The CEO Role and Its Expanding Challenges
by William J. Catacosinos, Laurel Hill Advisory Group
All of us have seen the emphasis that is being put on corporate governance and the role of the board of directors. I think it is fair to say this is a result of the Dodd-Frank legislation that was passed as a result of the economic downturn we have had and continue to suffer. Whether it is The Wall Street Journal, The New York Times, or the folks in Harvard, most of the emphasis has been on the role of the Board, it’s Compensation Committee, Say- on-Pay, and the expressions that have come about – Over boarding, the Golden Leash, Refresh. What appears to be lacking is the importance of the role of the Chief Executive Officer during these troubled economic times and the onset of the Activists.
We may or may not have lost sight of the role of the Chief Executive Officer of the company, but it is relevant to review. The CEO is the individual who is the driving force that makes the company work, or not work. The CEO is the one the Board of Directors looks to, to develop the long-term strategy of the company, and obviously, to review that plan with the Board. This is the individual who has the responsibility to develop an executive succession plan which is deep enough that he has individuals within his organization who could be tapped for a senior position in the event it becomes vacant or, in fact, enable the Board to act in the event of a tragic event which requires a successor for the CEO position. One would want that successor to be a competent individual who has been developed within the organization. No company would want to have the experience Hewlett Packard has had where in three successive, short-term periods the CEO had to be replaced, and the Board determined no one within the HP organization was an individual the Board would be comfortable in appointing CEO. The result was, each time the Board went to the outside for a replacement. In our view, that is a problem which truly should never have occurred and could have been avoided.
ACTIVIST’S ROLES AND THEIR EXPANDED REACH
Activists look for economic opportunities they believe will result in financial benefit to their investors, and once they have identified these economic opportunities, they look for vulnerabilities to justify their interest, investments, and proposed changes.
The Activists are creating challenges for the CEO’s not only in the United States, but in Australia, Europe and the U.K. They are no longer viewed as they were in the 80’s, an annoyance that needed to be bought off. Rather, they are and have established themselves as very credible professional entities that are inhabited by smart individuals, they are well financed, and they have demonstrated they can be, and are successful in providing extraordinary returns to their investors in this economic environment. Their success has led many institutional investors to either support them or, in fact, to invest in their funds in order to participate in the returns they have been able to achieve.
We know from a recent publication Activist Investing, the top ten Activist funds in 2013 launched 85 campaigns, made 77 investments, totaling 30 billion dollars. This obviously is not the total capital available that has been invested in 2013 because we have not explored the data concerning the other 90 Activist funds and the capital they have available. Clearly, this is serious business. As we have witnessed, no company, no matter how large or successful, can escape the attention of the Activist.
The CEO has to determine whether or not his company may be vulnerable and as a result become an attraction to Activists.
This is another challenge for the CEO. That individual has to be the one to be prepared to respond in the event his company is approached by Activists and their demands. The CEO has to be in a position to evaluate the demands of the Activist, determine the manner in which he would respond, and then bring his Board into the picture so they are aware of the circumstances surrounding the interest of the Activist in their company. It is important, of course, that the CEO not ignore the Activist, and with the support of the Board, engage in a dialogue with the Activist to determine specifically what their interest may, or may not be. The benefit it may or may not have to his company, and the position he would recommend the Board take concerning the Activists and their interest. The CEO has, as a result, an additional burden that has been imposed upon his office that he has to be prepared to engage – if the need arises.
So what should the CEO do? Our position is the CEO has to do a thorough review of his company in order to determine if there are vulnerabilities that could lead to interest by Activists. This review would have to be done in an objective, robust manner – with the complete support of the CEO and the Board. To begin, the CEO has to put in place a team that would have the responsibility of carrying out the assignment of evaluating the company against this backdrop of Activist interest. We would recommend that the CEO include, as part of his team, outside counsel familiar with Activists, what they look for, how they conduct themselves and the strategies which may be put in place in the event there is a need. We will outline below, and it is strictly a simple outline and varies from Company to Company, what needs to be looked at – the starting point and the end point.
Once the team is assembled and their charter clearly annunciated and understood, the starting point is the bylaws of the company – and then it flows from there:
1. Number of Board members;
2. Board committees;
3. Board independence;
4. Self evaluation;
5. Criteria for selection;
6. Frequency of Committee and Board meetings;
7. The Management Structure of the Board;
8. Board diversity;
9. Committee charters;
10. Responsibilities of the Board;
11. Strategic Plan review;
12. Assessment of Executive Team;
13. Succession plan in place;
14. Crisis Management Team;
15. Peer review evaluation, that is – market share, revenue growth, profitability, etc.;
16. Assess with management any major issues and/or concerns;
17. Quarterly financial reviews;
19. Retainer committee fees;
20. Stock awards;
21. Communication – How often? Who is responsible?
22. Meeting with the CEO alone periodically;
23. Meeting with key members of the executive team periodically;
24. The Board interaction with institutional investors.
All of this revolves around the Board, as Activist Investing research suggests – 40% of Activists objectives involve Board personnel changes. The reality is the CEO, with help from his staff, has to manage all of these issues. The role of the team, doing the detailed evaluation is obviously to look for flaws. As we said earlier in the beginning of this topic, the Board is and has been the focal point of Corporate Governance since Dodd-Frank.
However, we have lost sight of the key role the CEO plays in the well being and health of the company and the value that he/she is responsible for providing to his or her shareholders. The evaluation we are discussing clearly requires an assessment, not only of the bylaws, but also the Board to address any issues which may arise to avoid being used as a wedge against the company. The most recent example is the ongoing eBay battle. But vulnerabilities may exist in other areas, e.g., a peer evaluation in terms of market share, revenue growth, profitability, R&D expenditures, which are the heart and soul of a company’s well being. Companies either grow and continue to prosper, or they slowly fail and eventually fade away in some manner.
That is a heavy burden for any one individual to carry, but we have imposed that upon the role of the CEO of the company which he or she has accepted and he or she is being measured in the market place in the form of valuation that the markets put on the company, which obviously is going to be reflected in the stock price. These flaws may show up in different areas that we may not have considered vulnerable. We might have considered that an asset or a positive for a company is the amount of cash on hand. Some people have seen that as a positive, but can be viewed as a negative because it is not being distributed out in some measure to the shareholders. Which leads to another responsibility the CEO has, that is to communicate effectively the company’s strategic plan to its major shareholders and articulate why the cash is being built up and held in the company’s treasury. There may be a solid, valid reason for that, but unless the market understands the rationale, it may become an area of vulnerability.
It is essential to conduct a rigorous self evaluation so the company can determine areas that may make them vulnerable to Activists. It can also uncover flaws that the company did not know existed. By having this exercise take place, the CEO is in a position to assess his company’s situation and if there are areas that create exposure and require to be addressed, then the CEO can move forward to correct them.
Further, he will be better armed and better prepared to deal with an Activist in the event there is an interest. The odds are, if a company does a significant objective, no holds barred evaluation, and uncovers vulnerabilities and corrects them, the company reduces its chances of becoming a target of opportunity.
All of us need to pause, step back, and evaluate the additional burden imposed upon the CEO as a result of the activities emanating from the requirements of Dodd-Frank which all of us are familiar with. But, they continue to arise. The latest, if it survives the comment period and the court challenge will be the ratio between the median compensation in a company and that of the CEO. For many companies the exposure of this kind of ratio is going to be a public relations nightmare – which the CEO and his team have to be prepared to deal with in the event this requirement is put in place. It is something that cannot be ignored. It has to be faced with rational, understandable dialogue, tailored for the various constituents to which the company is responsible. Not the least of which may be Union Pension Funds, funds that have a Social and/or Environmental interest, State and City funds, and the media that can turn this kind of information into an on-going circus.
The Boy Scout motto is “Be Prepared.” In order to “Be Prepared,” take a thorough, objective look at oneself by not only insiders, but by outsiders who understand the additional risks the CEO is burdened with today.
Prepare by not assuming or taking the status quo for granted.
Prepare by having in place a source of continuing intelligence concerning the shareholder base and its dynamics. That is, a Stock Surveillance process that provides daily and weekly intelligence – not merely a data dump, but an ongoing, daily analysis via an effective analytical Stock Surveillance program that flags unusual activity or changes, identifies any suspects and any trends that need to be observed and evaluated.
Dr. William J. Catacosinos is the Senior Partner of the Laurel Hill Advisory Group, North America’s only independent Shareholder Communication and Asset Recovery Firm. With offices in New York, Boston, Toronto, and Vancouver, Laurel Hill specializes in contested or Annual Meeting Solicitation, Information Agent Services, Corporate Actions, Mergers and Acquisitions and Shareholder Asset Recovery Programs. For more information please contact Dr. Catacosinos at firstname.lastname@example.org or call (516) 933-3100. Or visit us as www.laurelhill.com.