The new U.S. universal proxy rules, implemented in September 2022, may drive a higher volume of proxy contests this upcoming season, giving investors greater leverage to influence the makeup of the board and raising the stakes for executives and boards. As company resilience continues to be tested by several external near-term challenges, investors are increasingly focused on boards being stewards of long-term strategy.
It is critical for boards and directors to prepare, as investor voting policies may leave directors more vulnerable. In fact, a 2023 EY Center for Board Matters survey shows that just over a quarter (27%) of investor respondents said they may be more inclined to support dissident nominees.
What Changed?
Historically, contested director elections at U.S. publicly traded companies have used a competing proxy card format, in which the company issues a proxy card listing its director nominees and the dissident issues a separate proxy card listing the dissident's nominees. In nearly all cases, each side was allowed to list only their own nominees, forcing shareholders to choose between mutually exclusive slates of directors. If a shareholder wanted to vote for even one of the dissident's nominees, they had to vote on the dissident card and, thus, no votes were cast for any of the company nominees. As of September 2022, companies and dissidents alike are required to issue proxy cards listing all candidates. While each party in a proxy contest will still produce and distribute their own proxy cards and accompanying proxy solicitation materials, shareholders now have the opportunity to vote for their preferred candidates regardless of who nominated that candidate.
For dissident shareholders, the impact of the new rules likely depends on the individual activist. For the largest, highest-profile activists, these changes may provide marginal incentive to move forward with the occasional contest that would not have previously been pursued.
The real impact will be seen with small- and medium-sized activists, because these changes make running a proxy contest much more palatable in terms of both cost and probability of success. The increased ability to attract shareholder votes also shifts the leverage in favor of the activists in any settlement negotiations, which could bolster activists' incentives to initiate a proxy contest in the first place. As a result, some activist campaigns that would have not been viable from the dissident's perspective will now see the light of day.
The bottom line is that boards should expect a higher volume of proxy contests in coming years, with more individual directors being targeted and more shareholders potentially willing to vote for change.
What Should Boards and Directors Do Now?
While the traditional rules of activism preparation continue to apply, boards and companies should be even more focused on key issues related to the board itself to dissuade or defend against a contested election. Key actions companies and boards can take to prepare themselves include:
- Seeking education for the board and senior management about the new proxy rules and potential implications. Incremental risks should be fully understood, as should the steps the company is taking to mitigate those risks.
- Conducting a holistic activist vulnerability analysis and taking action based on the findings. Share price performance is only one data point that activists use to identify potential targets. Companies should evaluate risk from the perspective of an activist, which is likely different from the risk assessments traditionally conducted.
- Engaging proactively with shareholders on issues important to them. It is important to tell a robust strategy story tied to sustainable value creation for shareholders. In many cases, shareholders who vote for dissident nominees are simply voting for change, not specifically for the activist's agenda.
- Looking closely at the board's composition and making changes now, if necessary. Many boards use a skills and diversity matrix to assess whether the board has the right mix of experience to support management's execution of the strategy and oversee changing risks and opportunities. Tenure and perceived independence should be examined as well.
- Reviewing how the board's qualifications and effectiveness are communicated. The proxy statement should provide a compelling view into how the board's talent and skills align to the needs of the company. Leading-class companies often publish their skills matrix in their proxy. Doing so helps shareholders understand — and buy into — the rationale for each director's role on the board and can help undermine a dissident's potential call for change.
- Reviewing existing articles and bylaws to make sure they are up to date and making changes where necessary. While the new proxy rules provide minimum requirements with respect to advance notification and information regarding nominees, companies can implement more robust requirements via their articles and bylaws.
- Having a plan in the event an activist emerges. No amount of preparation can completely inoculate a company, but timing is everything, and missteps in the first 24 to 48 hours can prove very costly. A response plan positions the company to retain control of its own narrative as well as credibility with shareholders.
The status quo is no longer acceptable. Shareholders are demanding more than just a rising share price from their portfolio companies. New universal proxy rules will make it easier for traditional shareholder activists and others to seek board representation. Boards and directors should recognize the impact of these rules and act decisively to prepare.