The current playing field for companies is becoming an increasingly complex environment in which to operate; potentially leading to a loss of focus on issues that matter to the business. Fundamentally, companies exist to make a profit and investors provide capital to companies in order to earn a return. Within this reality, as also encouraged by the recently revised UK Corporate Governance Code and the British Academy’s ‘Future of the Corporation’ project, companies should be cognizant of the broader impact their businesses may have on their stakeholders when deliberating their strategy and defining their corporate purpose.
The challenge for companies in this new landscape is to communicate a robust equity story that captures both the business fundamentals and efforts in extra-financial issues to be appropriately valued by the financial markets. To this end, investors’ focus will increasingly be on the quality of the board (as described, for example, by disclosures like a board skills matrix) while determining whether board members are able to successfully fulfill their role as the investors’ representatives. This is clearly evidenced by the decreasing levels of support board members are receiving from investors at problematic companies.
Earlier this year, BlackRock, the world’s largest asset manager, highlighted that board composition, effectiveness and accountability would remain a top engagement priority for it while also confirming that the board’s review of corporate strategy was key in light of shifting assumptions. In late October 2018, Norges Bank published three position papers on board composition. Of particular interest was its publication on industry expertise within the boardroom, which states that Norges is looking for at least two of the independent members to have worked directly in that industry.
Active managers, by virtue of their investment strategy, have already been engaging with their investee companies and holding them to account in light of their deeper knowledge of the business and sector from both a fundamentals perspective and, increasingly, from an extra-financial perspective. What may be a newer phenomenon is the growing sophistication of the stewardship teams at the passive shops; these shops are continually adding thematic and sector experts to their engagement teams to focus on specific material business risks.
The increased sophistication of stewardship raises the question of whether activism remains as an investment strategy or if it has become a mainstream behavior. Our view is that it has become the latter and that, as a result, companies shouldn’t expect activism to resemble the adversarial environment that has persisted until now. Earlier this year, with Melrose’s hostile offer for GKN, we saw that mainstream investors were comfortable with taking public positions against each other even as the situation became political. Despite last-minute efforts from GKN to convince its shareholders not to tender their shares, its board and management failed to convince the base that they were better fit to deliver long-term value considering their track record until then.
During the summer, Whitbread announced the sale of its coffee business to Coca-Cola to focus only on its hotel chain following calls from two US-based activists to split its business. It appeared the board couldn’t find salient arguments to convince shareholders as to why those two distinctly separate businesses should remain under the control of one management team and board. Most recently, we saw Unilever abandoning its corporate headquarters move from the UK to the Netherlands following public opposition by its investors in what appeared to be a communication breakdown between the board and its largest shareholders.
There are countless other examples across the globe where boards have lost their credibility in the face of challenges from their long-term shareholders. This suggests to us that companies need to upskill their engagements with investors and strategically build long-term relationships through discussion of long-term strategic issues. Investor buy-in to your long-term strategy, either through engagement or a shareholder vote on your strategic plan – like at Atos in France – will prove beneficial at a time of crisis or when an activist is snooping around your shareholder base to look for potential allies.
In early October we released our inaugural Progress Group report, which brought together internationally recognized experts from both the investor and corporate sides to discuss the future of shareholder engagement. The report recommends that boards, and those in management who support them, be sufficiently well informed on which topics should be addressed with which shareholders while also providing investors the opportunity to suggest additional agenda items for those engagement meetings. While this certainly creates additional pressure on resources, if done properly, we feel it can lead to improved outcomes, thereby ensuring the engagement process provides returns for both sides.
Ali Saribas is partner at SquareWell Partners