On the frontline of the war against shareholder activism with Harlan Zimmerman
Shareholder activism. A phrase and an idea that is familiar but yet to be fully understood. What does shareholder activism mean for businesses now? And what could it mean in future?
The news offered something of an answer earlier this year when the hedge fund Engine No. 1 managed to occupy three seats on the board of Exxon after a showdown over the company’s environmental strategy. But, for a fuller answer, this week’s Big Conversation enlisted both Harlan Zimmerman, a senior partner at Europe’s largest activist fund Cevian Capital, and Julian Long, an M&A partner at Freshfields, to explain shareholder activism and its potential. They discussed the different types of activist investor, the process behind those investments, how companies and boards should respond, and much else.
Here are the key takeaways:
The discussion began with a definition of activism in the investment context, courtesy of Harlan Zimmerman: ‘Activism, for us,’ he said, ‘is an investment that is made when there is a plan to do something at the company, to increase some kind of value, and that plan is baked right into the investment decision. Which means that – day one – [the investor is] already planning on doing things.’ Which, he added, distinguishes investment firms such as Cevian Capital from those such as Vanguard and BlackRock, which are less ‘proactive’ in trying to cause change.
The many different types of activist can be broadly divided between those who are more short-term orientated and those focused on the long term. The former tend to have quarterly time frames and concentrate on quickly achievable goals – such as putting pressure on companies to pay out a large dividend – meaning that they are unlikely to build working relationships with companies. These short-term investors could also be hedging their positions, so their incentives may not always be clear.
Longer-term activism, which might also be called ‘constructive activism’, is exemplified by firms such as Cevian and ValueAct Capital. This doesn’t involve hedging or shorting or using leverage, but instead means trying to help a company to become more competitive and sustainable over time, thus increasing its value. A typical holding position might last five years, so there is a premium on working with the company in question and developing mutually beneficial relations.
The process of committing to a long-term activist investment can itself take quite a long time. In terms of Cevian’s most recently disclosed investment, the first meeting actually took place a decade ago. The years since have been filled with research: working out whether the company is fundamentally well placed for the long term, whether improvements are possible, and how those improvements might be made. This culminates in a three- to six-month process of conversations, with not just company representatives but also customers, competitors, suppliers, regulators and even former employees.
Constructive activists can find that, particularly in underperforming companies, the company board may not have been getting the complete picture. Board members generally only see what’s in the board packs, and it can be the job of activists to help inform the board by providing more information. (There is also the separate question of board performance: in Harlan’s words, ‘Being a board director is about the easiest job in the world if you’re prepared to do it badly; it’s about the hardest job in the world if you really, really want to do it well.’)
The end goal of a constructive activist is to leave the company through a sell-out in the market. It’s, thus, in the interests of a constructive activist for the company to be sustainably successful, with the right personnel and strategy for the future. While the original investment might cause a splash in the papers and raise share prices, a well-planned and smooth departure will often be barely noticed.
How should boards respond to activist investors? Of course, it depends on the particular activist investor. ‘As activism has proliferated, the bar to become an “activist” has been getting lower and lower,’ said Harlan, adding that boards must learn to distinguish between activists, and determine their motivations and incentives. But, fundamentally, boards also have a broader responsibility to design and execute a strategy that shareholders and other stakeholders want to get behind. An indicator as to whether this has been achieved might be the type of investors on the register: a surplus of index funds – whose decisions are based on the index rather than, necessarily, conviction in the company itself – could be a bad sign.
The past few years have also seen a rise in first-time and occasional activists. These investors might not follow the traditional playbook, may not be as familiar with all the rules and regulations, and could be hungrier for publicity, which further confuses the dynamic for board members. It doesn’t help that, while most companies will actively monitor their shareholder registers, it’s relatively easy for stakes to be acquired in under-the-radar ways, with an investment coming unexpectedly.
Company owners are increasingly coming to see activism as a generally positive thing – and are approaching activist investors in the first place. There has also been an increase, notable in the first quarter of this year, of activist investors being appointed to company boards; and not just people nominated by the activists, as happened in the past, but actual employees of activist investment firms.
This relationship could grow in future as both companies and investors do more to embrace ESG (environmental, social and governance) goals and explore how those goals can result in traditional (ie monetary) shareholder returns, too. In fact, Julian Long predicted that the ‘social’ part will become increasingly prominent in future years – and an area where activist investors could offer support to companies.