Assessing the merits of an activist investor's point of view: by adhering to these recommended principles and practices--objectivity, dialogue, appropriate involvement of management, attention to major investors, and prudent use of outsiders--boards can more adequately and accurately respond to an activist's approach.

• Author: Dysart, Theodore L

Comb through any major business publication or website over the past two years and you were likely to see a story about "the golden age of investor activism." And no wonder. According to the firm Hedge Fund Research, activist investing was the top-performing strategy among hedge funds in 2013, with such firms returning, on average, 16.6 percent while other hedge funds returned 9.5 percent. Activist funds continued that dominance in 2014, earning through the first half of the year almost double the returns for the average hedge fund.

Not only have the returns grown, but so have the targets. According to the financial information firm Activist insight, which tracks trends in shareholder activism, the number of companies worth more than $10 billion that were targeted by activist investors was almost twice as high in 2013 as it was in 2012, rising to 42 large-cap companies from 23 the previous year.

The activists' campaigns are also enjoying more success. Institutional Shareholder Services (ISS) estimates that activists secured board seats in 68 percent of proxy fights in 2013 (not including cases in which board seats were gained in a settlement without a fight), versus 43 percent in 2012. In the context of M&A deals, says the Harvard Law School Forum on Corporate Governance and Financial Regulation, it has been estimated that the percentage of activist attacks that were successful in either raising deal price or terminating a deal was 71 percent through November of 2013, an enormous increase from 25 percent in 2012.

What this suggests is that few companies are immune to the attentions of activists either now or at some point in the future, especially if the stock slips significantly or the company performs poorly. Inevitably, directors will find themselves squarely in the middle, compelled by their fiduciary responsibility to the stockholders to carefully weigh the wisdom, value, and soundness of the activist's proposals and respond appropriately. Assessing those proposals begins with an assessment of the activists themselves.

Assessing the activist

As John Cahill, chairman of Kraft Foods Group and a former partner at private equity firm Ripplewood Holdings, observes, activists run the gamut from those who want to cooperate with the board and management of target companies to "headline hunters" who do not genuinely have the best interests of all shareholders at heart. Many activists, he says, are reasonably easy to work with and most want to be extended the...