Rise of the Activist Investor

Rapidly growing shareholder activism is demanding listed boards engage more with investors on a broader range of issues. This requires deeper focus and different skills, reports Tony Featherstone. Is your board ready?

Shareholder activism will radically transform the board’s role in investor relations and directors are unprepared for the change, warns Canadian governance practitioner Professor David Beatty. He believes investor relations is becoming a board role, rather than a management one, as shareholder activism intensifies and the market shifts its focus to corporate environmental, social and governance (ESG) performance.

“Boards will have to own investor relations,” he says. “It’s a new governance responsibility that has emerged in the past few years and is going to get much bigger.”

Beatty is a senior advisor to McKinsey & Company and Conway chair of the Clarkson Centre for Business Ethics and Effectiveness at the University of Toronto’s Rotman School of Management. Having served on some 40 boards and chaired nine publicly traded companies, Beatty has followed the shareholder activism boom in the US and its impact on listed company boards in the areas of strategy communication and investor relations closely.

“The effect of activists on governance and investor relations has been spectacular,” he says. “We are now seeing activists work together or with pension funds, to mobilise trillions of dollars of previously passive capital. Investors want to know a lot from the board about the organisation’s governance and strategy, and will take action if they’re unhappy.”

Beatty says the global governance community is lagging behind the change. “The trend is reasonably new and, frankly, a little scary for boards, particularly those that suddenly have to communicate with a wider group of investors on a wider range of issues.”

His view has support — and American corporations and investors are leading the change. Intel chair Andy Bryant reportedly meets with the company’s largest shareholders quarterly, while the heads of the world’s largest investment firms, BlackRock and The Vanguard Group, have recently written open letters to CEOs and boards on the issue.

In January, Larry Fink, CEO of BlackRock, which has US$6.3 trillion under investment, warned companies it was stepping up its “investor stewardship” program and that companies must start accounting for their societal impact. BlackRock expected companies to demonstrate to investors that the board was engaged with the strategic direction of the company.

If Beatty’s view is correct, boards of large Australian companies will have to re-examine their organisation’s investor-relations capability and their own role in shareholder engagement. At one extreme, it could lead to the sharing of investor-related tasks among directors — the investor relations officer reporting to the board, the formation of shareholder engagement committees, and it being considered in board composition and skill matrices.

At minimum, the board workload around investor relations will expand in the next five years. Chairs of large ASX companies could spend up to 20 per cent of their time on shareholder engagement tasks (double the current amount), which is in line with the proportion of time CEOs spend on this function, according to Ian Matheson, CEO of the Australasian Investor Relations Association (AIRA).

How directors are responding

Diane Smith-Gander FAICD says investor relations has become a “hot topic” in governance. “A lot of non-executive directors are talking about the board’s increasing workload in shareholder engagement. Some boards are trying to benchmark their activities against other companies and work out which areas to focus on.”

A former chair of Broadspectrum and current non-executive director of Wesfarmers and AGL Energy, Smith-Gander says chairs of ASX 200 companies are making themselves more available for investor meetings.

“The offer was always there, but chairs are a lot more proactive on this issue.” High-performing boards have comprehensive shareholder engagement strategies, she says. “There is a lot of work behind the scenes to understand the company’s share register and issues that matter to key investors. Boards understand the importance of building and maintaining relationships with key investors and that it’s not only a management task.”

She says her work on shareholder engagement at Broadspectrum (before its 2016 takeover and ASX delisting) reinforced the value of boards in IR. “The board had an excellent relationship with Broadspectrum’s largest investors. These relationships are critical during a takeover attempt or when investor support is required on another matter. [They] cannot be built overnight and require a lot of board effort to maintain.”

Blurring board-management boundaries

Deborah Page AM FAICD, a non-executive director of Brickworks, Service Stream and GBST Holdings, says the governance focus on shareholder engagement blurs the line between board and management. “The concept of the non-executive director is increasingly [being] challenged. Shareholder engagement is another example of boards taking on management-type work. If you go back as little as five years, it was management who mostly met with institutional investors and were accountable for shareholder engagement.” Page says regulators are also spending time with boards. “The UK regulator [Financial Conduct Authority] meets with boards of asset managers, particularly audit and risk committees. That adds to the work boards are doing in their broader stakeholder engagement programs.”

However, Page outlines the tensions that can emerge. Like others, Page is concerned about the risk of too many directors meeting with investors.

“On the one hand, there is a groundswell of investors who want deeper engagement with boards through one-on-one meetings,” she says. “On the other, we have non-executive directors who often have several roles and are not working every day in the business, so they don’t have the knowledge that management has about specific company issues.”

Warwick Bryan, the former executive general manager of investor relations at the Commonwealth Bank, now an advisor at Reunion Capital Partners, believes boards can overestimate their skill in this area. “Directors who have not been the CEO or CFO of a listed company often have limited experience in interacting with investors and don’t necessarily understand how markets operate. They don’t fully understand the complexities of this field or the risks if it’s done poorly,” says Bryan. “It’s a huge risk to have different directors talking to investors. The chair must lead the board’s shareholder engagement because other directors might not sufficiently understand the market’s expectations for their company. There is potential for mixed messages, confusion and continuous disclosure breaches.”

Shareholder class actions are another consideration, adds Page, as the number of securities class actions has been rising in recent years. “Boards are very concerned about the threat of shareholder class actions and realise that there are people out there every day looking for class-action opportunities. Putting more news in the market, potentially through investor meetings, adds to this threat.”

What’s driving shareholder engagement?

• Growth in responsible investing: At December 2016, 44 per cent of professionally managed assets ($622b) in Australia used responsible investment methodology (up nine per cent on the previous year) according to the Responsible Investment Association Australia (Responsible Investment Benchmark Report 2017). Responsible investing incorporates environmental, social and governance data into buy-and-sell decisions, a trend that has led to the emergence of specialist analysts, data collectors and advisors — and, in turn, a wider range of ESG-focused investors seeking board meetings.
• Internalisation of asset management: Large superannuation firms are investing directly, rather than outsourcing to fund managers. They want meetings with boards on ESG issues.
• Risk management: As ESG issues such as climate change exposures morph from environmental matters to material financial issues, asset owners want deeper understanding of the board’s risk-management oversight — meaning extra meetings.
• Changing community attitudes: Young investors increasingly see their capital as a force for social change — a trend that has led to a boom in ethical investing in the past three years. Superannuation funds are responding to member demands to invest responsibly by lifting their focus on ESG performance, governance and communication with boards.

Reforming investor relations

In November, the Australian Council of Superannuation Investors (ACSI) argued that the current shareholder resolution framework is flawed and recommended reforms to give shareholders a “greater voice on ESG”. In the proposed reforms, outlined in its report, Shareholder resolutions in Australia: Is there a better way? ACSI suggests a “mechanism for escalating ESG issues where company engagement is not working”.

The council has provided guidance on four environmental, social and governance issues it has identified as impacting the majority of ASX 200 companies — climate change, labour and human rights, corporate culture and tax disclosure. “We want to see all companies better managing climate-related, labour and human rights or disclosure risks. Our proposal for reform will help deliver this,” said CEO Louise Davidson.

Governance guidelines also extend to tax transparency — essentially, ACSI is calling on boards to ensure their organisation does not engage in aggressive tax planning. Also in November, AIRA released ESG Engagement Guidelines to help listed companies effectively engage with investors. It believes an organisation’s investor relations officer should coordinate ESG communication from board and management to the market, saying there is a risk of inadequate internal communication on issues that straddle various parts of organisations.

The revamped Markets in Financial Instruments Directive (MiFID II), implemented in January in the European Union, also has IR implications for Australian boards. The change, designed to unbundle stockbroking research and corporate access from trading commissions, could lead to ASX-listed companies having more direct contact with international investors as sell-side broking firms organise fewer meetings.

What boards have to get across

Feedback from the latest AIRA conference suggests international investors will increasingly approach ASX-listed companies directly for meetings, to avoid paying brokers a fee to organise corporate access. The onus will be on companies and boards to lift engagement with international investors if they can no longer rely as much on broking firms for offshore promotion.

AIRA’s Ian Matheson says some ASX-listed companies in the top 100 excel at shareholder engagement. “But in many cases, boards are not getting sufficient IR intelligence. Shareholder engagement trends have crept up on them.”

Up to a third of ASX 200 companies don't have an internal IR executive, according to AIRA, the role led by the CFO or another executive, or outsourced. This potentially exposes boards to continuous disclosure and selective disclosure risks (where information is not disclosed uniformly to the market), and alienates beneficial owners such as superannuation funds.

“ESG issues are becoming more material and thus subject to continuous disclosure requirements,” says Matheson. “Asset owners expect boards to be across a range of ESG issues and for the company’s investor relations to incorporate ESG matters.”

Relying overly on an organisation’s investment banking advisor for investor information is another threat, says Bryan. “In some companies, the investment banker becomes a proxy for investor relations advice. That can be risky because the investment banker is not independent and/or an expert in IR.”

Perhaps the biggest challenge for boards is internal. As ESG issues broaden, boards will have to re-examine the interaction of subcommittees on shareholder engagement matters. Investor relations issues increasingly will cut across the board’s risk, audit, sustainability and remuneration subcommittees.

“Ensuring the firm’s IR officer is tapped into the right subcommittees and that important shareholder engagement information from multiple committees is reported to the main board are critical,” says Bryan. “It’s dangerous for boards to look too far beyond their primary purpose of safeguarding shareholder interests. The best defence is good company performance. Directors should not go overboard in IR.”

In his annual letter to CEOs, BlackRock’s Larry Fink challenged companies globally to focus on the social impact and responsibility.

“The time has come for a new model of shareholder engagement,” he wrote, “one that strengthens and deepens communication between shareholders and the companies that they own. Engagement needs to be a year-round conversation about improving long-term value.”

How boards are approaching investor engagement

Generally, Australian boards have reasonable balance in shareholder engagement. The chair of an ASX 200 company might have 20 to 30 meetings with investors and intermediaries in the lead-up to its annual general meeting. These could include domestic and international meetings with super funds, fund managers and proxy advisors.

Usually, the meetings are conducted over a week or two and the chair of the board or the chair of the remuneration committee (for executive pay issues) almost always leads them. Other meetings may occur around the organisation’s half-year result or an extraordinary general meeting. A corporate crisis — such as an unexpected CEO succession event or hostile takeover — could easily double the number of meetings between the chair and key investors.

The evolution of shareholder engagement and boards quickened after the GFC. The board’s main communication with investors through the AGM morphed into a small number of meetings with fund managers. That broadened about five years ago to include proxy advisory firms, which make voting recommendations for clients. The focus was mostly on corporate performance, executive pay and governance.

Today, the meeting schedule can include beneficial owners, such as industry superannuation funds, active and index asset managers, proxy advisors, environmental, social and governance performance analysts and, in some cases, non-government organisations on environmental matters. More international meetings are being held, partly because ESG analysts from key American firms are based overseas.

The chair could be expected to discuss everything from corporate strategy, succession planning, executive pay, board composition and skills, digital disruption and diversity, to climate change exposure, human rights issues in supply-chain management, corporate culture and ethics, staff turnover, occupational health and safety, and sexual harassment policies.