BOARD MEMO 2022
Activism in 2022: A Pivotal Time Dividing the Well-Prepared and the Less-Prepared
Activism in 2022 will highlight a stark differentiation in public companies based on their boards of directors’ and their executive management teams’ perception, understanding and reflection on the messages coming from their respective stockholder bases.
Boards of directors and companies that are late to the game in understanding either how to effectively communicate with their stockholders – or in absorbing the information and feedback stockholders provide – will find that they have a more challenging year (or years) ahead. What the past few years in the activism landscape have shown is that stockholder concerns can crescendo and become a primary board issue, despite the best intention of boards.
Last year, we commented that we were witnessing the business model of activism evolve. We saw those drivers and trends come to fruition and expect them to continue to develop over the next year and beyond. While the public activism of the first half of 2021 was largely in line with 2020 levels, both 2020 and 2021 did see lower levels of public campaigns relative to the pre-COVID period. However, one has to look at activism activity in 2020 and 2021 against the background of the pandemic and the economic recovery in different markets, and lower levels of public campaigns overall should not be misconstrued as a lack of activist activity.
On the contrary, both 2020 and 2021 saw quarters with the number of public campaigns in line with historical averages, indicating a significant undercurrent of activity by activists and a sign of the continued rebound in public campaigns. Companies enter 2022 in a robust activism market, building on the momentum over the past year and the trends and considerations outlined below.
Lessons from an ESG proxy contest
In 2021, the first ESG-focused proxy contest (won by the at-the-time little-known activist fund Engine No. 1) underscored a number of crucial elements. First, many stockholders view ESG issues as inextricably linked to the board’s strategy, and more activists will likely try to seize on this dynamic. The presence or absence of a well-defined strategic plan that incorporates ESG issues is fast rising to the top of stockholder considerations. This is axiomatic at climate-affected companies, but stockholders view ESG as a much broader set of topics than those connected directly to climate and natural resources.
For instance, over the past two years stockholders have been emboldened to make demands, in part, due to the increase in the importance to companies of human capital management issues. As the pandemic unfolded, a company’s ability to retain, train and attract a dedicated workforce became a significant board-level concern. As we enter 2022, many industries are experiencing a shortage of qualified labor. Companies with top-down, board-level investment in human capital management have competitive advantages.
Second, boards of directors and management teams need to prioritize engagement with stockholders on their priorities, lest other actors, including activists, make compelling arguments to them in a manner that results with the board in a defensive posture filling gaps that could have been addressed on a clear day. This consideration should not be confused with simply capitulating to the wishes of stockholders (and activists). Boards of directors and management teams continue to retain an informational advantage over outsiders to the boardroom and their decisions need to be rooted in their information and satisfaction of their fiduciary duties. It does, however, require engaging and incorporating feedback, when and as appropriate, keeping a line of open communication and demonstrating how feedback was incorporated.
Third, good ideas prevail. An activist does not need to be the largest or the most well-resourced to be disruptive. A vacuum of understanding in the stockholder base combined with a good external idea can be compelling, and a mismatch of resources may not be able to overcome a fundamental deficit of stockholder support and goodwill. .
The beginnings of a feeding frenzy fueled by the growth in public companies
Between the second half of 2020 through the end of 2021 (and beyond), there has been an explosion of new public companies thanks to a run on de-SPAC mergers and a heated traditional IPO market. Those companies have emerged with varying levels of traditional defense measures and governance profiles. Not all of them will be successful over the long term, and during the next few years there will be significant opportunities for transformative transactions for both buyers and sellers.
M&A continues to be a primary thesis in many activism campaigns, and the opportunity to engineer, broker and participate in transactions among the newly public company base will be significant for activists. Established public companies will not be immune to this trend, as their own underperformance – or their potential to act as an acquirer – will be areas traditional activists seek to exploit. As a result, boards of directors of public companies will be well-served to continue to think like activists, regularly reviewing their company’s expectations, guidance, and internal projections, being cognizant of real or perceived governance deficiencies, keeping abreast of market developments and evaluating whether it is time to consider strategic alternatives.
Universal proxy on the horizon
The 2022 spring annual meeting season will be the last season in which current proxy cards are in use. Starting August 31, 2022, companies and activists will be required to use a universal proxy card that identifies all nominees for election as a director at an upcoming shareholder meeting. The rules permit companies and activists to list each other’s director candidates and eliminates the short-slate rule. Activists will need to commit to soliciting at least 67 percent of a company’s voting power in a proxy contest. Given the concentration of institutional investor ownership at most public companies such that the top 10 holders can comprise between 30 and 50 percent of a public company’s voting power, this is not likely to be a significant hurdle.
In the 2022 annual meeting season, we expect the dynamics between activists and boards of directors to begin to shift, as companies and activists begin to understand how the impact of universal proxy cards is likely to alter the considerations between settlement and a full proxy contest. In particular, the importance of an activist’s significant stake in a company to the success of their campaign has been diminishing over time and activists have experienced success with even small stakes, including those below the 5 percent Schedule 13D reporting threshold.
As discussed above, the strength of the activist’s idea and its resonance with the stockholder base are more determinative. With activist nominees listed on a company’s proxy card, this trend is likely to continue and spread to additional new and first-time activists, including, perhaps, stockholders that had never considered themselves to be activist in nature.
As a result of these factors, it is imperative that boards of directors and their management teams continue to make progress on their own strategic plans, communication with stakeholders and robust stockholder engagement. For boards of directors that may have perceived a temporary respite from public activism, it is an opportune time to re-engage. For newly public companies, it is never too soon to begin investing in the company’s long-term strategic plan through considered engagement and activism defense. For boards of directors that have made significant progress over the past year, such investment pays dividends only when the investment is nurtured over time.
Key takeaways for boards
- A long-term strategic plan that is well understood by stockholders continues and will continue to be the backbone of activism preparation. ESG considerations do not change that, but there is a shift surrounding the inclusion of ESG and other long-term financial impacts and their role in a well-communicated long-term strategic plan.
Stockholder engagement is imperative. A stockholder base that understands the company's perspective on its standalone plan and a company that understands key issues from stockholders pays dividends to companies in terms of activism preparation and beyond.
- The activism environment continually evolves and for a number of years, has been expanding to include stakeholders not traditionally thought of as activists. 2021 was no exception and we predict these trends will continue through 2022. It is important for boards and management teams to continue to understand the evolving dynamics to reap the benefits of investment and preparation.