Archive for December, 2012

Shareholder Activism: acting persons, aims, themes, targets, and behavior

December 29, 2012 Leave a comment

Shareholder activism is the effort by owners of equity capital to use their shares’ voting power to change the behavior of corporate management. They use to act through Shareholder Proposals.

  1. Shareholder proposals, (which -in the US- any owner of shares valued at $2,000 or more, and held for one year, can introduce at the annual meeting of a publicly held corporation, -one per shareholder and company-); investors vote in person or by proxy. In 2012, at the USA, proposals were submitted by:
    1. Labor or union pension funds, (36%). Most of these cases, proposals have nothing to do with performance, but with union`s agenda. In the USA, though, they are forced to pursue the best for the value of the investment, so they shouldn`t and are not so free, to follow different objectives.
    2. Socially responsible investors, 22%. Religious, or public policy, or political involvement agenda, …the base being the idea that directors have fiduciary duties not only to shareholders, but to other stakeholders.
    3. Institutional unaffiliated investors, (1%). Hedge funds, mutual funds and the like, with guiding stars such as Ackman, Icahn, and others. They are well-known since the 80`s, (Nabisco, and so on), and look for improving shareholder value, to the benefit of all shareholders.
    4. Other normal individual investors, (10%).
    5. Four “gadflies”: Evelyn Davies, John Chevedden, William Steiner, and the Rossi family. 31%.
  1. There is interaction between social activism, the kind that forces companies to enhance corporate governance, (majority voting, declassified boards,…), and activism pursuing shareholder returns. The first one, has enabled the second activists, because their costs and efforts have been reduced. Also, by SEC and NYSE regulation, brokers cannot vote on uncontested elections by their beneficial owners`shares.
  1. The objectives are more or less by thirds, these ones:
    1. Executive compensation: proposals pursue to enhance shareholder control on theses matters. The number is going down, as disclosure has been enforced by regulation.
    2. Social objectives: environmental, social, labor relations, animals and human rights, ….independently of the shareholders interests. Both a and b, are substance-based proposals: a specific theme to be dealt and changed.
    3. Corporate governance: they pursue to differently allocate power among Board, management and shareholders. The number of these process-based proposals is going down, because of a certain success in previous years. Usual topics are:

                                                          i.      Shareholding voting rules: majority vs. plurality and super-majorities; cumulative voting; declassified boards.

                                                             ii.      Independent chairman

iii.      Rules allowing shareholders to act out of General Meeting: special meetings or written consent,

  1. Targets of shareholder activists:
    1. Larger companies.
    2. Company industry: financial services and energy.
    3. Where organized labor is interested, (unions). Retail, telecom and finance, mainly.
  1. How do proposals fare: they normally fail, when substance-based, and succeed when process-based.
  1. Among institutional investors, we can find Hedge Funds. They can be classified for type and style:
    1. Types of Hedge Funds: among equity focused hedge funds, we may distinguish: hedge equity, (hold long and short positions, normally keeping a net long position), market neutral, (try to produce results not correlated with any market), event-driven or macro funds. There are also fixed income funds, etc.
    2. Style: equity hedge, short selling, event-driven, and long-short.
  1. How do hedge funds usually act? Their behavior is determined by certain factors:
    1. Their investor base: the more they rely on super-rich wealth, the more they accept volatility. But more than two-thirds of their funds come from pension funds, endowments, and the kind, too risk-averse for the 80`s hedge fund industry`s behavior.
    2. Leverage: it is at its low in these times.
    3. Rigidity: funds owners require stickiness to the known manager`s strategy, not accepting changes.
    4. Funds allocated to hedge funds have soared from $ 0.5 trillion in 2000 to 2.2 trillion in 2012, so that many second-rate bets are accepted; thus, profitability is not expected to be so high now.
    5. Hedge funds normally charge a 2% management fee plus a 20% on profits. With the current low-level in interest rates, this seems high, so they need to compete with mutual funds, exchange-traded funds and so on.
    6. As for activist funds, $ 57 billion are said to be dedicated to activist strategies.It is interesting to follow some of the main hedge fund managers`strategies, so as to be aware of their acting pattern, for instance Carl Icahn, Bill Ackman, and others.
  1. How do equity hedge funds usually act? It is interesting to follow some of the main hedge fund managers`strategies, so as to be aware of their acting pattern, for instance Carl Icahn, Bill Ackman, and others. The following steps can be identified:
    1. Fund starts purchasing a stake in the company, normally under 10%, for profit disclosure reasons. Share is normally undervalued.
    2. Fund then discloses its stake and agitates for change: strategy, M&A options, and so on. Usually at this moment, fund is already in the money.
    3. It the target company resists to adopt suggested change, the fund manager usually proposes a minority slate of directors, (that with shareholder approval will replace current ones and agitate adopt changes).
    4. Failure is usually followed by new election campaigns, (normally with a full slate of directors now).
    5. Finally, fund manager may decide to cash-out, or to make a bid for the company stock.
    6. If the bid succeeds, funds need to be prepared to manage the company.
    7. A different approach involves using derivatives, (short positions), when discovering a negative feature in a company, (Ackman`s case in Herbalife, when he made the case the company had accounting wrongdoing to cover a Ponzi-kind performance).

The risk oversight function of the Board

December 9, 2012 Leave a comment

The number of yearly bankruptcies (generally low), shows that management-led enterprise risk models are not always effective, if they exist at all. But in many other cases, underperformance and loss of shareholder value are the consequences of that failure.


Traditional Corporate Governance models establish that “the board cannot and should not be involved in actual day-to-day risk management. Directors should instead, through their risk oversight role, satisfy themselves that the risk management policies and procedures designed and implemented by the company’s senior executives and risk managers are consistent with the company’s strategy and risk appetite, that these policies and procedures are functioning as directed, and that necessary steps are taken to foster a culture of risk-aware and risk-adjusted decision-making throughout the organization”.


What is the objective of the Risk oversight role of the Board:


We can identify the following two:


  • Preserving the viability: the bankruptcy case, even if it needs to be considered, is not generally in the path of most companies.
  • Improving shareholder value, is what really should bother directors. This is the main risk oversight role of directors.


Where does the oversight risk role of the board come from?


This board`s task comes basically from regulations on the role of directors:


a)      Directors`fiduciary duties: directors comply with their obligations by assuring the risk management oversight adequate systems are in place. Provided this is in place, the level of risk-aversion adopted by a company, is covered by the business judgement rule, which means directors are not responsible for the effects of risk, but only for a “sustained or systemic failure” to exercise oversight.

b)      Other: Other laws, listing requirements, sector-specific regulations.


What is the role of a board? Is that role the same, whatever the risk?


It is generally agreed that Boards are responsible for:


  • Determining the company`s approach to risk, the risk appetite or tolerance, and its relationship with expected rewards for the company, and for managers.
  • Setting the right culture throughout the organisation,
  • Assuring the material risks the company faces are identified, (dynamically) reviewing the risk categories and their interrelationships.
  • Assuring the company has risk strategies tailored to the company`s risk profile, strategy, and the kind of material risks confronted.
  • Reviewing with managers: the independence of the risk management function, the risk policies in place and their implementation, and all external reports, as necessary for the risk function.
  • Assuring risk is integrated into business decision-making throughout the organisation, and the adequate information flow systems are in place.
  • Transferring relevant information on risks to managers and committees.


Nevertheless, there are certain areas where a deeper role is recommended. In particular, where managers cannot be relied on to do a good job, for different reasons, as in the case of risks associated with leadership and strategy, for instance.


Strategic Risk: it can be defined as that risk that may most severely affect shareholder value, prevent the company from reaching its objectives, and even from surviving. Thus, directors need to challenge managers about the risk to the proposed strategy, particularly coming from external factors. The first step is a continual strategic risk assessment. There are several steps to properly deliver it, (understanding strategy, obtaining data, prepare risk profile, develop strategic risk management action plan, communicate both, and implementing the second), and it should be embedded in the management team. The second step is integrating risk management in strategy setting and measurement processes, (following Kaplan and Norton`s “The Execution Premium” could help).

Leadership: it is understood the board is responsible for assessing the performance and leadership capabilities of managers and particularly the Ceo.


How should the Board execute its oversight function?


Many boards delegate the function to the Audit Committee. Separate Risk Committees are not common out of the financial industry. Sometimes, several committees are responsible for the risk oversight role, (when different relevant risks are present), which requires some kind of coordination. In any case, the board should engage annually in a review of the risk management system, probably with external help.


Flow of information


The board needs to assure there is enough information flow about risk and risk management procedures, and gather this information from managers directly, if necessary.

The power of shareholders. Ballots, and the option for staggered or declassified boards

December 1, 2012 Leave a comment

The shareholder franchise, (right to vote), is the ideological support for directorial power in a company with dispersed ownership, so that whenever shareholders think directors do not deserve their trust anymore, they can use democratic tools to oust them. But, are director elections really available and adequate for this? We are going to follow the debate between Bebchuk and Lipton on this matter, as in other previous posts, (noting that they mainly refer to the US).


Why is the shareholder franchise relevant?


Boards have a role in correcting the agency problem between shareholders and managers. Given their functions, their selection is a critical decision, and compensating them so that they stay aligned with shareholders, is a must. The power to replace directors by shareholders has a role in both points, (in particular Courts do not judge directors` decisions, but shareholders need to do that). Some corporate decisions are reserved to the Board, precisely on the ground that directors can be replaced, and even director independence is not enough to provide incentives to work in favour of shareholders` interests.


When analysing Contest Solicitations, the number of directors challenged to be replaced by others still seeking to manage the company independently but differently,  is very small, (mainly in middle-sized or small companies), and a majority of them fail. When those numbers are compared to the number of public companies, the number is low. Mr Lipton considers this a fact, not a proof of difficulties to ballots. But…


The more outstanding obstacles to elections are the following, according to Mr. Bebchuk:


  1. The costs are high: sending the proxy to shareholders, and receiving it back; filing the proxy statement with the SEC, and communicating the proposed strategy, through costly proxy solicitors. But only a fraction of the eventual benefits would flow to the challenger, (according to his ownership percentage).
  2. The uncertainties under the challenger`s flag: the strategy, the Ceo that will be hired, etc.
  3. Staggered boards, where only a fraction, (usually a third) of directors comes for re-election each year. Controlling that board means winning two elections, which is more expensive, reduces the challenger`s chance, and makes shareholders reluctant to vote for, so as to avoid one year of unrest and uncertainty.


Bebchuk`s reform proposal


Consequently Mr Bebchuk proposes elections should be allowed to take place annually for all directors:


  1. The frequency would not necessarily be annual, (because of costs, short-termism being imposed on directors, etc).
  2. Access to the ballot should be opened to shareholders trespassing some ownership thresholds, and committed to keep its position for a certain time, (after the proposed director is elected).
  3. Reimbursement of funds spent in the contest, would be granted to those gaining sufficient support.
  4. Shareholders should be able to replace all directors, although unless a shareholder revolt takes place, elections could be consistent with a staggered board.
  5. Some arrangements for all elections:
    1. Directors should not remain when more votes are against than in favour. First, shareholders need to be able to cast “against” votes, and not only “withhold” ones; second, majority voting needs to be implemented, against the plurality system, because most elections are uncontested.
    2. The vote should be confidential
  6. Legislators should facilitate shareholders to initiate certain bylaws changes for introducing the proposed reform, and prevent directors from doing the same when the objective is making their ousting more difficult.


Staggered boards defendants (and Mr Lipton) concerns follow:


  1. The associated costs of annual contests,
  2. Certain major shareholders could happen to launch elections in order to pursue their own agendas,
  3. Directors would be invited to abandon their long-term focus, and the board in general would be disrupted by internal dissent and “electoral” attitudes,
  4. Director recruitment problems could arise from the permanent election forecast.
  5. Independence of Independent Directors and their stability and experience could be undermined.


The activism for the Power of Shareholders has been developed by Harvard`s Professor Bebchuk through Harvard`s “Shareholder Rights Project”, which advises some institutional investors, and in particular helps them submit proposals for declassification.


The main argument in favour of declassified boards, and against staggered or classified boards, is an empirical one, and the debate should mainly be kept in this area. There are some empirical studies which help link staggered boards with a lower firm valuation, lower returns in case of a hostile takeover bid, less pay and managers` turnover correlation with performance, and so on.


Those favoring staggered boards, attack this empirical evidence. But they also validly argue the concerns included above, and the loss of value captured by shareholders in the case of a hostile takeover bid. This last point is clear when a staggered board is combined with a poison pill. We will deal with that part of the debate in a forthcoming post, because it is critical: in fact, Professor Bebchuk`s ballot proposal is compatible with staggered boards, but not with its combination with poison pills as a hostile takeover bid defense.