently acquired a number of food and beverage companies in emerging economies, like Brazil, India, Russia and Ukraine.
Nooyi acknowledged that there were a few bumps in the road, but by educating herself on investor tactics and being prepared, she eventually brought long-term gains to her company.
The Role of Modern Governance and Board Effectiveness
As Sam Palmisano noted, to be effective, managers and boards need to take stock of the long-term interests of the company, and those interests should align closely with those of the shareholders. The board’s strategy needs to focus on the issues that lead to long-term success, which, in the modern marketplace, is governance. The best defense against investor activism is consistent performance; anything else makes the company vulnerable.
The challenge this presents for boards is to get the right information at the right time so they can make decisions that provide new solutions to the issues that cause investor activism. A modern governance approach lends itself to increased shareholder engagement and the type of collaboration that assures investors of transparency. With the new spotlight on good governance, boards need digital solutions that provide them with data and analytics that support their efforts in identifying opportunities to improve board effectiveness and set the stage for long-term success. Being able to access the same information that proxy advisors and shareholders rely on gives boards common ground to initiate productive shareholder discussions.
Diligent Corporation has brought digitization into the modern boardroom with a suite of highly secure, fully integrated products that support good governance. Diligent Boards and the digital solutions that compose Governance Cloud place contemporary solutions at every board director’s fingertips.
Diligent Nominations is a tool that is particularly helpful for the effectiveness of board composition and board succession planning. The tool brings over 125,000 profiles of board directors and executives as collected from over 5,500 companies in 24 markets and 40 indexes. Nominating committees can rely on this tool to recruit top talent to strengthen board composition. Granular filters make quick work of sorting candidates by experience, demographics, region, sector and discipline. Also, the tool helps boards address investor concerns like director interlocks and overboarding.
In his advice about activist investors, Warren Buffett offered professional counsel by telling them to remember that they have a fiduciary duty to the company and all its shareholders, not just the most meddlesome ones, and that they should work to ensure the long-term viability of the company’s mission and strategy. Diligent tools make it easy to put that advice into practice.