United States: Thwarting Shareholder Activism Through Engagement

Last Updated: May 30 2017
Article by R. Douglas Harmon

As the 2017 proxy season draws to a close for most companies, it is obvious that shareholder activism remains alive and well, though the actual number of public activist campaigns appears to have tapered off slightly as compared to recent years. Activism takes many forms, ranging from takeover proxy battles to proxy access proposals to single-issue social welfare proposals. Particularly noteworthy is an apparent trend among institutional investors to target small and mid-size companies, perhaps believing (perhaps correctly) that these companies are ill-prepared to resist their forays.

Companies have a wide array of defensive techniques at their disposal, depending on the nature of the activist's approach, one of which is effective shareholder engagement. The good news is that more and more institutions are welcoming, and even encouraging, engagement with their portfolio companies. And while small and mid-size companies still sometimes struggle to get the attention of major institutions, this has become less problematic now that shareholder engagement is standard practice in corporate America.

Although many of the governance benefits of shareholder engagement are widely known, often overlooked is its ability to thwart shareholder activism. Better communication between the company and its major shareholders reduces misunderstandings about management's strategy or the reasons behind its latest moves. Misunderstandings, in turn, may lead to activism, or a willingness to side with activists. Strong relationships with traditionally non-activist institutional shareholders (by far the larger percentage) have the ability to actually deter activist behavior before it even happens, or to nip it before it gains too much momentum.

For example, many activist shareholders own a relatively small percentage of the target company, particularly as compared to the well-known institutional behemoths. Therefore, the success of an activist's initiative will depend, in part, on its ability to enlist the backing of multiple institutional shareholders. If it is obvious that the target company has open lines of communication with, and the general support of, its major shareholders, an activist is less likely to spend much energy launching a major campaign. Even social welfare proposals are less likely if an activist feels that they will fall largely on deaf ears. Furthermore, the influence of shareholder advisory services (SASs) continues to wane as companies have become more proactive in addressing SAS hot buttons and institutional shareholders have realized that SAS methodologies are not infallible.

The summer months are an excellent time to plan an effective shareholder engagement strategy for the fall. Most companies are fresh off of evaluating governance issues related to their proxy statements and may even have received shareholder overtures (formal or informal) during the proxy season. It's the perfect time, therefore, to consider lessons learned and possible changes in approach. Summer will quickly become fall, which is the best time for actual engagement because institutional shareholders and SASs have more time to focus on your company.

Keep in mind that effective engagement goes beyond financial roadshow presentations to small groups of shareholders, investor conferences or rating agencies. Effective shareholder engagement is often conducted one-on-one and addresses governance issue and strategic vision—governance roadshows, as it were. This allows time for in-depth dialogue, including discussion of any shareholder suggestions or concerns that may be bubbling beneath the surface, and the opportunity to be proactive in addressing them. And it is an excellent opportunity to "test the waters" regarding concepts the company is considering (always within the limitations of Regulation FD). As a result, institutional investors will be more likely to side with management in the event of an activist campaign.

Finally, remember that institutional shareholders and SASs experience regular turnover in their decision-making personnel, as well as frequent changes to their internal hot buttons and policies. Therefore, don't be lulled into false security because they seemed happy enough when you spoke to them a few years ago and you haven't heard from them since. Regular contact is crucial to maintaining the kind of communication flow and relationships that could minimize the disruptive impact of a determined shareholder activist.

This Client Alert is intended to inform readers of recent developments in the field of compliance law. It should not be considered as providing conclusive answers to specific legal problems.

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