Risk and the Role of the ‘Activist Board’Principal and co-founder of Nadler Advisory Services
Being on the board of directors should no longer be a spectator sport. In an era of increased activism that is reshaping the entire dynamic of how corporations interact with stakeholders, it is time for the rise of the “activist board,” one that actively engages with management on strategy, direction and process.
Corporations today function in an environment fraught with potential risk from an ever-growing list of sources, from new technologies to cyber attacks to macro-economic and regulatory changes to upstart competitors and pandemics.
Any one of these factors can create conditions that threaten the existence of the enterprise. They present fundamental strategic challenges—raising the possibility that the basic vision, direction, purpose, and rationale of the company may be threatened.
During the past few years, we have seen a new catalyst for change—the activist investor. Since the 1980s the outside investor who seeks to influence fundamental changes in the company has operated under different names—LBO deal makers, takeover firms, etc. In recent years, we’ve experienced a period of low growth and low returns and the accumulation of capital in funds that are run by activists. An estimated $100 billion now sits in the hands of activist investors.
The term “activist investor” covers a lot of territory. Some activists want to reshape the company (through divestiture, merger or acquisition); others look for changes in the balance sheet, usually through reduction of cash. Some want changes in governance, and others want to see operational improvement. Not all activist investors (usually in the form of hedge funds) have the same strategies and approaches. All are looking to realize gains on investments. Some do it by forcing events that enable them to monetize their investment quickly, regardless of the impact on the long-term value of the company. Others seek to build value, and their engagement leaves the company stronger.
Either way, the activist investor cannot be ignored—and that’s truer now than ever before, because the activists have recently succeeded, to an unprecedented degree, in persuading large institutional shareholders to get off the sidelines and support their campaigns. That is quickly reshaping the entire dynamic. It also is convincing boards that they, too, must better anticipate new pressures and respond effectively.
Recently, I participated as a member of the National Association of Corporate Directors (NACD) Blue Ribbon Commission on Strategy Development. Interestingly, we started with the title of “Strategy Recalibration” (how you change strategy when conditions change), but we quickly realized that we were dealing with something much bigger. The ability of a management and a board to thoughtfully and quickly make changes in strategy depends on how the strategy is developed to begin with. A board that was a bystander during strategy development simply lacks the perspective to work effectively with management to make major changes in a short period of time. This provides the board with a deeper understanding of the business and what is driving it.
This era of activist corporate stakeholders—especially activist investors—is giving rise to the “activist board.”
In an environment full of activists who are stakeholders in the corporation—especially activist investors—it is time to think about the “activist board.” What do we mean by that?
Shaping the Role of the ‘Activist Board’
In the past 15 years, the role of the board has changed dramatically. In the 1990s many boards could be viewed as passive observers, frequently under the sway of management due to board structure, composition, and dynamics. Starting with the financial bust of 2000-2001 and the introduction of new rules and regulations (NYSE Listing Requirements, Sarbanes Oxley, Dodd-Frank, etc.) the role of the board has evolved—to that of a more active partner, rather than an occasional collaborator. Recently, many have advocated a more engaged leadership role for the board. The NACD Blue Ribbon Commission came to a similar conclusion.
To be clear, we are not advocating that boards violate the boundaries between governance and management. The board is still responsible for making sure that the management of the company does its job well, not doing management’s job for them. However, in this new environment, the board can only do this by engaging with management more intensively, rather than being a spectator.
The area where this is most dramatic is corporate strategy. The determination of strategy is the most central set of decisions that management makes, and we felt that the board can and should be a more active player in this process. Unfortunately, in many companies, the process for involving boards in strategy is what we call “present and concur.” Periodically the management develops a new major strategic direction (often following a significant problem, the arrival of a new CEO, etc.) and then presents that strategy to the board, often in a strategic offsite. Much of the activity is presentation, question, and answer. However, the board is basically presented with a strategy and it has few choices—concur with the strategy and approve it, concur with some suggested changes, or fail to concur. Failing to concur usually indicates a fundamental lack of faith in the direction of management, which raises other issues.
So we proposed a different approach—to provide the board with optionality. This involves the board in jointly exploring the strategic and environmental challenges with management, agreeing on fundamental assumptions, and working on developing strategic alternatives—different potential approaches. The board partners with management and brings its perspective to the discussion, which may occur over a period of six to nine months. As a result, the board develops a deep understanding of the strategy, the assumptions that drive it, and the decisions involved in it. This equips the board to be helpful when and if the company faces a new source of risk or uncertainty, and needs to make changes in the strategy. The board is an active partner with management in the development of strategic direction.
At the same time, we recognized that there are some inherent barriers to the board becoming activist in a way that adds value to the process. Some of these are:
- Information asymmetry. The board, by definition, has much less information on the company and the industry, and is dependent on management for most of the information it does have.
- Board composition. The board may not have the necessary industry/domain knowledge and experience to add value. The board should not all be from the same industry, but in the service of independence too many boards end up with no industry expertise.
- Lack of clarity about the board’s role. The independent board leader (Non-Executive Chair or Lead Director) needs to create an environment in the board and a relationship with management (especially the CEO) that will enable management to see the board’s activist role as value added, rather than interference and micro-management.
There are examples of boards that have successfully worked through these and other challenges, and made major contributions—in some cases resulting in preserving the existence of the enterprise. The new environment is one that demands activism, and in key areas that activism will need to come from the board of directors.