Investors Fighting Mad

Editor's note: This is the first in an occasional series exploring the rise in shareholder activism and its impact on U.S. corporations amid the economic downturn.

Just a half decade after the stock market recovered from the collapse of tech stocks, the bursting of another asset bubble -- in housing and credit -- is refocusing scrutiny on the large executive-pay packages at underwhelming companies.

A revolution that started simmering in the post-Enron era has boiled over, with a new generation of shareholder activists determined to change the corporate status quo. Empowered by rich financial backing, an explosion in digital communications, friendlier laws and regulations, widespread discouragement with the stock market and a sea change in public perceptions, these activists are rattling the walls of corporate boardrooms like never before.

"This is shaping up to be the busiest year on record for activist investors," says Chris Young, director of M&A research with RiskMetrics Group, a firm that advises shareholders on proxy matters. "Some predicted the credit crunch would end the rise in activism that we've seen since the governance revolution began at the beginning of this century. Our opinion was that a slower economy or weakness in the stock market is likely to lead to an increase in activism, and that's exactly what we have seen. There are a lot more targets to go after now, and the investor community gets frustrated and more receptive to activists' proposals at a time like this."

FactSet Research Systems, a firm that tracks shareholder activism, reports that the first quarter of 2008 set new records; 149 activist campaigns were launched against boards of directors. During the period, companies gave up 28 board seats to activists, marking the biggest tally since FactSet began tracking that measure at the end of 2005, and the number of proxy fights -- the most confrontational form of activism -- hit an eight-year high for the quarter.

Proxy season, the annual spring ritual where corporate directors face off with their constituents at shareholder meetings for feedback and re-election, has only just begun. Observers are expecting it to be a contentious year.

"When things are going badly, the long knives come out and people start to point fingers," says Whitney Tilson, a fund manager with T2 Partners. "In this post-Enron era, corporate boards of directors are much more sensitive to their duties to represent shareholders, and shareholders are more likely to accept that maybe directors aren't living up to their obligations. There have been some legal changes but also perception changes as well, so the days of the imperial CEO with irrelevant boards of directors are fading."

'Low Tide'

While an old mindset may be fading, memories of Enron, the energy company that collapsed in an accounting scandal seven years ago, are returning to the fore.

Back then, the widespread accounting gimmicks and excessive compensation practices that were exposed at Enron, WorldCom and others led to court battles, changes in accounting laws and rising distrust among the investing public. As a result, shareholders sought more sway over the directors charged with representing their interests at the companies they own.

Assessing the situation facing Wall Street today, the legendary investor Warren Buffett, CEO of Berkshire HathawayBRK.A, began his annual letter to shareholders this year by saying that "you only learn who has been swimming naked when the tide goes out -- and what we are witnessing at some of our largest financial institutions is an ugly sight."

In early March, the former CEO of CitigroupC Charles Prince, and the former head of Merrill Lynch MER Stanley O'Neal, appeared before a congressional committee to justify their lavish exit pay packages in light of the huge losses they delivered to shareholders on their way out last winter. They testified alongside mortgage giant Countrywide Financial CFC CEO Angelo Mozilo, whose questionable lending standards and flurry of personal stock sales before the company's share price tanked 83% last year drew outrage from the investing public.