Turning a ‘Cash Cow’ or a ‘Question Mark’ into a ‘Star’ undertaking, as enunciated by the Boston Consulting Group (BCG) Matrix,1 requires the adoption of the modus operandi of Corporate Restructuring. The same is done either by the management of the company itself or, in case of the failure of the management to do so, by the dissident shareholders of the company. Corporate restructuring is a mode of promoting inorganic growth for bringing about a rise in the business capacity of a company. It refers to the process of effecting a change in the organizational structure of a company so as to bring it a step closer towards achieving its pre-determined strategic goals.2 The process is aimed at gaining competitive edge in the market, ensuring survival in difficult economic conditions, increasing market share or enhancing output generating capacities and supply,3 as a response to some external or internal inducement. It culminates in a change in the ownership, control of management, capital structure or operations of the company and sets a path towards better and more efficient growth,4 while skipping a few steps that the organically growing entities have to necessarily follow.
One of the most efficient ways of effecting Corporate Restructuring of a poor-performing company is through gaining control over the management of the company so as to procure a substantial influence over decision-making, policy formulation, resource allocation and financial planning of the company.5 The separation of ownership from the management of the company has facilitated the emergence of a check-and-balance mechanism wherein the control-seeking owners/shareholders constantly monitor the managerial operations while the management tries to pay heed to the continued satisfaction of such shareholders to prevent them from exercising their ownership powers to overthrow the board.6 If dissatisfied, the shareholders can resort to wolf packs to purchase the stock of the company and leverage the same to divert the decision-making in their own favour.7 Wolf packs essentially refer to the hedge funds or other companies, the main business of which is to bring about major structural changes in companies.8 The case of CSX’s proxy contest, wherein two hedge fund companies commenced a battle against the management of CSX highlighting the mis-management of the company and its inefficient performance,9 is one of the most famous examples of proxy contests.
The aforesaid technique of resorting to wolf packs and various other techniques in the hands of dissident shareholders of a company can bring into force proxy fights. With the surge in the instances of shareholder activism,10 many corporate boards have occasionally faced proxy contests which result in the victory of either the incumbent management, essentially implying its continuation as the corporate board of the company, or that of the control-seeking shareholders, implying a change in managerial positions or enhanced shareholder influence on the decision-making process.
The present research discusses the different aspects of proxy contests and analyses the viability of proxy contests as a Corporate Restructuring method in hands of the shareholders. The discussion proceeds as follows: Section I discusses the meaning and scope of proxy contests in light of the growing shareholder activism. Section II describes the positives and negatives of proxy contests. Section III throws light on the defences that incumbent managements can resort to for averting proxy contests. Section IV deals with two recent cases of proxy contents as well as their implications, and analyses the same in light of the discussions made in previous Sections. Lastly, Section V concludes the research article and furnishes few suggestions with respect to proxy contests being used as a measure of corporate restructuring in the hands of dissenting shareholders.
A Proxy Contest refers to the campaign launched by the shareholders of a company, who are either driven by the motive of controlling the company or are dissatisfied with the current functioning of the company through its management.11 Eventual motives of dissidents might include increasing the shareholder’s value by selling a part of the company,12 horizontal or vertical expansion of the company, technological overhaul, market expansion and diversification etc.
The control-seeking dissident shareholders convince other shareholders of the company to vote in a manner that furthers the purposes of disciplining or that of overthrowing the incumbent management of the company.13 In most of the cases, these dissenting shareholders aim at securing seats for themselves or their nominees in the Board of Directors of the company.14 Major factors that evoke proxy contests include inefficient allocation of resources, non-exercising of available and profitable opportunities by the management, unreasonably low stock prices, reduced return on investments and earnings per share for shareholders and other managerial decisions that the dissident shareholders believe will be detrimental for the company.15 No management is completely guarded against proxy contests.16
The suboptimal performance of the management, when conjoined with significantly high ownership holdings of dissident shareholders or their ability to approach institutions like hedge funds etc. to secure votes in their favour, paves way for proxy contests.17 The consideration promised by the dissidents to the other shareholders for lending their valuable votes is not in the form of monetary payment. Rather, such payments are in the form of increased shareholders’ value through improved prospects for the company.18 Both, the management as well as the dissidents, aim at settling the issue at the earliest in light of the mounting costs and outcome uncertainties.19
As previously discussed, proxy contests can be brought about by having recourse to wolf packs. The control-seeking shareholders may approach and agree with the entities forming part of these wolf packs to purchase the shares of the target company and leverage the same to force-out the incumbent management.20 Subsequent to the fulfilment of the purposes of such share purchase, i.e. the victory or the failure of the contest, the wolf pack entities sell-off the target company’s shares,21 for their main business is not to hold onto the shares but is to facilitate changes in corporate control.
Proxy contests and tender offers generally fulfil similar purpose in the eyes of the activists, i.e. of acquiring managerial control in a company. However, the selection of one measure to be adopted out of the two is made on the basis of the ownership structure that the company possesses. Tender offer is more suitable option for the companies having major ownership in the hands of the shareholders that are not a part of the management.22 At the same time, proxy contests are a feasible option for companies that are majorly owned by the management.23 Further, a firm drawing a major part of its capital from loans and borrowings does not leave much window for tender offers, owing to the shortage of acquirable shares, and hence, are more prone to proxy contests.24
Another reason for increasing instances of proxy contests is the adoption of anti-takeover measures by companies. These measures rule-out ‘acquisitions and takeovers’ as a strategy of gaining control over companies and hence, leave fewer alternatives for shareholders to gain corporate control.25 Similar disincentives to use other modes of acquiring corporate control, resulting from unfavourable external or internal business environment factors, further incentivize the usage of proxy contests to instigate managerial changes.26
A proxy contest is a powerful weapon in the hands of the shareholders that can be utilised to discipline the management of a company. Proxy contests and tender offers are used as complementary tools for acquiring control over managements,27 for quite often the former paves way for the latter measure. Control-seeking shareholders can offer a high and attractive bid to other shareholders to avoid the hindrances, including but not limited to shareholder persuasion, outcome uncertainty and preventive managerial tactics, that proxy contests are tainted with.28
With the continuously growing sense of protecting the shareholders’ rights, especially of the minority shareholders, it is imperative that shareholders do not accept to be mute spectators to an ill-functioning management.29 Therefore, proxy contests are an effective tool when seen in light of the notion of shareholder activism, which can be used to create a constant pressure on the management to give out its best performance so as to maximize the shareholders’ value.30
Moreover, proxy contests are easier and cheaper modes to pursue than other modes of gaining managerial control when it comes to small-cap companies, for such companies, though not all of them, tend to be under-prepared for such challenges. Further, they have small market capitalization, making the acquisition of their substantial voting rights even easier, small or no in-house legal department and lesser resources to fight back in cases of contests.31
Therefore, proxy contests can be highly beneficial, provided that the control-seeking shareholders have deeply analysed the capital structure, the scale and the nature of the company. Without triggering any actual damage or loss, they can pressurize the management to ensure that the interests of shareholders are not given a back-seat. In light of the analysis made, shareholders can any day prefer proxy contests over tender offers or any other restructuring method.
The costs of effecting proxy contests are rather high. Sending out proxy forms through mails, circulating newspaper advertisements of the notices of meetings, other meeting expenses, preparation and handing-out of literature, regulatory compliances etc. altogether constitute these costs.32 The shareholders can expect the reimbursement of the same from the company treasury only if they emerge as successful in the contest.33 The defences adopted by the management to escape such contests further enhance these costs and reduce the chances of the shareholders’ victory.34 Undoubtedly, mustering majority vote to win a contest is a difficult venture that entails further search costs and information costs.
One cannot expect the shareholders, other than the control-seeking shareholders, to give a ‘go ahead’ to the contest and to lend their votes against the management of a company unless some evidence of sub-standard performance of the management is furnished to them.35 Such evidence itself is difficult to collect, and absent such evidence, these shareholders lack the motivation to overthrow the corporate board merely on the word of another shareholder. In addition to that, dissident shareholders are required to establish before other shareholders that the company will function better under their management.36 These barriers in turn demotivate the control-seeking shareholders from resorting to proxy contests, thereby stimulating the adoption of other modes of taking over the management of the company.
Moreover, in companies having dispersed ownership, as against concentrated ownership, the former essentially referring to the situation wherein no individual shareholders have substantial ownership or control of the company,37 gaining the support of the majority is a tedious and an extremely difficult process.38 In such cases, shareholders that are dis-satisfied with the managerial performance tend to sell-out their shares rather than raising a proxy fight for control, for they never really intended to participate in the management of the company, given their insubstantial holdings.39
Another negative factor with respect to proxy contests is that it entails the possibility of a subsequent takeover, irrespective of whether or not the dissidents win the contest. Acquirers usually tend to eye companies in weak positions for making their acquisition moves. Further, a management facing a proxy contest is successfully able to trump the votes of financial institutions transacting with the company including banks etc., by threatening a withdrawal from their services in case the management emerges as victorious in the proxy contest.40 This, in turn, ensures that such institutions do not side with the dissidents and further their interests.
Therefore, proxy contests have their own pros and cons. A wise decision of resorting to a particular method of acquiring corporate control can be made only after a thorough study of the ownership pattern and capital structure of the company and pursuant to the collection of robust evidences to support the claims of sub-standard managerial performance.
In the anticipation of challenges in varied forms, managements of companies in today’s scenario try to keep abreast with the tactics to avert the danger.41 Further, they keep in constant contact with hired external advisers and seek continuous advice as well as immediate advice in cases of impending danger of proxy contests.42 However, the ultimate defence that a management can adopt against proxy contests is to ensure high performance levels and to put in best efforts to maximize shareholders’ value.43 Nevertheless, the management may also adopt innumerable other measures and tactics in order to prevent the instances of such contests launched by dissident shareholders.
Quite often, managements tend to window-dress the financial statements and other publically available information related to companies to keep the shareholders satisfied with the managerial performance.44 This is a preventive strategy adopted in the wake of circumstances that suggest that activist shareholders might launch a proxy contest. Occasional extension of Rights Issues, maintenance of transparency in company’s operations, ensuring high stock market prices, issuance of handsome amounts of money as dividends, exercising innovation and regular tapping into new ventures are some other preventive measures that can keep proxy contests at bay. Further, the management of a company shall be on a regular lookout for abnormal increases in trading volumes of its securities, for this might indicate an impending proxy contest by dissidents who are in the pursuit of acquiring substantial holding of the company.45
A wholesome understanding of the capital market performance of securities, value-creation prospects for the company like capital restructuring, better resource allocation options, profitable investments, helpful political activities, measures of enhancing workplace satisfaction, and the requirements of effective communication between the management and shareholders and prompt actions with respect to detrimental changes in the business environment can do wonders for a management that wishes to prevent proxy contests.46
The management shall consider instituting an advance notice period requirement, essentially providing that a challenge can be brought by the shareholders of the company only after furnishing a written notice of a fixed period of time, mentioning all the relevant details with respect to the proposed challenge.47 Such a measure can facilitate the avoidance of surprise challenges to the management and hence, can allow it some time to launch defences to avert such challenges. Further, the management can add few sub-requirements in consultation with legal experts to make a robust provision shielding the management from overthrowing drives.
In fact, the possibilities of proxy contests can be minimised in the very initial stages of the incorporation of a company, especially in the case of a family owned company.48 This can be achieved by issuing dual stock shares that provide superior voting rights, and hence, a greater degree of managerial control, to a particular class of shareholders.49 Therefore, such class is able to control the management by securing major votes in the company. Further, the company may use the Lobster Trap mechanism by issuing a direction that the shareholders holding convertible securities, including warrants, bonds, preference shares etc. amounting to 10% or more of the total capital or the respective stock classes of the company are not allowed to convert the same into voting stock.50 The tactic enables the management to prevent a control-seeking shareholder to muster the required voting power to launch a proxy contest. Additionally, making private placements to friendly investors can be beneficial for the management as such investors can offer support to the management in the wake of a proxy contest.51 Hence, the company can occasionally make private placements and bolster the shield against shareholder activism.
Employees of a particular company would any day prefer to vote for the incumbent management rather than voting in favour of the creation of a new managerial team,52 for the latter might imply a threat to their job security, major changes in workplace environment and work methods, and new policies and objectives of the company. Therefore, a company can provide substantial amount of shares to its employees in the form of Employee Stock Option Plans (ESOPs) rather than handing it out to investors. Such a measure will serve the dual purpose of securing managerial purpose and enhancing employee satisfaction.
A management under attack can protect itself by devising and putting forth a strategy that provides for creation of value for the shareholders.53 The management may consider constituting a small working group consisting of legal and financial advisers for the purpose of formulating such strategies.54 Luring the activist shareholders by highlighting the benefits of such strategies can quench their desire of overthrowing the management. In fact, the management can be accommodative of the views and problems of the activist shareholders and inculcate the same in the aforesaid strategy. If the proposed strategy is sound and satisfactory, activist shareholders might change their minds and afford another chance to the incumbent management. After all, pursuing a proxy contest is highly expensive and hence, the shareholders have the incentive to grab every opportunity to avoid pursuing it.
Another defence, in fact one of the most common defences with respect to corporate control, is the buy-back of shares by the company.55 Such a measure disables or discourages the dissident shareholders and others from mustering votes to gain corporate control,56 for buy-back results in lesser number of shares available for voting against the management. This when coupled with other hindrances including outcome uncertainty and high costs, acts as disincentive for dissidents to continue pursuing a proxy contest. The management may also come up with an amalgamation of different defences to safeguard its position against dissident shareholders.
The instances of proxy contests are rather a few, let alone the instances of successful proxy contests. At this juncture, it is pertinent to analyse few famous cases of proxy contests and understand the nitty-gritties of the same.
In 2018, a restructuring plan was announced by Hyundai Group, a South Korean Conglormerate, with respect to Hyundai Mobis and Hyundai Motor.57 The plan resulted in numerous issues and created considerable dissent among the shareholders, for the company’s stock prices dropped immediately after the announcement of the said plan. Pursuant to this, Paul Singer’s Elliott Management Corp, a United States based Hedge Fund that acquired more than one billion dollar holding in Hyundai,58 targeted Hyundai Motor Group, through a proxy contest. In its letter addressed to the fellow shareholders,59 Elliott highlighted the unsatisfactory treatment of the shareholders by Hyundai on the ground that the management is tainted with the absence of autonomy and answerability and that a huge amount of surplus capital in the company is lying idle. Quoting the same, Elliott called for the votes of other shareholders on its resolutions, to be brought forth in the Annual General Meeting, proposing dividend distribution of ₩4.5 trillion for equity shareholders, constitution of a Compensation and Grievance Committee in the company and appointment of independent directors nominated by shareholders.
Further, Elliott communicated to the other shareholders of Hyundai that efforts have been made for an entire year to persuade the management for resolving corporate governance problems and overcapitalization problems that have resulted in poor stock performance of the company. It stated that the Return on Equity has hit low to 2.2% in 2018 and that the independent directors currently appointed in the company are improper fit for the job. Bringing to light the aforesaid, Elliott extended the assurance that the shareholders will be able to create better value for the company by passing the proposed resolutions. The high dividend will solve the problem of overcapitalization while the independent directors will bring the company at par with international standards of corporate governance.
In order to handle the mounting activism, Hyundai proposed to issue “shareholder-friendly policies”. It tried to justify the retention of liquid money by stating that the same was for the purpose of making acquisitions and for novel car technologies. Eventually, Elliott Management lost the launched proxy contest against Hyundai.60 Even after agreeing to the shortfalls of the company’s management, the shareholders decided to discard the resolution proposals of Elliot because of the advice rendered to them by proxy advisors, including Glass Lewis & Co. and International Shareholder Services Inc., who believed that the demands of Elliot are impractical and exorbitant and will render Hyundai incapable of investing in research and development.61 Henceforth, the shareholders chose to give another chance to the management. Also, the independent directors nominated by Elliott Management were believed to have conflict of interest.62 They favoured the dividend plan as well as the independent directors appointed by Hyundai, but did allow the resolution proposing the setting up of Compensation and Grievance Committee.63
The Hyundai/Elliot matter clearly evinces that the shareholders closely watch the market prices of the shares of their company. They expect from the management, a well-structured and thoroughly planned investment of the surplus capital, in the pursuit of maximizing shareholder’s value. Low-dividend payments, while a company is holding on to enormous amounts of liquid money and has no immediate plans to invest the same, provoke the shareholders to launch proxy contests against the management and to take matters of the company in their own hands.
It is not true to say that Elliott did not try to evoke dialogue between the shareholders and the management to convey their issue to the latter.64 The problem arose when Hyundai disregarded these initial efforts. It is pertinent to note that when Hyundai was retaining surplus money while its stock performed poorly, its competitors including Toyota, General Motors and Fiat Chrysler, were all distributing high dividends and were increasing shareholders wealth by share buy-backs.65 Therefore, it was but natural for some shareholders to raise concerns regarding the management’s functioning.
A definitive proxy statement was filed by Third Point LLC, an SEC registered investment adviser holding more than 8% of Campbell, with the Securities Exchange Commission against Campbell Soup, a multi-national soup company. Third Point demanded the replacement of the entire board of Campbell with the nominees that it appointed.66 Third Point also communicated to the fellow shareholders a presentation depicting the reasons for the inability of the incumbent management of Campbell to run the company well and highlighting the shortcomings of the management that had gravely hampered the shareholder’s value.
In its letter to the fellow shareholders,67 Third Point urged them to replace the Board with better capable “shareholder-aligned leadership” (called the “Independent Slate”) and mentioned about Campbell’s continuously worsening performance due to the blunders already made and being presently made by the management. Third Point also furnished numerical data to the shareholders regarding the negligible accretion in the market value of shares over twenty years, its reducing market share, the high amount of debt in the balance sheet owing to unworthy transactions and the reduction in the earnings per share (more than 50%) as compared to the last quarter.
On top of this, the company did not even have a permanent Chief Executive Officer. Further, Third Point extended the allegations that the board had been busy in serving its own interests, for while the shareholders were making low returns, the board members were earning hefty amounts. Stating the aforementioned, Third Point put forth its own proposals and sought the votes of the shareholders for revamping the board.
In October 2018, Third Point filed a suit against Campbell Soup, alleging that the latter represented wrong picture to the shareholders with respect to the proficiency.68 It further alleged that there was a breach of the fiduciary responsibility of Campbell’s management towards its shareholders due to the non-disclosure of material information that would have significantly affected the voting process at AGMs.69
After few months of heated contest, the two companies reached to a settlement, whereby Campbell agreed to allow two of the nominee directors proposed by Third Point to its Board immediately and to add a third nominee director within few months.70 In return, Third Point agreed to not take any further action for a period of one year.71 Clearly, the management was able to dodge a bullet by reaching the settlement that merely three directors were to be added to the board, as against the replacement of the entire board.
As a result of the settlement agreement, Third Point will have substantial say in the future decisions of the Campbell. Both the groups assured the shareholders of better future performance of Campbell and of creation of higher shareholder’s value. However, Third Point clarified that it will not remain a mute spectator if the company starts to falter again. The two shared their future strategic plan of selling-off Campbell’s foreign business and novel operations of production.72
The manner in which the incumbent management of Campbell Soup handled the proxy contest launched by Third Point is highly commendable. While granting substantial say to Third Point in the decision-making process, the management successfully managed to secure its own position in the company. The case evinces that proxy contests can reach extremely heated stages, even to the extent of filing of suits by the dissident shareholders against the company. The best way to overcome the challenge is to devise a manner in which the hunger of the control-seeking shareholders is satiated, the concerns of other shareholders are appeased and the management does not face a complete overhaul. Nevertheless, the management has to keep a watchful eye and fulfil all the commitments made to the shareholders so as to prevent any further proxy fight with dissident shareholders.
The growing number of proxy contests evidences the growing popularity of the tool in the hands of shareholders. Over time, the value of good corporate governance has gone considerably high in the eyes of shareholders. They demand corporate governance practices to be consonant with the internationally acclaimed standards. Further, activist funds are always on the lookout for the mistakes of managements. Once found, such mistakes can render the shareholders highly dis-satisfied with the management and hence, can conveniently trigger proxy contests. The aim of the shareholders can either be to discipline, pressurize or intimidate the management to efficiently perform its duties or to take the control of the company in their own hands. The decision of launching proxy contests largely depends upon the capital structure, for companies having large proportion of borrowings render it difficult for dissident shareholders to muster shares and votes in its favour. The decision also depends upon the extent to which the ownership of the company is staggered and not accumulated in few hands, especially in the hands of the management itself. The incentive to use other methods of gaining corporate control is inversely related to the incentive to use proxy contests.
Although proxy contests can be costly and can give rise to uncertainties, such contests are truly feared by the management, for the latter would have to spend enormous resources in activating defence mechanisms and would also face job uncertainties. Tactics including window-dressing, buy back, institution of advance notice period, lobster trap, dual stock shares, private placements, ESOPs etc., are highly expensive. In light of this, it is beneficial for the management to perform its duty to the best and not leave any window for challenge. The same can be seen from the case of Hyundai Motor Group and Elliott Group wherein although the dissidents failed to win the contest, there was considerable pressure and uncertainty created for the management for a period of time during which productivity was definitely hampered. Further, the Third Point/Campbell Soup case highlights the importance of strategic future planning, for even the smallest issue, in today’s scenario, can trigger proxy contests.
Therefore, the managements need to pay heed to the expectations of shareholders so as to avoid the chances of the overhaul of the board, and at the same time, monitor and anticipate the future actions of shareholders, especially the large shareholders.73 It shall not ignore the initial signs of dissent among shareholders and shall seriously consider any issue communicated by the shareholders. The management shall keep a continuous and close watch on the stock market performance of the company. It shall try to settle the matter at the very initial stages, without disturbing the productivity of the company. Overall, the management needs to be extremely careful about what is to come in the near future, and hence, keep the defences ready to be used. After-all it is duty of the management to ensure that the interests of the shareholders are not given a back-seat.