Unfortunately, almost all public company boards have limited working hours. The only thing standing between a company's directors and a messy proxy fight is strong financial performance, but the standard for “consistent financial performance” is constantly changing.
Company directors should expect that when their company's stock price experiences double-digit declines, activist investors will begin to take notice. Directors should understand that some of these activists are “professional takeover artists” who firmly believe they can achieve better financial performance than their target boards, and they have the resources and experience to make a compelling case that they can do so.
Sometimes it seems as though activists are waiting for their portfolio company boards to make mistakes, but company boards have the power and expertise to thwart such mistakes.
Southwest's board of directors is currently embroiled in an ugly battle with Elliott Investment Management that has gotten so bad that Elliott has acquired about 11% of the company's shares, allowing it to call a special shareholders meeting to force a change in Southwest's CEO and board of directors. According to Reuters, Elliott has “launched a campaign to oust Southwest's board of directors.” [CEO Bob] It fired Jordan and other senior executives, blaming them for the airline's poor performance. It is pushing Southwest to make changes to how it operates and has laid out plans to replace two-thirds of the airline's 15-member board of directors.
If an activist goes to the trouble of acquiring shares to force the board to act, a proxy contest is inevitable. Activists typically use the following evidence and arguments to remove directors and retain their board seats:
unchecked declines in our stock price and/or deterioration in our financial performance; According to Reuters, Southwest Airlines shares have fallen 43% over the past three years. Can such a long period of poor performance be defended by the CEO and the board without major adjustments? Generally, shareholders who believe in the company will give the board some time to turn things around, but the time given to the board to implement changes varies. Shareholders are not as patient as they used to be. The board must consider that the time to make strategic changes before activists start to question the board's capabilities is decreasing, not increasing. Taking swift and decisive action when performance declines may be a better defense against activist criticism.
The composition of the board lacks the appropriate experience to be effective. If the company's performance worsens, the current board will be held accountable. Elliott called for the removal of the CEO and two-thirds of the board, and introduced several credible candidates with airline experience as replacements. Poor performance will cause the CEO and board to lose confidence in their ability to run the company.
Poor performance will encourage activists to conduct their own evaluation of the board, which will undoubtedly be unfavorable. Therefore, especially in times of poor performance, boards should consider conducting their own independent self-evaluation. Boards have the authority to implement their own board renewal program that can improve overall company performance before being forced to do so by activist investors. Sometimes it is better to refresh the board on your own terms rather than on other terms.
The CEO and the board of directors' decisions cannot be trusted. If the CEO and board take more than a year to show they are on a path to turn the company's fortunes around, their decision-making could be called into question. In his second open letter to shareholders, Elliott said that “trusting these executives, who have a proven inability to run an airline well, to implement 'transformative' strategic changes and make 'difficult decisions' represents long-term risks to the business and its culture.”
It can be hard for boards to convince shareholders that they have the right solutions to problems that have not been resolved for years. Boards may need to consider leveraging ongoing shareholder engagement to build ongoing trust with potential activists. Boards may be able to find a middle ground by listening to criticisms privately before a proxy fight, rather than engaging in acrimonious exchanges in open letters because both sides have reached an impasse. Continuous shareholder engagement may help board members convince investors to trust them to turn the company around. Think about it: if you were a shareholder, who would you trust more: someone who makes their case in person or someone who sends you letters? Putting in the extra effort may help you keep your seat on the board.
