
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 Hathaway
(BRK.A) - Get Report
, 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
Citigroup
(C) - Get Report
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.
Ironically, Mozilo was the only director on the board of
Home Depot
(HD) - Get Report
that won overwhelming support from the retail chain's shareholders after its infamous annual meeting in 2006. Then-CEO Bob Nardelli was pilloried for his compensation valued at $245 million over five years, during which the company's stock dropped 12%. Nardelli was ousted later with a severance package valued at $210 million, and since then, shares of Home Depot have shed a quarter of their value.
"There's a general feeling that executive compensation had gotten out of line and it's not being properly correlated with performance to create healthy incentives," says Jim Melican, chairman of Proxy Governance, an advisory firm for institutional shareholders. "Now adding to that, the shareholder losses as a result of the subprime mortgage debacle have created a perception that while shareholders are feeling the pain, the corporate executives who steered them into this mess are still living large."
Hedge Funds Exert Their Influence
Time Warner
(TWX)
Chairman Dick Parsons, who also was summoned to Capitol Hill to testify as head of Citi's compensation committee, once barely fended off a proxy fight from Wall Street's pioneer in activist investing, Carl Icahn, who called on Time Warner to break itself apart to unlock value after its disastrous AOL deal. Parsons helped negotiate the ill-fated merger as the company's president.
Time Warner is just one of many major U.S. companies whose stock price is languishing below where it stood one decade ago. Elsewhere in the media sector, shareholder activism has also held sway.
Disney's
(DIS) - Get Report
former CEO, Michael Eisner, was ousted in 2005 after a surprising and unprecedented 43% of the company's shareholders withheld their proxies to reelect him to the board a year earlier.
At
General Electric
(GE) - Get Report
, pressure is mounting on CEO Jeff Immelt to cut loose its media subsidiary, NBC Universal, as GE shares remain mired well below their decade-old highs.
"Market cap used to be a defense against shareholder activism, but now, no company is too big to become a target," says Young. "These actions at some of the world's largest companies are really unprecedented."
Other bouts of shareholder activism making waves this year include Icahn at
Motorola
( MOT), Jana Partners at
CNet
(CNET) - Get Report
, The Children's Investment Fund at railroad giant
CSX
(CSX) - Get Report
and Harbinger Capital at
New York Times
(NYT) - Get Report
and
Media General
(MEG)
.
Pensions, Unions Join the Fight
In addition to hedge fund activists, so-called governance activist groups are also on the rise. Rather than seek control or strategy changes at target companies, these groups try to force changes in a company's corporate governance practices by targeting board members or policies. They often have backing from large public pension funds and labor unions.
CtW Investment Group, which represents pension funds sponsored by a federation of labor unions called Change to Win, is launching proxy fights to oust directors at a number of financial firms such as Citi, Merrill and
Morgan Stanley
(MS) - Get Report
.
Likewise, the American Federation of State, County and Municipal Employees union is a leading sponsor of say-on-pay proxy proposals, which allow shareholders to cast a nonbinding vote for or against their company's executive compensation plan. Shareholders at nearly 100 U.S. companies, including
Apple
(AAPL) - Get Report
, will vote this year on whether to adopt the measure; a few others, including
Verizon
(VZ) - Get Report
, have already adopted the idea.
Another popular cause for activists is proxy access. Shareholder advocates argue that in at least some cases, public companies should be required to include competing nominees and other proposals from shareholders on their proxies. Otherwise, shareholders are left with little recourse to exercise their rights as owners, unless they can afford to hire a proxy solicitation firm.
For now, the
Securities & Exchange Commission
has quietly opted to allow public companies to block proxy access to shareholders, but that is expected to be reversed if a Democrat wins the White House in November. In the meantime, activists have turned to other popular governance measures that are helping shareholders hold more sway.
Many companies have adopted majority voting rules at their annual meetings. These rules require directors to win approval from over 50% of the votes cast in order to hold their seats. Companies are increasingly abandoning staggered election systems so that shareholders can vote on their entire board of directors every year rather than just a fraction of them, and they're giving up various kinds of takeover defenses that insulated boards from shareholder dissatisfaction.
One of the most important steps for shareholder activists, according to former Vanguard CEO John Bogle, was the SEC's decision in 2003 to require mutual funds to disclose to their clients, the shareholders, how they vote their proxies. Bogle, once named by
Fortune
as one of four investing giants from the 20th century, has argued that the explosion of financial intermediaries like mutual funds and other institutions has distanced the investing public from the companies that put their capital at risk. That has contributed to the rise of a new form of capitalism in the U.S. designed to benefit managers at the expense of owners.
"The consequences of this mutation in our system have substantially weakened our nation's system of capital formation, and what is wrong must be remedied," said Bogle in his 2005 book,
The Battle for the Soul of Capitalism
.
His remedy is simple: "Shareholders unite!"








