This is the heyday of institutional investor activism in proxy contests. Insurgents are running more slates and targeting larger companies. They are also enjoying a higher rate of success: 66 percent of proxy contests this year have been at least partially successful. The reason is probably the support that activists have received from the principal proxy advisors: Institutional Shareholder Services (ISS) and Glass Lewis & Co. According to a recent New York Times Dealbook survey, ISS has backed the insurgent slate in 73 percent of the cases so far in 2013.
All this may be well and good. Shareholders certainly have the right to throw the incumbents out at underperforming companies. But there may also be a dark side to this new activism.
This year, two activist investors, Elliott Management Corp. and Jana Partners, have run minority slates of directors for the boards of Hess Corp. and Agrium Inc., respectively, and each has offered to pay special bonuses to its nominees (and no one else). Elliott will pay bonuses to its five nominees measured by each 1 percent that Hess shares outperform the total rate of return over the next three years on a control group of large oil industry companies. A ceiling limits the maximum payment to a nominee director to $9 million. In the case of the Agrium proxy fight, which Jana narrowly just lost, Jana offered to pay its four nominees a percentage of any profits that the hedge fund itself earned within a three-year period on its Agrium shares.
Both Hess and Agrium have objected that these bonuses are intended to incentivize these nominees to sell the company or promote some other extraordinary transaction in the short run. The activists and their defenders respond that there is no conflict because all shareholders will benefit if the new directors cause each company to outperform its peers.
This claim that incentive compensation aligns the nominees’ interests with those of the shareholders ignores much. First, there are timing conflicts. Two years from today, a bidder might offer a 50 percent premium ($60 for a $40 stock). But for these bonuses, the directors might all believe it was better to decline this offer, because the company’s long-term value in two or three more years was expected to exceed the current premium. Second, there may be disagreements over risk: Leveraging the company up to its eyeballs may raise the short-term stock price, but also expose the company to failure in the next economic downturn. Finally, special bonuses may balkanize the board, creating suspicion and tension.