Investor Relations: A Power Shift in the Making

By Deborah E. Wallace

Investor Relations has become a lightening rod in the current Governance Reform movement.  In an effort to have greater say in company performance, individual shareholders and institutional investors are engaged in major power struggles with their companies’ boards and executive leadership.

Parties in power struggles have various means of resolution available to them, including litigation. But while litigation may be a viable option for institutional investors and for extravagantly funded private equity groups, it is not viable for the vast majority of individual shareholders.  How, then, can the interests of ordinary shareholders have a chance of being protected? 

Investor activism may be a partial solution, despite its relative immaturity and questionable impact. The goals of responsible activism are to give voice to shareholder concerns, to protect the interests of shareholder, and to achieve a positive financial impact on company performance.  While there are many instances in which activism has achieved one or more of these goals for shareholders, the manner in which activism is carried out is often problematic.  Hedge fund and private equity activists as well as institutional activists continue to be perceived, fairly or not, as self-serving and ethically irresponsible.

As the newest eight hundred pound gorilla to enter the IR arena, institutional activism has drawn the attention of both proponents and skeptics.  Proponents argue that, when exercised judiciously, institutional activism is not only an effective way to monitor a company’s performance but also a means of creating shareholder wealth.  Skeptics, on the other hand, argue that institutional activism has a serious downside. Because of the vast resources available to it, institutional activism, the argument goes, is vulnerable to abuse by unethical or “uninformed” portfolio managers seeking to line their own pockets rather responsibly managing the investments of the shareholders they represent.  Ironically, this split between those who favor institutional activism and those who oppose it creates another locus of disagreement, a by-product power struggle of sorts, producing conflict within conflict.

On an optimistic note, there is evidence that a more equal balance between investor and corporate interests can be achieved and not always as a Pyrrhic victory.  Nelson Peltz’s attempt to win 5 seats on the H.J.Heinz board in 2006 (he eventually secured 2 seats) was a notable exception to the recklessness and greed that often characterizes a more typical corporate raider's bid for control. While this battle certainly had its share of tension and unpleasantness, it avoided at least two major traumas. First, it did not cost shareholders hundreds of millions of dollars, as proxy battles so often can. While Heinz disclosed that it spent $14 million on its campaign, which is no chicken scratch, the figure is far less than it might have been.  Second, despite bitter words between Peltz and the board during the campaign, both Peltz and CEO Bill Johnson committed to working closely together once the deal was done and the board restructured.  Burying the hatchet paid off handsomely for shareholders. Within one year of Peltz's Trian Group assuming 2 board seats and working closely with Johnson, Heinz stock increased 34% percent.

CalPERS, the California Public Employees' Retirement System, is another example of how responsible activism.  CalPERS, which in 2006 filed suit against UnitedHealth Group (NYSE: UNH) over its stock-option grant practices, has since partnered with UnitedHealth Group in a very public effort to permit greater shareholder participation in the director nomination process.  As the largest pension fund in the country, with more than $240 billion in assets, CalPERS has developed a proposal that would allow certain UNH shareholders to nominate its own directors of choice on the condition that they, the nominating shareholders, own at least 3 percent of the company’s stock for a minimum of 2 years.  In parallel, UnitedHealth Group has launched a comprehensive website to educate its shareholders about its past problems, the CalPERS proposal and the potential benefits for shareholders of actively engaging in the proxy voting process.  (To read an evaluation of CalPERS, see "Monitoring the Monitor: Evaluating CalPERS Activism".)

For now, we are not yet at the point where we can attempt to define an overall approach to activism by which investors and corporations might come to enjoy some semblance of mutually shared power.  The jury is still out on the costs and benefits of investor activism. The environment in which constructive activism should be most useful is in radical flux.  In the meantime, our time and effort as directors can be best spent by requiring of ourselves more effective and consequential communication with shareholders; routine consideration of the downside as well as the upside of our individual and collective decisions; and a willingness to explore global models of effective investor relations.