Idea in Brief
Institutional investors have become a vocal constituency, pressing the board to act in ways that will ensure the company’s long-term survival. At the same time, directors cannot ignore the interests of activist investors who seek short-term wins.
By meeting regularly with big shareholders, board members can gain valuable information about the company and its competitors and build alliances to help defend against activist attacks.
The Way to Engage
The board should be transparent about its approach to talent, strategy, risk, and oversight of management. It should leave financial disclosures to the CEO but encourage open dialogue with investors—including activists, whose analytical rigor can be useful regardless of their goals.
Index funds and other long-term investors are no longer a silent majority of shareholders. They have become a vocal constituency, asking boards to resist short-term pressures and act in ways that will ensure the perpetuity of their companies. This development gives boards an opportunity to help shift the center of gravity toward long-term thinking—something that many management teams, academic experts, and public policy makers advocate.
Boards can make their biggest impact by bringing that long-term focus to what we call the new TSR—not total shareholder return but talent, strategy, and risk. When a company gets those aspects of the business right, sustainable success will follow.
Yet as boards attend to shareholders who favor patient capital, they cannot ignore the interests of others aiming for quick profits. They need a new playbook to manage the inherent tension and complexity that come with an increasingly diverse range of shareholders and stakeholders.
We’ve spent years working with boards, top executives, and the investment community, and we’ve interviewed the heads of dozens of public and private companies and investment firms. In this article we provide guidance on how and when to meet with investors, how to get useful feedback, how to understand what each type of investor is looking for, and how to anticipate and ward off attacks from activists pressing for short-term wins. Although our advice is directed at board members, the insights will be valuable to CEOs, other members of the senior management team, and large shareholders as well.
Think of your investors as a resource. Whether aligned with or hostile to your long-term objectives, they often have fresh ideas about the company and its competitors.
Why Meet with Investors?
Some boards resist talking with investors, reasoning that management has that base covered. We think such a mindset is a mistake. Investors can be an independent source of information, supplying important details that management may not convey but that the board should be aware of.
For many years Estée Lauder discouraged its directors from talking with investors. But Vanguard, which has a sizable stake in the company, recently asked to meet with the board member in charge of the compensation committee. Following much discussion, the member agreed. After the meeting, the director returned to the boardroom with several insights that management hadn’t shared about its investor interactions. Board member Lynn Forester de Rothschild says the report was an eye-opener. “I was skeptical of board engagement with institutional investors, but I now think it is a really good idea for both sides,” she told us. “It makes management nervous, for obvious reasons. But I think we should try to do as much of it as the investment community wants.”
When you meet with investors, they are likely to ask questions designed to expose your vulnerabilities—operational, financial, and competitive.
Engaging with big shareholders can help you identify which are committed for the long haul and which might support activists pushing for a quick profit. It’s an opportunity to build alliances. The point at which an activist arrives on your doorstep is not the moment you want to start educating major investors about your story and strategy. Communicating clearly all along can keep them on your side when you stumble or encounter opposition.
Sharing a clear rationale for what you’re doing and what to expect may also head activists off at the pass. When Rajiv Gupta, now the chair of Aptiv, was on the board of Tyco International, an activist fund took a position in the company. Gupta recalls that the fund’s representatives met with the chairman of the board and the CEO and concluded, “You guys are doing just about everything we would do.” Three months later, Gupta says, “they walked away and sold their position.” A potentially bruising battle for control had been averted. (Disclosure: One of us, Carey, recruited board members to Tyco, and Charan consulted for the company years ago. Charan also previously consulted for four other companies mentioned in this article—DuPont, Ford, Nokia, and Microsoft—and gave several presentations at a Microsoft CEO summit.)
What Investors Want to Know
When you meet with investors of any sort, they are likely to ask questions designed to expose your vulnerabilities—operational, financial, and competitive. They will also probe your oversight of the management team. They want to satisfy themselves that you are managing talent, strategy, and risk to enhance shareholder returns, whether for short-term gain or long-term value.
To prepare for this scrutiny, you need to adopt an investor’s mindset. For starters, that means candidly sizing up your fellow directors. Dan Riff, the head of investor relations at Advantage Solutions, advises looking to see whether directors who are former CEOs bring the same expertise and urgency to their board work that they exhibited when running their companies. “Sometimes,” he says, “they retire from CEO roles where they were amazing and settle back a bit on the board and rubber-stamp a lot of what the others are doing. When was the last time the board really got in the field and got its hands dirty with upper-middle management?”
Be mindful of time constraints and pacing; you want to keep investors engaged rather than crushed by information.
Investors might also ask how you prepare for succession, both in the company and on the board, and how you ensure that the company is building the capabilities needed for sustained growth. In addition, they will want to know how you are developing sources of information so that you can make independent judgments about the market for talent.
You should also be ready to discuss executive compensation. The level of pay, along with the types of compensation and the triggers for enhanced rewards, will tell investors whether the company is emphasizing short- or long-term growth or balancing the two. For instance, annual bonuses and rewards often rise in tandem with the stock price; that’s normal. But if the CEO gets a 200% bonus for exceeding the target price, that’s a driver of short-termism. And if the company wants to pull money from the future to meet short-term goals, investors will want to know whether management must first seek board approval.
Investors will be curious, too, about the board’s operations. What are your biggest debates about? Are discussions truly focused on strategic opportunities and risks, or do they devolve to procedural matters? What skills will the board lack as the business evolves, and how is it addressing the holes? How much time do you spend on each important matter in your purview? Do you engage with outside experts when making decisions about large capital allocations?
Investors will also ask questions related to social impact. What has the board done to help the company be a good corporate citizen, to promote diversity in its ranks, and to respond to climate change? In most companies, management decides how to track value creation. Do directors ever question management’s methods or ask for changes in them?
You can be certain your investors are poring over your proxy statements, looking for insights about what metrics the board uses to assess performance, along with information about incentives and stock ownership levels among managers. Make sure you know as much about your company as those who are researching you do.
When to Meet with Investors
Creating a relationship with an investor takes time—and you want to solidify it before you need that party’s help. We believe regular meetings are key. Former Xerox CEO and board chair Anne Mulcahy aimed to meet with the top 20 or 30 investors every 18 months to two years. “The intent is to have a regular cadence so that you can actually have relationships,” she says. “It’s both listening and sharing messages that you’d like them to hear.” Be mindful of time constraints and pacing; you want to keep investors engaged rather than crushed by information. But Mulcahy recommends accommodating any sizable investor who asks for a meeting: “Try to say yes 99% of the time.”
Some people advise a lighter hand. “I wouldn’t prescribe boards to interact on a regular basis with all sets of shareholders,” says Daniel Pozen, of Wellington Management. “It would be responsible practice for a board to invite one shareholder per year to give a presentation on its perspective of the company.” With this approach, the type of shareholder should rotate: One year it could be a passive shareholder, another year a long-term active shareholder, then a former shareholder whose exit holds important lessons.
Investors’ desire to meet with your board, and the optimal frequency of meetings, will depend on your company’s size and the size of the investment. Tailor your approach accordingly.
Who Should Take Meetings—and What Should Be Discussed
We recommend that boards establish a talent, compensation, and execution committee to oversee the recruitment, pay, and performance of the company’s senior leaders. Ideally, the chair of the strategy and risk committee will be part of this new group. Thus, it is the one place on the board where the key areas of the new TSR converge, and its members are the directors who are best prepared for investor engagement.
Whoever takes such meetings should limit what’s disclosed. The board’s main task is to find out what investors think of and know about the company. It’s appropriate to tell them how you oversee talent, strategy, risk, and the management team. But it’s not your role to disclose material information about financials or future plans; that’s the job of the CEO, with advice and coaching from the board. Some best practices to encourage:
Be transparent, and honor your commitments.
Companies should do what they have promised, even if that doesn’t align with an investor’s favored strategy. General Motors, for example, has a highly diverse investor base, with widely different timelines for realizing returns. It tries to manage the relationship with each investor but always does what it believes will foster long-term value.
Warren Buffett, the CEO and chair of Berkshire Hathaway, argues for a high degree of openness. He treats stockholders as he would co-owners who are siblings, discussing what worries him, what the various businesses are worth, how durable their competitive advantage is, and how he plans to allocate capital. “The CEO absolutely owes that to the owners,” he says. “I believe strongly that everybody’s entitled to the same information, and that means information about valuation prospects and personnel—exactly what you would tell a silent partner.”
Avoid or limit earnings guidance.
Whether to issue earnings guidance is one of the thorniest issues public companies face in dealing with investors. Our advice: Don’t do it unless you absolutely have to—and if you do, give yourself plenty of leeway. “As a public company ourselves, we avoided issuing guidance like the plague,” says former T. Rowe Price chair Brian Rogers. “Companies and management always want to underpromise and overdeliver, but all too often management teams get caught up in the overpromise, because it feels good in the short term. And if you disappoint, there’s hell to pay.”
Moreover, while it can cause companies grief, guidance is rarely very useful to investors. If a stock goes down because of a nonstructural issue, it will usually bounce back soon, because in most companies the 10 biggest shareholders—likely to be institutional investors who won’t pull their money out—own at least 50%. The rest is in the hands of activist traders, who have no choice but to react.
Giving guidance will change analysts’ advice, however, focusing them more keenly on short-term performance. So if you can get out of the guidance business, or at least make guidance very long-range, you will have more room to pursue long-term objectives.
Keep an open mind.
The information flow with investors operates in both directions, and companies stand to gain valuable insights from it. General Motors CEO Mary Barra considers input from any investor. “The first thing we do when we get a suggestion is ask, ‘Hey, is this a good idea? Let’s go research this,’” she says. After every earnings call, she and a few other executives reach out to some of the firm’s top investors and to short-term-focused hedge funds and listen to them all. The conversations have sparked new initiatives, especially on environmental issues, and contributed to GM’s adoption of a more comprehensive set of sustainability goals.
Dan Saelinger/Trunk Archive
Anne Mulcahy recalls that when she sat on Target’s board, the activist investor William Ackman, whose Pershing Square Capital Management owned 10% of the company, approached with proposals for restructuring. Although much of what he recommended didn’t resonate, the directors benefited from hearing him out. “He had one good idea, which was to sell our financing arm—and we did,” Mulcahy says.
How to Deal with Activists
If you want to manage for the long term, activist investors pose a special threat. Be on guard, but don’t assume they are the root of all evil. Even if their goals are wrong, they can be a fount of information.
In our experience, activists do much more extensive analytical work than any other players to identify deficiencies in a company’s strategy and structure. They might invest millions of dollars consulting experts and interviewing former and current employees, suppliers, and customers. You might not act on their analysis in the same ways they would, but they do get to the bottom of performance issues. So be prepared to learn from their questions and to discuss their input with the CEO.
Activists also pour resources into evaluating portfolios and mergers and acquisitions; for example, they will typically investigate how many of your acquisitions created value and how many destroyed it. They will look at whether your answers jibe with their research, which will tell them how solid and knowledgeable the board is. So prepare for such inquiries thoroughly.
Know what type of activist you’re facing.
Activists come in different stripes. Some may want to break apart your portfolio; some may try to create opportunities for a merger; some think a lot like long-term investors.
The greatest threat comes from activists who operate on a short timeline and are prepared to launch a takeover bid if earnings are disappointing. Smart companies anticipate and head off issues that might make them vulnerable. For instance, although liquidity is important as a hedge against crisis, you must balance the benefit against the risk of carrying too much cash on your balance sheet, which could make you an appealing takeover target.
But don’t abandon long-term thinking because of concern about activist threats. “When we go on [a corporate] board, we find that management is the one that is short-term-focused,” says Ed Garden, the chief investment officer at Trian Partners, speaking of companies in which the hedge fund invests. “They’ve been conditioned by the market to think short term. We’re the ones saying, ‘Let’s plan for 2025.’”
Be pragmatic when activists buy into your firm—even if they join your board.
You can’t control who owns you, but you can sway the conversation. If activists take a position in your company, engage them and try to help them understand your objectives.
Most hostile suitors don’t act alone. Remember that the top 10 investors in a company usually own at least half the shares. Without their support, no activist can split up the company or oust its board or CEO. So the best way to defend against short-term activists is to keep your large investors close. Focus on communicating with them and persuading them to remain on your side.
If activists force their way onto the board, your best move is to listen closely and judge them by what they are saying, even if you don’t like how they are saying it. It may pay to actually invite activists to join the board, if they have demonstrated a genuine interest in long-term growth.
In some cases activists come onto the board because the fundamentals of the company aren’t working. After ValueAct Capital bought a $2 billion stake in Microsoft, the software company made several bad bets, such as spending $7.2 billion to buy Nokia’s mobile-phone business. ValueAct used its clout to place its president on the Microsoft board, after which Steve Ballmer stepped down as CEO—changes that helped set the company back on course. (Ballmer has said that leaving was his idea, though insiders attribute his exit to pressure from ValueAct, which prefers not to comment.)
And consider what the activist investor Nelson Peltz, a founder of Trian Partners, does when he joins the board of a company in which Trian holds a sizable stake. He will install one of the firm’s most knowledgeable industry partners in a war room with the board members and insist that they hold meetings with multiple layers of management. The tactic can feel like an invasion, and it can rattle the other directors. But it generates valuable questions and information.
If activists force their way onto the board, your best move is to listen closely and judge them by what they are saying, even if you don’t like how they’re saying it.
Here’s another example from Trian of positive change triggered by an activist investor, although in this case the firm didn’t secure a board seat. In 2013, after Trian took a position in DuPont, its team had a series of meetings with leaders of the chemical maker to discuss three imperatives in the activist playbook—cutting costs, reshaping the capital structure, and rethinking the portfolio of businesses—plus strengthening corporate governance. One idea Trian proposed early on was to split the company in three. But according to Nick Fanandakis, who was DuPont’s CFO at the time, Trian’s estimates of savings were over the top. “They said we could cut $2 billion to $4 billion from overhead costs,” he recalls. “We only had $4 billion to $5 billion in overhead costs.” DuPont wanted instead to merge with the Dow Chemical Company.
The conflict raged for two years. Then, after a downturn in DuPont’s agricultural business, the CEO retired, and Ed Breen—a recent addition to DuPont’s board—took the reins. DuPont eventually combined with Dow, realigned the collective businesses, and split into agriculture, specialty, and commodity companies—an amalgam of Trian’s suggestion to divide the company in three and DuPont’s preference for a straight-up merger.
The transformation from a conglomerate to a trio of focused businesses unlocked tremendous value. Under Breen’s leadership, DuPont jettisoned its long-standing matrix organizational structure for one based on business lines, generating direct and indirect savings. As the businesses got their costs under control, Fanandakis says, they took a more critical look at expenditures. In all, DuPont shaved $1 billion from annual costs—just a portion of what Trian had claimed it would save, but still a significant sum.
Looking back, Fanandakis thinks the company was too quick to perceive Trian Partners as the enemy. “Because the information Trian hit us with in the first meetings was so extreme,” he says, “we hunched our shoulders and went into battle. If we were going to do it tomorrow, I wouldn’t be so defensive.” In the end, the activist’s presence helped DuPont cut expenses, improve its capital structure, and revamp its portfolio, all to the benefit of long-term value.
Prepare for destructive activists.
Unfortunately, some activists will live up to your worst nightmares. Former Vanguard CEO Jack Brennan argues that having one on the board almost always changes the dynamic for the worse. “The market should be the force ensuring that boards and management teams are as productive and cost-effective and driven to succeed as they can be,” he says. “Having a person with an agenda—that’s different. The activist takes advantage of an aberration or creates an aberration to be disruptive.”
The disruption may come from demeanor alone. Shelly Lazarus, the chair emeritus of Ogilvy & Mather, believes that some activists go too far in board meetings. “The content of what activists bring is really important,” she says, “but it doesn’t make a board more effective when you have somebody throwing firebombs every half hour.”
Sometimes disruption from investors—of any type—takes the form of obsession with minor details. If you’re an old-line company, you may suffer from a double standard in the way investors treat you. State Street’s Ron O’Hanley says that when Mark Fields was Ford’s CEO, Wall Street and the media subjected him to a lot of nit-picking, although his plan for leading the automaker proved to be pretty good. Meanwhile, investors gave the more-impulsive Elon Musk, at Tesla, a relative pass. “We let the disrupter get away with the conceptual charts, and we’re boring away at the incumbent, looking at spreadsheet line G42 and saying why is it x as opposed to 1.2x?” O’Hanley recalls. “We may be asking different questions [of legacy firms and upstarts], but we should have the same level of scrutiny.”
Be cognizant of such frictions; that way they won’t blindside you. And remember that even the most challenging relationships can bear fruit. Remain open-minded, but also be prepared to stick to your guns. The most important thing is to engage with your long-term shareholders early and often—that is, before a crisis. Regular dialogue will help your permanent investors understand what you’re doing, and they’ll be more likely to help you if a proxy fight erupts.
Think like an activist.
As a director, you need the backbone to support managers in taking the long view, but you should also understand why they might be tempted to emphasize the short term. So you must be aware of all the pressure points and opportunities an activist shareholder might identify.
Activists evaluate companies in a number of ways. They look at capital structure and cost structure—both operating and marketing costs. Legacy companies tend to treat sales, general, and administrative expenses as one item. Digital companies, however, break out the cost of sales and consider it an investment in growth. Investors measure the efficiency of these firms by seeing how their sales expense as a share of revenue compares with the same ratio for their peers. At the software company Citrix, for example, sales and marketing expenses amounted to 40% of revenue in 2014—well above the industry average. Activists moved in the following year.
Activists look at a company’s portfolio too. If it contains unrelated businesses, does each piece perform better than its industry peers? Do management claims of synergy translate to dollars and cents? Would any pieces be more valuable to somebody else? Managers of diversified companies sometimes allocate cash from a healthy business to a sick one—a red flag. Sears did so in the 1980s and 1990s when it branched out into financial services, real estate, and online network services and consequently failed to invest enough in IT, causing the company to flounder.
Regular efforts to communicate will give your investors a fuller picture of the company they own, and you will gain insights into their concerns.
Companies that are slow to adapt to the digital age—such as brick-and-mortar retailers—are also common targets. And activists look for undervalued stock. The market may not see the potential in a company’s strategy or its latest initiatives, perhaps because management has failed to earn investors’ trust. The board must create allies in the investment community to ensure support for well-founded long-term plans.
Throughout, the role of directors is to build credibility with investors. You need to help managers find ways to meet quarterly performance milestones even as they forge the company’s future. If your firm makes investor calls, encourage the CEO to provide detailed information about what is happening on the ground—the progress of a product launch, say, or an update on a plant expansion announced the previous year—while heading off discussions focused on quarterly results. When responding to investors’ questions, executives should connect the short and long terms. Listen carefully to the calls, and watch for defensiveness on the part of management and within your own ranks.
Some companies hold so-called investor days. Smart executives use them to talk about strategy. JPMorgan Chase holds a conference for investors every year, covering every line of its business. Three months beforehand, managers start grilling one another on questions they might face. When getting ready, Mary Erdoes, the CEO of the firm’s Asset & Wealth Management business, asks her staff to “tell me the truth, nothing but the truth, so help me God.” She says, “You prep like nothing else.” Regular efforts to communicate will pay handsome dividends: Your investors will get a fuller picture of the company they own, and you will gain insights into their most pressing concerns.
. . .
Leading for the long term is easier said than done. After all, the long term is made up of many short terms, and some shareholders are simply looking for quick profits. It takes courage, vision, and will to balance the siren call of short-termism with a truly long-range vision.
Boards have a key role to play in this effort. A company’s sitting directors may collectively span decades of service—far longer than their CEO’s likely tenure. They thus have a unique perspective from which they can counsel management and focus their attention on talent, strategy, and risk—the surest way to create long-term value. But directors must also be open to what investors have to say. Engaging more deeply with investors can help boards make smarter decisions about the new TSR and win support for their plans—to the benefit not only of their companies but of the economy and capital markets too. Nations depend on capital markets, and boards are central to their efficiency. If you, as directors, take advantage of your position, you can be true leaders for the future.
Editor’s note: Bill McNabb, Ram Charan, and Dennis Carey are the coauthors of Talent, Strategy, Risk: How Investors and Boards Are Redefining TSR (Harvard Business Review Press, 2021) from which this article is adapted.