Shareholder activists seek to effect change at public companies in a manner aimed at increasing the value of the companies in which they invest. While a company’s management team is responsible for running such company’s day-to-day business, the company’s board of directors provides oversight and is ultimately accountable to the shareholders for the decisions made by the company. The well-worn idiom “The buck stops here” fairly summarizes the nature of a board’s ultimate responsibility. As such, the only way that a shareholder activist can truly effect meaningful change is at the board level, and specifically, by electing new directors to a company’s board. Usually, a company targeted by a shareholder activist has some underlying problem(s) that are negatively impacting the company’s valuation which, given the board’s sweeping responsibilities, must ultimately be placed at the feet of the board.
The vast majority of commentary voiced by shareholder activists, which is often aided by detailed presentation material, is on a company-specific basis as the activist seeks to address the underlying problems impacting the company’s valuation and elicit support from other shareholders. There has been much less commentary, however, seeking to address the frequently-seen, endemic issues that can interfere with the overall investment practice of shareholder activism, and it must be noted that any impediment to activism can reduce the ability of all shareholders to effectively address company problems.
To put it another way, the activists have been very good in terms of pointing out the trees, but they have not spent much time pointing out the forest, or more precisely, the factors that enable many trees in the forest to proliferate. Contrast this with the efforts of publicly-traded companies and the many paid professionals defending these companies against activists, as there is an abundance of critical, fear-inducing material warning about the perceived “dangers” of shareholder activism and the need to take preemptive moves to counter any activist threat, real or imagined.
The “Poison Pillars”
Against the backdrop of this informationally-skewed playing field, those who have seen the recent articles written by this author (me) may have noticed that each of the last four articles seeks to address a specific issue that very frequently arises in the context of a shareholder activist campaign yet often goes un-mentioned and/or un-examined. Mixing metaphors and invoking “the defense rests” as a phrase, companies seeking to fend off shareholder activists often rest their defense upon one or more of four “poison pillars” that are employed; or, if a pillar was a structure in a metaphorical obstacle course, these four “poison pillars” are frequently-encountered barriers that serve to obstruct the efforts of shareholder activists to effect change.
While the poison pill was an innovative legal defense conceived in 1982 to prevent companies from falling victim to predatory hostile bids mounted by the corporate raiders of that era, these poison pillars are less formalistic, yet more insidious in certain ways. While a poison pill, which is formally known as a shareholder rights plan, is a technically complex legal document that a company can implement to prevent an acquiror from buying more than a limited amount of stock, these poison pillars are not formalistic documents but amorphous constraints and often cynical gambits that a company employs when the target of a shareholder activist.
Distilled to their very essence, these poison pillars are designed to maintain the status quo of a company’s board of directors. Meaning, when companies spend millions of dollars defending against an activist, what they’re really doing is spending this money solely in an effort to keep all of the director candidates proposed by the activist from being elected to the board. More often than not, these companies rely on some combination of one or more of the following four poison pillars to aid in such effort:
Selective Definition of the “Long-Term”
Companies and their boards of directors often espouse their concern for the “long-term” when defending a poor track record and commonly seek to portray activists as “short-term” oriented, yet conveniently ignore the fact that several directors on a company’s board, who may have presided over poor results for several years and thus a period already approaching the “long-term,” have amassed significant compensation along the way. Shareholders, however, have often suffered from an underperforming stock price in such situations and have not fared nearly as well over this same period.
Reliance on Questionably “Independent” Directors
Companies use the incredibly broad, and forgiving, definition of an “independent” director as set forth by the New York Stock Exchange and Nasdaq to claim their board is independent, yet quite often some of these “independent” directors are not impartial and may have varying degrees of inherent bias due to some connection to the company’s CEO or other directors.
Reflexive Addition of New Directors
Rather than add director candidates proposed by an activist that may have a better background and skill set, companies often reflexively add their own, hand-picked new directors to the board shortly after an activist shows up, thus giving the cosmetic appearance that the company is upholding high standards of governance by “refreshing” its board.
Weaponization of Company Money
Companies can spend a nearly-unlimited amount of their existing cash to “defend” themselves against activists, yet often forget that the company’s owners are its shareholders, and thus, the company is using its owners’ money against the activist, who is itself an owner and fellow shareholder. Or, more to the point, the existing directors are spending the shareholders’ money solely in service of defending their existing jobs.
Keep in Mind: Poison Pillars Exist by Choice of a Company
While admittedly reductive, the above four poison pillars are encountered time and time again, and what makes them merit particular attention is the fact that each poison pillar exists solely because of actions taken by a company and its board of directors. That is, while there are impediments to shareholder activism that may result from organizational documents sanctioned by state law (e.g. corporate bylaws, articles of incorporation) and industry trends that may serve to impact effective shareholder activism (e.g., the consolidation of voting power in the hands of passive index funds, the significant influence of proxy advisory firms), these poison pillars are not the result of market-wide structural factors but exist wholly by choice of a company.
These Impediments Can Harm Many Shareholders
The adverse effect that these poison pillars may have on shareholder activism can negatively impact a broad spectrum of investors. For all the efforts that traditional institutional investors (read: mutual funds) have devoted to corporate engagement and the recent success that some of these investors have witnessed in terms of influencing corporate behavior related to environmental and social policies (the “E” and “S” of ESG), the vast majority of investors who have been successful in effecting meaningful change at the board level have been shareholder activist firms, the preponderance of which are hedge fund organizations.
In contrast to these activist-oriented hedge funds who are conducting most of the proxy campaigns seeking to effect boardroom change, a vanishingly small number of mutual funds have initiated proxy contests for the purpose of electing new board members. As noted above, the “buck stops” with the board, and the board is ultimately responsible for the decisions made by a company, so traditional institutional investors/mutual funds need to realize that any impediment to the practice of shareholder activism serves to impede the only means by which shareholders can ultimately effect true, meaningful change.
When one considers the many people in the United States who have their savings invested in the public market (according to the Investment Company Institute (ICI), there were over 115 million individuals in the United States that owned mutual funds in 2022), this country’s institutional shareholders, who owe a responsibility to the people whose money they manage, as well as the corporate governance and investor stewardship solutions providers such as Institutional Shareholder Services (ISS) and Glass Lewis, who provide voting recommendations that carry so much weight, need to have a heightened awareness of these poison pillars and should not be swayed by the cynical impediments to shareholder activism.