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January 26, 2016

It has become apparent in recent months that no company is too large or too geographically remote to escape the attention of activist investors. With hedge funds awash in cash and large institutions increasingly supporting activist goals, oceans, borders and unfamiliar regulatory regimes represent less and less challenge.  

In this issue of Raising the Bar, Ernest Brod, Managing Director, Global Forensic and Dispute Services at Alvarez & Marsal (A&M), draws on decades of experience in worldwide corporate investigations, as well as his role leading A&M’s Business Intelligence team, to share a unique perspective on the rise of activist investors and the critical questions every CEO needs to be prepared to answer in today’s environment.  

How did activism become such a widespread and impactful phenomenon? I began my career in corporate investigations in the late 1980s and early 1990s, when predators roamed Wall Street.   These “raiders” put fear in the hearts of corporate America with “hostile takeover” attacks.   Almost 30 years later, companies are coming under attack by bold shareholders, now labelled as “activist investors.”

Unlike the raiders, activists have become more accepted by the corporate world and the public, as the shareholder democracy movement has grown.  Today, there is less of a reflex reaction to oppose them and corporations are more likely to respond to activists respectfully and make an effort to consider their proposals.

But in order to make that decision, companies and their boards need to be prepared for activists’ arrival.  During the raider era, I introduced an article about gearing up for a raider with the question, “What do you call a CEO who has not prepared his firm for a raider’s attack?”  Answer: A former CEO.

Today’s CEOs and directors who would like to keep their jobs need to be prepared. Thinking like an activist can help avoid the activist’s gaze, but will also prepare you for when he knocks on your door.  The activist will:

  • Pick apart your financials

Are you holding lots of cash?  Activists frequently push for a dividend to shareholders.  You need to have a plan in place for the useful deployment of the cash.

  • Assess your strategy

Have you been slow in implementing your plans?  The activist may argue that your plans have failed in the past and/or you don’t give enough weight to shareholders’ preferences.

  • Examine your governance

Are CEO or director compensation poorly aligned with financial results or out of proportion to similar companies, presenting an attractive issue for other shareholders to support the activist?  Does senior management have perks which are hard to justify or are there “related party transactions” which benefit senior executives or directors?  The activists’ investigators always look for self-dealing or waste.

  • Evaluate the quality of your board of directors

Will your directors’ backgrounds stand up in the face of investigative scrutiny?  Have they misrepresented or failed to disclose any part of their history?  Have other companies with which they are or were connected flourished?  Are your directors truly independent, or acting as cronies?  Have they been in place too long, without appropriate turnover?  Do they have experience in your industry?  Is there sufficient diversity? You need to look at your directors objectively, through the eyes of an outsider.

The Takeaway
By asking yourself these questions, and taking the critical  steps outlined above in advance of shareholder pressure, you will be a sort of “internal activist,” which increases the possibility that the real one will pass over you and move on to the next target.

A good place to start is to understand that the activist’s analysts and investigators will be searching for facts to demonstrate weaknesses and vulnerabilities of your company, your senior management and your directors. A self-due diligence exercise will next help you anticipate and get out ahead of issues likely to be raised. 

Preparation is always the key.  From my experience supplying intelligence in dozens of activist forays and over a hundred hostile takeovers, there are eight key steps that every company should take to prepare for the activist:

  1. Review your shareholder list to identify activist investors.
  2. Study the history and tactics of these activist shareholders.
  3. Objectively review the background and performance of your fellow directors for potential vulnerability.
  4. Review corporate governance policies.
  5. Ensure your long-term corporate strategy is well articulated and supported.
  6. Scrutinize your balance sheet and income statement from an activist perspective.
  7. Review executive compensation for potential misalignment to corporate performance.
  8. Create a SWAT team of advisors to react quickly and appropriately to an activist attack without bringing the company to a halt.