Food for Thought

• Published date: 01 January 2015
• Date: 01 January 2015
• DOI: http://doi.org/10.1002/bl.30008

4 BOARD LEADERSHIP

“Blame is established

after the fact and is always

a negative appraisal.

Accountability, in contrast,

is established before the

fact and is judgment-free.”

John Carver, “Accountability Isn’t

Blame: It’s a System Characteristic,”

Board Leadership, no. 93 (Sept.–Oct.

2007), San Francisco: Jossey Bass.

FOOD FOR THOUGHT

set of factors that should enter the

vulnerability assessment are more or

less finite. They refer to those issues

that might catch an activist’s eye given

their investment strategy and targeting

objectives. As hinted above, sharehold-

ers’ investment strategy and their tar-

geting decisions are related: Financial

activists (i.e., those on the left-hand

side of the Figure 2 continuum) engage

in activism in order to realize their

investment objectives. Social activists

(i.e., those on the right-hand side of

the Figure 2 continuum), by contrast,

(also) invest in order to realize their

targeting objectives. In extreme cases,

social activists buy stock just for the

purpose of activism. In other words, in

these extreme instances investments

are means to ends and activists use

their ownership rights to push through

their personal, educational, and/or

political interests. Admittedly, these

extreme cases are rare, but they exist.

Most commentators and advisors on

shareholder activism focus on financial

activists and those issues that make

companies vulnerable to financial activ-

ists’ attacks. In their Harvard Business

Review article, Coyne and Witter6 cat-

egorize investors into financial addicts,

strategy junkies, and organizational

mavens. Financial addicts, on the one

hand, engage in what can be termed

balance-sheet or financial activism. The

set of factors that makes companies

vulnerable to these activists’ attacks

are related to the company’s financial

condition, core assets, and results. Con-

sequently, to assess their company’s

vulnerability to become a target of

balance-sheet activism, directors should

scrutinize things like earnings esti-

mates, operating margins, and capital

deployment decisions, including stock

repurchases and dividends.

Strategy junkies, on the other hand,

engage in a type of activism that is

commonly referred to as income-

statement or operational activism.

Income-statement activists focus on

issues that affect a company’s income

statement or cash flow. They are par-

ticularly wary of the company’s cost

structure, technology, and products

and services. Targeting is triggered

when companies accumulate high cash

flow reserves; when they have an unfa-

vorable cost structure, high research

and development (R&D) expenses, high

restructuring costs, or when they are

on the verge of losing market share or

competitive advantage to their com-

petitors. A vulnerability assessment

evaluating the possibility of becoming

a target of income-statement activism

thus includes investigating whether the

company can be accused of hoarding

cash or to have a bad business strategy

or poor operational execution.

Organizational mavens, finally,

investigate a company’s leadership

structure and governance. Organiza-

tional mavens engage in what some

have termed governance activism.

Governance activists target companies

that they believe have a poor execu-

tive team, CEO, or board. They also

become active when dissatisfied with

the design of executive compensa-

tion or when they don’t see the link

between executive pay and company

performance. Poor governance in gen-

eral, such as the appointment of direc-

tors that they believe lack sufficient

independence, or the implementation

of takeover defense mechanisms (such

as dual-class shares or poison pills)

are also among the factors that make

a company vulnerable to governance

activists attacks. In assessing their vul-

nerability, companies should examine

to what extent they abide by principles

(and codices) of good governance, and

if they don’t what kind of explanation

they can reasonably provide for their

noncompliance.

Often neglected, yet no less impor-

tant, is social activism. Because social

activists often hold only few shares,

companies tend to underestimate their

impact. However, when their cause

finds the ear of a broader audience,

they can become a source of almost

irreparable losses to company and

director reputation. A prominent case

in point is Daniel Vasella, the former

CEO and chairman of Novartis, the

Swiss-based pharmaceutical company,

who was accused of receiving a fat-cat

salary and surrendered to public pres-

sure, renouncing his “noncompete”

pay-out of $78 million.

Social activists thus are well-

informed, well-networked, and very

persistent and can become very pow-

erful. As a result, companies are well

advised to include social, environmen-

tal, and spiritual factors into their vul-

nerability assessment. A good way to

do this is to include their social rating

scores into their analysis. A number of

organizations, such as Risk Metrics, pro-

vide such scores. Companies can then

use the movements in these scores

as an early warning system and brace

themselves with answers should activ-

ists come knocking on their doors.

A final step necessary in the vulner-

ability assessment is the weighting of

factors that found their way to the list.

Be it due to a different shareholder

makeup, company size or visibility, or

different industry or sector, the factors

discussed above will not be equally

important for all companies. Instead,

directors should additionally assess

each factor according to the impact it

has commensurate with its potential to

hurt the company’s financial and repu-

tations capital. The factors can then

be mapped in a vulnerability scorecard

(see Figure 3), providing a quick insight

into the vulnerability level at a given

point in time. Needless to say, the

vulnerability assessment should be peri-

odically repeated. Again, movements of