When Bill Ackman of Pershing Square came knocking at the door of Canadian Pacific Railway with a request for two board seats, it struck many as a move doomed to failure. CP was an iconic Canadian company that had come off a string of profitable years and was presided over by one of the most stellar boards in this country, populated by the glitterati of the Canadian business establishment. CP directors enjoyed high approval ratings – in the form of extremely low withhold votes – at previous annual meetings.
Within a few months, however, Mr. Ackman was able to persuade shareholders that poor management and inadequate board oversight had allowed CP to decline to the point where it ranked last among North America's big six railways. The boardroom shakeup produced immediate positive changes. CP's share price has increased by 28 per cent since the changes (on top of the 64-per-cent increase from the time of Pershing Square's initial investment). Under new management, CP's operating ratio has already improved and analysts are forecasting record first-quarter 2013 earnings.
As CP shows, shareholder activism can be a very good thing. North American regulators have been pursuing the holy grail of improved corporate governance for public companies over the past decade. During that period there have been numerous initiatives – from best practices guidelines to prescriptive laws – directed at increased board independence; the separation of the chair of the board and the CEO; reforms to executive compensation disclosure; majority voting policies for directors; say-on-pay initiatives; and massive amounts of mandated disclosure required from public companies about their corporate governance practices.
These reforms have generally been constructive developments. But they are not sufficient to enhance board performance.
CP, for example, was a model of compliance with governance standards. But all the legal compliance in the world cannot fix the problems in many Canadian boardrooms: the complacency of the board, the premium placed on "getting along," and the phenomenon of "board capture" where directors are both dependent upon and beholden to the CEO whom they are supposed to supervise. Resort to the courts is not the answer either. The law does not require directors to be smart or pro-active. Moreover, Canadian courts have long shown considerable deference to board decisions.
The shareholder activist therefore is an essential player – a private enforcer of good governance, an antidote to and, in time, an inoculation against boards that are complacent or out of touch.
Shareholder activism is also a healthy alternative to mergers and acquisitions. Traditionally, takeover bids have been the market mechanism of choice for moving assets from bad managers to good managers. But a takeover bid in this context is like using surgery to solve a problem that can be fixed with a headache tablet.
A takeover removes the assets from the public realm, out of the hands of public shareholders, who no longer have the opportunity to benefit from the improvement in the management of the assets, and who no longer have any say in how they are managed. It removes an investment alternative from the marketplace and further limits the opportunity for Canadians to invest their capital. When change is achieved through shareholder activism instead, the disease is treated, but the nasty side effects are avoided.
This year has seen an extraordinary increase in the number of announced proxy contests, to 35 in 2012 from 21 in 2011. The headline-grabbing campaigns of Pershing Square for CP and Jana Partners for Agrium have led some to question the legal regime that governs communications among shareholders.
Securities regulators are also expected to issue new disclosure requirements that will affect activists, by lowering the threshold for reporting ownership of shares of public companies and possibly by limiting the use of the alternative monthly reporting system favoured by institutional investors. Longer term, there may be rules that will attempt to distinguish between shareholders entitled to vote on a matter and those whose economic interest is insufficient to entitle them to a vote – the so-called "empty voters."
Lawmakers will need to tread thoughtfully in this area and think hard about the impact of rule changes on the fledgling business of shareholder activism. In seeking to prevent abusive tactics by some activists, lawmakers should not frustrate the ability of shareholders to push the governance agenda – which, as we saw in CP, can be for the benefit of all shareholders and ultimately for the benefit of Canadian business.
Patricia Olasker is a partner at Davies Ward Phillips & Vineberg in Toronto, which acted as lead counsel for Bill Ackman and Pershing Square Capital in the proxy fight.