Bulls in a china shop—or catalysts for change? The divides created when activist investors muscle their way onto boards as varied as those of Hewlett-Packard, J. C. Penny, and Yahoo can run as deep as those on Capitol Hill. Has Ralph Whitworth of Relational Investors restored shareholder value at HP? Did William A. Ackman of Pershing Square Capital Management destroy value at J.C. Penney? Has Daniel Loeb of Third Point rebuilt value at Yahoo?
And what about private-equity partners and sovereign-wealth managers who come on boards of large publicly-traded firms—not as activists but in the wake of taking a stake? Consider TPG, the American-based PE firm that acquired a significant fraction of China’s Lenovo after its 2005 purchase of IBM’s personal-computer division. TPG took a seat on the board, and by all accounts its principal played a strategic role in helping Lenovo grow to become the world’s largest PC producer. Elsewhere, at Chrysler by way of one well known counter-example, private equity has had a less sure impact on value creation.
Whether major investors on a board add or subtract value has become a contentious debate of the era, fueled by a sharp rise in activist campaigns. Law firm Wachtell Lipton identified 27 activist-investor initiatives in 2000, but more than 200 in 2013. The firm also estimated that more than a hundred hedge funds have now migrated into the activist camp. Even Microsoft is soon to have a hedge-fund activist, ValueAct Capital Management’s president G. Mason Morfit.
We believe this is a good moment to reframe the question from whether an activist adds value to how directors and executives can draw the best from active investors on the board: What can board leaders do to prepare new activists for their governance role? How should directors best work with the activists in guiding company strategy and taking major decisions?
This reframing has become especially important because the primary function of boards at many large publicly-traded companies has expanded over the past decade from monitoring management to partnering with management. In many boardrooms, directors now engage more actively with company executives in setting the tone, defining the strategy, and building talent at the top. It is no longer enough just to keep executive feet to the stockholder fire.
As companies’ inner sanctums have been so reconfigured, boards function less as a passive aggregation of a dozen shareholder-hawks—and more as a forcefully led team of business contributors. As we report in Boards That Lead, the role of the non-executive chair or lead director has morphed from titular to orchestrator, from one of formal stature to that of team leader. Board leaders at many firms meet with incoming directors to inform and prepare them for their governing duties, and this can be particularly important for investor activists given their penchant for short-term value extraction.
When activists move from outside critic and cajoler to inside fiduciary and counselor, it is now up to the board leader to mold the more diverse boardroom players into a productive team. Still rivals, yes, but nonetheless a working group that can partner with management to drive value.
For the board leader, no rocket science is required, just active listening and a readiness to take charge, focusing the board on strategy and performance instead of personal conflicts, of working with the executive team rather than allowing anybody to attack or micro-manage it. If any director, activist or otherwise, still edges toward dystopia, it is the business of the board leader to isolate the dysfunction. In one case, a new activist began to place daily calls to the chief executive—until the lead director intervened. A board that defers to a bull in the boardroom is a board that has failed in its emergent mission of leading the company, not just monitoring it.
Activist investors are sometimes ready to embrace the new calling. Seasoned directors have reported to us that activists freshly on their board have occasionally confessed that they were genuinely surprised and impressed with the substance of boardroom deliberations. Directors were actually bringing more strategic thinking to the table than the activists had appreciated before coming in from the cold, and that was exactly what the activists wanted more of.
Some activists are less likely to seek a seat in the first place if they know that a board leader is indeed leading the board, and that the board is no longer a passive player or pawn of management. For that, regular personal contact between outside activists and the board leader can help, though that is still a work in progress. Too few boardrooms have even one or two directors who are “camera-ready,” in the estimation of Abe M. Friedman, formerly head of corporate governance at BlackRock and now an advisor to companies on investor strategies. Still, more directors are likely to become better informed about their firm’s strategy and more able to articulate it to the activists who increasingly want to hear personally from directors about the inner workings of their boardrooms.
Investor activists on the board are likely here to stay and more can be expected—not in large numbers but certainly in some numbers—and even at the bluest of the blue chips, not just struggling players. They have already knocked at the door of Apple, Dupont and Kraft, and if not this year at a given company, then maybe next.
Directors and investors, in our view, can make the most of an activist presence if they see the boardroom as a place of mutually assured construction rather of destruction—and if they then commit to making the board a working partner of management and not just a monitor of it.