Ripping Up The Playbook: Identifying Activism Vulnerabilities
How have issuers’ vulnerabilities to activism shifted over the past 12 months?
In traditional financial activism, companies that benefited and saw rapid growth during the pandemic are facing greater scrutiny in their strategies, the sustainability of their growth, and their management of risks. At the same time, the pandemic intensified underperformance and exposure to risk for a significant share of the market, making those companies even more vulnerable, especially if they fail to control their narrative with shareholders. In addition to financially driven activism, ESG management has become a more significant driver of shareholder dissent. Even well-performing companies face tough conversations.
Early last year, some of the world’s largest asset managers announced potential votes against directors if they found companies’ management approaches to key ESG risks insufficient. Looking ahead to the 2021 proxy season, the response to the pandemic, concerns about human capital management and social inequities, and continued focus on climate change will feature high on investors’ agendas.
How are ESG and activism connected?
Large institutional investors’ willingness to hold boards accountable for environmental and social issues is a wakeup call for many companies. During the past decade, activist hedge funds have focused on perceived governance failures to justify why change at the board level was critical to drive value creation. Similarly, activists are beginning to add arguments about the management of material environmental and social issues to their arsenal of potential criticism against management. Statements about human capital management and climate change have already surfaced in 2021 campaigns. Issues will vary by company; however, expect underperformance in human capital management and the lack of a climate change strategy as prime potential drivers for dissent.
What do shareholders expect from companies in terms of ESG management and communication?
They want to see clear indication that the company is safeguarding shareholder value by protecting against risk. Also, as a strong ESG program will likely give companies a competitive edge, shareholders want to see their companies positioned to take advantage of opportunities related to ESG issues. As many investors look to quantify their portfolio’s exposure to ESG risks, they demand transparent reporting. As such, reporting frameworks such as SASB and TCFD have become very relevant, as they allow companies to report in a consistent, comparable manner.
How should companies tailor their responses to activism?
A lack of attractive financial prospects or the perception that management cannot deliver on the current strategy are more relevant for the outcome of contested situations than historical operational or share price underperformance.
Delivering a consistent and reliable message, setting expectations, as well as transparency and engagement, help build trust with investors. That said, every activism situation is unique, and the response should be tailored to address the underlying situation. We often hear about the “activism playbook.” While there are certainly many best practices when engaging with different types of shareholders, including hedge fund activists, we do not believe that any playbook can really serve as a cure-all. In many campaigns, we were able to drive a win for our clients because we broke what are considered the “playbook rules.”