IN-DEPTH: Defenseless companies invite activism
Nearly half of the Russell 3000 companies targeted by activists in 2023 had few defenses against such advances.
According to Diligent Market Intelligence’s (DMI) Governance data, of the 103 Russell 3000 companies targeted by primary- and partial-focus activists in 2023, 50 had a “low” corporate defense score. Another 33 had a defense score ranked as “medium” while 20 companies had defenses ranked as “high.”
DMI’s corporate defense score is based on key governance provisions and other metrics that can strengthen a company’s ability to defend itself against a shareholder activist demand or unsolicited takeover bid.
The score is calculated for all companies in the Russell 3000 and is based on three key components: anti-takeover provisions, board and shareholder rights, and voting rights.
“The second an activist gets interested in a company, they are absolutely going to do corporate defense vulnerability analysis, because things like whether a company allows consent solicitations and special meetings will inform their approach,” Sean Donahue, co-chair of Paul Hastings’ shareholder activism and takeover defense practice, told DMI in an interview.
Low-hanging fruit
Of the large-cap Russell 3000 companies targeted by activists last year, over 56% had a “low” corporate defense ranking while over 58% of the mid-cap companies that drew activist attention also recorded “low” defense levels.
For small-cap companies, however, only 20% of those targeted by dissident investors had a “high” level of protection against such attacks.
Many companies have rolled back takeover defenses adopted in the 1980s and 1990s over the past two decades as institutional investors made clear that they favor increasing shareholder rights. But despite the data showing that companies with low defenses may be more vulnerable, experts caution against boards entrenching themselves.
“For the smaller companies, where you probably have less sophistication or less ability to control an activist and to tune the process towards productivity, it probably makes sense to have some takeover defenses,” Didier Cossin, chaired professor of governance and finance at the Institute for Management Development (IMD), told DMI.
For larger companies, collaboration with an activist is often advised in order to achieve the best possible outcome for both the company and its shareholder base. “If you're one of the large-cap publicly-listed companies, it's probably just as good to be quite open to the activist and figure out your game, but to be smart about it, and maybe have some anchor long-term shareholders rather than takeover defenses,” noted Cossin.
Risk mitigation
Preparation is considered key for boards wishing to proactively assess whether they could be a target of activism, what kind of activist would be more likely to take a stake and what kind of tactics they could potentially employ.
In 2023, 85% of the Russell 3000 companies targeted by activists gave their boards the option to implement a poison pill. All but two companies had advance notice bylaws in place, according to DMI’s Governance data.
“Many corporate defenses like dual-class share structures and classified boards are really hard to get back once given up, which is when you should look at things like tuning up the advance notice bylaws, making sure you have the directors’ and officers’ questionnaire as part of the bylaws, that you've dealt with the universal proxy rules and that you're asking for the information investors need,” Donahue said.
However, a rise in such bylaw tweaks since the introduction of the universal proxy card has generated backlash from the investor community with many arguing such measures are intrusive and go beyond what is required by law.
Chris Kiper, managing director at Legion Partners told the recent DMI Proxy Season Preview conference in New York that questionnaires are often being “weaponized” to collect all sorts of data. “Really frustrating that it has come to this. It’s not helping anybody. There is a lot of friction in the system.”
In a closely-watched situation in early 2023 considered a test case by many activists, medical devices company Masimo erased several controversial bylaw amendments that activist Politan Capital Management had alleged were designed to stifle dissent. The changes would have forced investors seeking board seats to reveal information about their backers as well as other sensitive details. Prior to the u-turn, Politan had accused Masimo of adopting a poison pill and other defensive bylaw changes in response to its privately stated interest in joining the company's board.
Controlling the narrative
In a changing financial environment with interest rates remaining uncertain, company boards are advised not to solely focus on defenses but also to direct the same level of attention to ensuring there is a consistent level of engagement with the shareholder base. “A lot of the time, it's less about what defenses you have and more about your relationship with existing shareholders,” Yaron Nili, professor of law at the University of Wisconsin Law School, told DMI.
Referring to Disney's recent victory in securing backing for its incumbent board, Nili observed that defenses are not always needed when shareholders “are with you.” “Even in the event that an activist does come on board, those shareholders are going to help the incumbents fend off that campaign.”
Both in and outside of proxy season, Cossin expects the topic to continue to generate discussion in boardrooms across the globe.
“If an organization has not figured out where it wants to be in terms of defenses and does not have a response plan ready for when an activist comes knocking, then I think it's high time to do it,” Cossin advised.
