For good or ill, activists now are important players in the investor ecology, with increasingly successful records for changing a board’s makeup. At Egon Zehnder, we identified 58 incidents of investor activism against S&P 500 companies over the last two years. Of those, 16 contests involved changes to board composition, urging a “no” vote on the management’s slate of directors or proposing, or threatening to propose, an alternative slate. And of those, only six concluded in favor of management, resulting from the activist slate being withdrawn before a vote or management’s victory in a vote.
It is not surprising, then, that many boards are evaluating their plans for responding to an activist slate this proxy season. Broadly speaking, however, there are really only two possible courses of action a board can take. One path is to accept the reality of activist scrutiny and build it into the nominating committee’s ongoing work. The nominating committee needs to look at the board with an objective eye and identify how its composition might give an activist a foothold, such as directors with conspicuously long tenures or directors whose experience is unaligned with the company’s business and its strategic direction. The nominating committee must then design a director succession plan that identifies, cultivates, and elects candidates with the desired competencies. Doing so is not a guarantee against activist action, but having a carefully chosen board with relevant backgrounds and perspectives deprives activists of a clear weakness to exploit.
Because board seats turn over intermittently and because competition for directors is so high, fully executing this strategy can take several years. In the meantime, an activist investor may well decide to put forth its own slate. When that happens, the nominating committee must shift into high gear. In the 16 activist initiatives involving changes to board composition, the median campaign length was found to be only 77 days—just 11 weeks from the initial announcement to some sort of resolution. And six of those 16 initiatives concluded in less than one month.
Of course, the company could stick with its current slate and hope it receives the necessary votes. But once activists have sown the seeds of doubt in the minds of other investors, events have shown that change is more or less preordained. It is simply a matter of whose change will prevail.
Because time is of the essence when faced with an activist slate, it is incumbent upon boards to watch closely for tremors that might precede such an action. Besieged boards might feel blindsided, but successful activist attacks rarely come out of the blue. Seven of the companies that were subject to investor activism on board composition were the targets of initiatives from more than one group. For example, while Starboard’s Jeff Smith may be the one credited with replacing the Darden board, that upheaval only followed an initial salvo from Barrington Capital Group. Once the board gets the faintest sense that it is the object of activist interest, it needs to move quickly to examine its composition and reshape it as needed.
When the battle is joined, boards must ensure they do two things. First, they must reach beyond their usual networks in identifying new director candidates. Expanded networks are more likely to allow the board to draw upon candidates with a wider range of perspectives and experiences. Furthermore, the wider pool of candidates (and connections to candidates) is essential if a company can hope to quickly assemble a slate that doesn’t look quickly assembled.
Once the company has its nominees, it then must convince the investor community to give its support. Here it is particularly helpful to steal a page from the activist playbook. Activists know that no matter how good their slate may be, their real power lies in their ability to sway a majority of investors to their side. As a result, the best activists are also the best communicators. They make sure that the story they tell is clear and compelling and then tell that story relentlessly. If management has been less than successful, it is because they have been out-maneuvered in the court of investor opinion. Management must make sure that the story they tell about their slate is even more compelling than that put forth in support of the activist candidates, and it must be told with the same energy and clarity.
The bottom line is that nominating committees must build strong director succession plans that result in boards that are clearly relevant for the challenges and opportunities the business is facing. Their only choice is whether to do so preemptively and with the luxury of time or, instead, with their back to the wall and the clock ticking.
George L. Davis co-leads Egon Zehnder’s Global Board Practice and is a trusted advisor across a host of corporate governance matters, with particular focus on leadership succession planning and board effectiveness. Kim Van Der Zon leads the U.S. Board Practice of Egon Zehnder International and has expertise in CEO succession. She has successfully served Fortune 500 clients across a broad spectrum of global companies from financial services and consumer packaged goods to pharmaceuticals and technology.