Insights on some of the most important tools and skill-sets that public companies need to have at the ready as we head into the 2017 proxy season…
Interview with Bruce Goldfarb, President & CEO of Okapi Partners
Q: Bruce, we have been watching Okapi Partners grow steadily, both in size and reputation, since you and Pat McHugh founded it in January 2008. As we head into the 2017 proxy voting season, what issue or set of issues should companies pay extra attention to as they begin to gear up?
A: One trend that has gone under the radar for some companies and will continue to gain steam in 2017 is the increasing engagement and assertiveness by traditional investment managers such as index funds and actively managed mutual funds. Fueling this rising vocalization has been a very significant shift by investors from active to passive strategies over the last few years. This shift has changed the balance of shareholder power, with index funds managed by Blackrock, State Street and Vanguard having greater ownership levels and thereby more voting influence than ever. Both passive and active managers will be even more vocal about board composition and refreshment, corporate governance, executive compensation and other issues in 2017.
We also expect to see more activist campaigns by traditional active managers in 2017 as they attempt to distinguish themselves from index-based investors. Neuberger Berman’s successful proxy contest against Ultratech Inc. was just the beginning. Activist hedge funds will also continue to look for undervalued companies, especially in the small and mid-cap space. Those companies would be wise to consider refreshment of their board and a robust engagement program with their top shareholders now - especially if they are underperforming their peers.
From what we can see and hear so far, there is likely to be a significant uptick in activist campaigns against small and mid-size companies. Not only have many large cap companies been targeted already, but in many instances their shares have rallied recently and they have become much more adaptable and open to voices outside the boardroom. Small and mid-cap companies, on the other hand, are often caught off guard when an activist investor shows up, either publicly or privately. Instead of opening up a dialogue, their first reaction in many cases is to dig in their heels and fight. Until that changes, we’re likely to see activist hedge fund managers look to shake up smaller and mid-cap companies, especially ones that have not had a change in the boardroom for a long time.
Q: What about so-called social and environmental investors? Should issuers be more concerned than usual these days?
A: I think that if a company has had social or environmental “issues” that have attracted attention in the press, they may be more vulnerable to activist approaches. There may also be a correlation between the identified issues and whether it has an impact on the company’s core business or manufacturing process. Companies certainly need to be proactive in addressing such concerns - and in addressing them directly with key investors as well. A number of investors are putting more focus on these issues – partly as a trigger for business development for the next generation of investors in a socially conscious world and partly because these issues can impact investment returns. As customers care more, investment managers will be more concerned.
Q: How should you best engage investors in today’s environment?
A: Boards that have had the same directors for over 10 years really need to take a hard look at refreshing some of their members, especially the independent directors. Beyond that, it is vitally important for managements and boards to articulate why their value creation strategies are working before an activist shows up. That requires winning the support of large index-fund shareholders, who may be inclined to vote with the activists in more instances than ever before, as well as other large (and frequently long-term) shareholders. Here are some more important steps to take:
Know the company’s major investors. This initiative is a process that should not simply be left up to management, as these large institutions expect the directors to be their representatives in matters of corporate governance policy-setting and decision-making. Understanding your shareholder base is an increasingly difficult endeavor, and a task that is constantly changing, especially as more derivatives and other ways of holding shares become used by more market participants.
Understand the interests and views of your passive investors. As I’ve noted, larger index-fund managers, such as BlackRock, Vanguard and State Street, are publicly vocalizing their beliefs on board refreshment, performance-based compensation, and other governance issues. These investors no longer blindly follow the research advice of proxy voting advisory firms and the most effective engagement recognizes the unique process of each investor. Your company’s investor relations team and/or outside proxy solicitation advisors can provide additional insights as to what these shareholders care about.
Communicate about what matters to the investors. Using any public statements they may make, and the insights from IR/proxy solicitation advisors as a roadmap, be proactive in engaging the index fund investors on the issues of primary interest to them.
Q: In the past year or so, there seem to be a lot of new entrants into the broadly defined “corporate advisory” business. How should a company properly evaluate these new advisors?
A: The emergence of these new advisory firms underscores how important good governance has become in today’s corporate landscape. Companies taking a fresh look at their advisors should focus first and foremost on the relationships and knowledge the advisor has with the institutional investor community, including mutual funds, index fund providers, hedge funds and proxy advisors like ISS and Glass Lewis. At the end of the day, these very different groups of shareholders (and voting advisors) are the ones that will drive the decisions about corporate governance. Understanding the eccentricities of different organizations, how they work internally and how they think is an extremely important aspect in devising a successful engagement strategy and making decisions about corporate governance.
Deciding whether an advisor possesses the skills, relationships and the understanding of these different constituencies is very difficult and cannot be done through a routine “check the box” RFP process. Companies should consult with their outside legal counsel, with corporate governance experts and influencers and with different types of market participants about the advisors with whom they work. Companies need to ask their prospective advisor how they would go about dealing with different types of shareholders. Which board members would they suggest are the right ones to reach out to shareholders in a given situation? Large index fund managers have investments in literally thousands of companies; how would the advisor best engage with them? The way an advisory firm answers these questions can provide insight into how experienced and knowledgeable they are about your investor base, and about the decision-making processes at each major investor. The one thing your company does not want from an advisor is a “check the box” approach to shareholder engagement.
Another very important factor, I think, is the size and composition of the team that will actually be “on your account.” Many of the firms in this space - both older and newer ones - have rather thin benches of talent with actual hands-on experience in challenging situations. Another important aspect to consider; how well does the personal style and chemistry of the team-members match with that of your own company, and that of your board members?
Once you establish that your advisor possesses the knowledge and the expertise necessary to effectively engage with your shareholders base, it’s equally important to ensure they can use that information to execute a successful campaign. Whether it’s an annual meeting, a contested election or a shareholder outreach campaign, making sure your advisor can successfully execute is vital. Look at their list of past campaigns, especially ones that were particularly contentious, high profile or full of twists and turns. Ask the prospective advisor to describe a particularly difficult campaign and how they dealt with it. Ask some of the advisors past clients how well they executed and whether they achieved a successful outcome. Ultimately, you are looking for a business partner who will provide the best advice possible, not just advice that is the easiest to provide.
Especially important, you need to have a partner that will be available to you, and to your board - basically on an around the clock basis - if activist investors should target your company in any way, or simply ask to engage on a matter of concern to them.
Q: What makes Okapi Partners stand out from this crowd?
A: Since our founding we have prided ourselves not only on the senior-level attention we give to every client but on our ability to understand how different types of investors think and behave. We have advised a significant number of activists on very high-profile campaigns, but most of our work is with issuers who are seeking to identify and reach their investor base. Our work with hedge fund activists as well as traditional long-only investors and index funds has given us unique insight into how to communicate effectively with different types of investors and how they make voting decisions.
We also pride ourselves on having a very deep bench that cares about providing exceptional service but also on being able to offer valuable advice. Many of our clients on the issuer side as well as on the investor side seek us out for strategic advice even if they haven’t engaged in a solicitation campaign. The insight we can provide to our corporate clients about what issues are important and what is on the minds of different investors has proven extremely valuable to them.
President & CEO of Okapi Partners