Modern boards are under a lot of pressure. They must represent shareholders, work with management, and perform all sorts of compliance duties. All of their various stakeholders have demands and desires, and their goals often conflict, making the job in some ways a no-win. Here are some of the key areas and players that put pressure on boards.
The glamor boys of the investing world, activist hedge funds are renowned for taking small stakes in underperforming companies and then pressuring their boards to sell or change strategies in a way that will pump up the stock price (at least in the short term), at which point they sell for a tidy profit.
When an activist investor arrives on the scene, it’s usually bad news for the board. These investors will threaten a proxy fight if they don’t get their way, which can result in directors losing their positions to rival candidates backed by the activists. It’s not unusual to see groups of activists converge on a company, wolf-pack style, if they smell blood. And make no mistake, activists are successful at changing boards. In 2018, activists won a record 161 board seats, up 56% from the year before.
Still mostly a US phenomenon, activism is going global. European companies accounted for 23% of those targeted, while 12% were headquartered in Asia. Some of the biggest names and their prey:
- Elliott Management: Run by Paul Singer, Elliott in 2018 launched 22 campaigns for board seats, making it far and away the most active hedge fund in the activist space. Recent targets included Dell, Britain’s Sky TV, Telecom Italia, and Hyundai, the South Korean conglomerate.
- Starboard Value: Starboard likes to win board seats—it’s replaced or added directors at more than 60 companies since 2002—and then work with management to address poor capital allocation practices, bloated costs, or other operational deficiencies. Faced with pushback, co-founder and CEO Jeffrey Smith and his team aren’t afraid to give everyone the boot, as happened in 2014 when they ousted the entire board of Darden Restaurants by successfully arguing in a detailed, 294-slide presentation that its operations were inefficient. “The first step in Pasta 101 is to salt the water,” read one slide. Recent targets include Symantec, where it won three board seats.
- Pershing Square Capital Management: Historical success and aggressiveness have made founder William Ackman one of the biggest names in the activist space. In 2014 alone, Pershing generated a return of more than 40%. While Ackman has lost money the past several years, punctuated by his capitulation on a high-profile short campaign at Herbalife, he’s still a force with which to be reckoned. Ackman likes restaurants. Among recent high-profile targets: Chipotle, the restaurant chain, and Starbucks.
As large corporations become more powerful, another type of activist—do-gooders focused on environmental, social, and governance (ESG) objectives—has grown in numbers and influence. One estimate pegs the size of the space at $20 trillion.
From climate change, plastic pollution, and gun control to pay equity, political-spending disclosures, and sustainability reporting, ESG investors use the power of the ballot to pressure boards to make their companies better citizens. The results of those resolutions are non-binding and rarely garner majority support, but they’re having an impact, nonetheless.
Relative to other parts of the investor community, the ESG world is loosely organized and somewhat rag-tag—a compendium of organizers, religious groups, socially conscious nonprofits, progressive smaller investment funds, and, increasingly, larger investors interested in the sustainability of earnings. Some of the players include:
- New York State Common Retirement Fund: State comptroller Thomas DiNapoli has made New York a leader in sustainable investments. Among other things, he has allocated more than $10 billion in retirement fund money to sustainable investments, and filed more than 125 shareholder resolutions related to climate change. Other areas of interest include board diversity and political-spending disclosures.
- The Church of England: The Church has $10 billion of funding for mission-based activities and pension obligations that it’s been using to get a seat at the table and pressure oil companies to reduce carbon emissions. It uses its positions to rally other religious organizations, including the Maryknoll Sisters, and large pension funds to the cause. Recent targets include Exxon and Royal Dutch Shell.
- Walden Asset Management: A pioneer in the space, this Boston-based fund group offered a mutual fund in the 1980s that pressured South African divestments during apartheid. Today it manages $9 billion in assets and is active in pressuring boards to reduce greenhouse-gas emissions and plastic pollution, and to embrace tougher workplace sexual-harassment rules.
- CtW Investment Group: The acronym stands for “Change to Win,” and among the more notable changes it’s after is putting an employee on the board of Alphabet, Google’s parent, and greater board diversity at Amazon.
Large institutional investors
There’s a lot of talk about the “Big Four” institutional investors—BlackRock, Vanguard, Fidelity, and State Street—who are among the biggest shareholders in pretty much any company. Large pension funds, including the California Public Employees’ Retirement System, fit in this group as well. They share a key feature: an inability to stock-pick, because they own parts of almost every company. Many of their most-popular alternatives are index funds.
Large institutions want returns now. But they’re increasingly concerned about ensuring that companies’ business models are sustainable enough to generate profits for pensioners and IRA holders 40 years from now. Among the most notable players in the space:
- BlackRock: The world’s biggest asset manager with more than $6 trillion under management at the end of 2018, the firm founded by Larry Fink has begun to embrace some of the ESG movement’s objectives. His annual letter to CEOs called on companies to find a purpose and to do more to address social issues.
- State Street Global Advisors: Cyrus Taraporevala, head of the $2.5 trillion fund family, likes to write letters, too, only his are penned to boards, not CEOs. In this year’s version, he served notice that the asset manager will be focusing on corporate culture as an “intangible value driver. … Boards sometimes fail to adequately ensure that the current corporate culture aligns with corporate strategy.” The letter was accompanied by a recommended framework for boards to use as a starting point.
- CalPERS: Smaller than the big fund companies, the California Public Employees’ Retirement System is the biggest pension plan in the US with $350 billion in assets under management and a mandate to provide retirement benefits to nearly 2 million state employees. Anne Simpson, director of board governance and strategy, takes the responsibility seriously and isn’t afraid to talk tough about, and with, boards. “The American board has always been best at having the most men, the oldest men and the men who have been there the longest,” she says. “We’ve been working to break up that cabal.”
Investors vote on more than 40,000 issues per-year—so many that even the largest can’t keep up with it all. Enter the proxy advisors, who earn their keep as outsourced research arms for investors and have played a key role in getting boards to embrace best practices in areas like pay-for-performance, transparency and boardroom diversity.
The firms review corporate proxy statements and make voting recommendations on everything from director elections to approving a big M&A deal.
Their influence on the relationship between boards and shareholders is enormous. They’re a source of controversy and consternation for many boards, which resent the proxy advisors’ power and formulaic approach to governance matters, but also need to win their support.
To critics, they’re quasi-regulators who have too much power over the boardroom. A growing movement in Congress would require the firms to register with the SEC and allow companies to fact-check their ratings before they’re published. The firms and big investors are pushing back. Two players control 97% of the market:
- Institutional Shareholder Services (ISS): Launched in 1985 as an entrepreneurial venture to help big investors manage the voting process, Rockville, Maryland-based ISS has grown into the 600-lb. global gorilla of the space. A thumbs-up or thumbs-down from ISS can influence up to 30% of the shareholder vote—more than enough to move the needle on a contested issue, or to produce an embarrassing outcome on a mundane election. ISS meets regularly with its institutional investor clients and is transparent about its expectations, publishing voluminous guidelines and policies to let boards know what it takes to win its support. In its latest push, the firm has threatened to recommend “no” votes against members of board nominating committees in 2020 if the board has no women directors. Critics complain that the benchmarks are overwhelming and too “check-the-box” in their approach, failing to take into account the nuances of a company’s unique situation. They say too many investors follow the recommendations blindly. An ISS recommendation can be overcome, but it usually requires the board working overtime making its case to investors. ISS also makes money by selling separate advisory services that help boards and companies get good scores on its ratings—to many, a glaring conflict of interest that should be remedied by Congress. In recent years, both the House and Senate have considered bills that would regulate them.
- Glass, Lewis & Co: The yin to ISS’s yang, San Francisco-based Glass Lewis is owned by two Canadian pension funds. It does not have a consulting arm and tries to separate itself from ISS as being more pure in pursuit of its original mission. But it faces many of the same criticisms as ISS about the opacity of its decision-making.
From the Sarbanes-Oxley Act to Dodd-Frank, US lawmakers and regulators have spent much of the past two decades setting more (and tougher) requirements for boards, and there’s no reason to expect things will get easier going forward.
The US Securities and Exchange Commission expects boards to play the role of management watchdog. That job includes everything from basic financial reporting and risk-management oversight to setting the right cultural “tone-at-the-top” to overseeing and monitoring cybersecurity efforts. In just the past year, it has issued dozens of orders penalizing companies for cybersecurity missteps.
Other regulatory agencies can get in on the action as well. In one notable example, the Federal Reserve Board, a banking regulator, imposed growth limits on Wells Fargo until the governance and risk-management processes deemed responsible for its phony-account scandal are fixed—and forced the Wells board to replace four directors.
The same applies in virtually every other market, where governance codes and responsibilities are constantly being revised and updated.
Sarbanes-Oxley and Dodd-Frank set new standards for boardroom independence and accountability. A corporate failing can also lead to more direct lawmaker scrutiny of the board’s actions and response—especially if it involves the public. Wells Fargo’s phony-account scandal, Equifax’s data breach, and Mylan’s exorbitant price hikes on EpiPens all led to the top brass being hauled before a high-profile congressional committee.
Don’t underestimate the power of political grandstanding when it comes to the board. The latest legislative effort—the Accountable Capitalism Act introduced last August by US senator Elizabeth Warren—would make all corporations with annual revenue of more than $1 billion subject to a federal governance regime. Among other things, the bill would mandate that at least 40% of directors be elected by employees and that boards consider the interests of all stakeholders—including employees, customers, suppliers, and communities—not just shareholders.
State legislatures are getting in on the act as well. In one of the more noteworthy efforts, California in 2018 passed a law requiring that all boards of public companies headquartered in the state include at least one woman.