COVID-19 continues to impact companies financially, operationally, and strategically. Confronting unprecedented levels of volatility and stock price declines, and the potential for a painful economic contraction, has many boards of directors and management teams searching for ways to protect their companies from opportunistic bidders and shareholder activists who may seek to take advantage of the current global disruption.
This environment demonstrates why boards and management teams must remain focused on all of a company's stakeholders. Whether it is the health of the company's employees, the soundness of the company's customers or the needs of the communities in which the company operates, the best companies are continuing to support all of those who rely on the company for everything from jobs to health insurance to the manufacturing and distribution of critical products.
At the same time, many companies are more vulnerable to shareholder activists and others who may seek to use the current situation to gain an economic advantage. Because many companies have eliminated their structural protections in recent years (including things such as classified boards and even dual-class stock), the opportunities for disruption are even greater. Paradoxically, companies with strong businesses and balance sheets may be particularly vulnerable to near term stock price declines because these companies will hold the most interest for shareholder activists and hostile acquirers.
Below are a number of steps that boards can proactively take to determine their company's vulnerability in this environment as well as to prepare in the event that their company becomes a target.
Board Preparedness. Boards and management teams should closely coordinate with the company's outside advisors to ensure that the risks to the company and its stakeholders from COVID-19, as well as management's strategies for minimizing and mitigating those risks, are well understood. Companies need to be proactive about ensuring that they have adequate liquidity in what could be a challenging environment, in addition to understanding how potential liquidity needs intersect with the company's existing indebtedness and sources of capital, including bank and bond financings, lines of credit, availability of revolvers, and key covenant terms. As part of this process, the board will want to consider, and potentially adjust, the company's current and future dividend and buyback polices. Similarly, the coming months will see many companies change their capital allocation plans, and boards need to understand how the management team intends to communicate those adjustments. Finally, boards should be proactive in participating in decisions to withdraw or change guidance, as these decisions (and the related disclosures) can subject the board to risk.
At the same time that boards are reviewing the impact of changed economic environment on the company's business, directors must also recognize that deep-pocketed shareholder activists are giving a renewed look at companies who have seen a decline in their stock price. Fortunately for many companies, director nomination and business matter proposal deadlines for annual meetings have passed for the current proxy season. That said, the oft-repeated advice to "think like an activist" is especially apt right now. If the board were looking at the company on an unemotional, financial basis (as a shareholder activist does), what are the options that might be considered to quickly increase the company's stock price? Does the current mix of businesses still make sense, or should some be prepped for sale or closure? Activists often focus on companies that have not exited businesses or product lines where they cannot be successful, or where the management team lacks reasonable operational capability. One historical issue that activists have focused on is pushing companies to return "excess" cash to stockholders, typically in the form of buybacks or dividends. Given the present instability of capital markets, however, this type of pressure may not be as great, at least initially.
Management succession plans should be reviewed to ensure that the company can withstand the unavailability of multiple key employees on a rapid basis. Boards should think broadly about which employees are critical. Now is also an ideal time to review crisis management plans and enterprise risk management and business continuity programs. It is safe to assume that few, if any, companies planned for the full impact of COVID-19. But it has provided important lessons that can be incorporated into these plans in preparation for the next crisis. For example, was the board able to get timely access to the information necessary to make quality decisions? More broadly, many companies may need to reevaluate and revise their long-term business plans to ensure that they still make sense given the substantial dislocation of COVID-19.
Directors should take a fresh look at compensation plans to determine if any changes are needed, particularly with respect to equity-based compensation. This review should not be limited to senior executives. Indeed, it is possible that this new environment will start to reward companies for providing appropriate compensation and benefit programs for all employees.
When conditions stabilize, boards should continue with rigorous self-assessments. This process, often best done with the assistance of outside advisers, seeks to identify weaknesses and avenues for improvement, including with respect to the skills makeup of the board. Board refreshment, and especially board diversity, has become a major focus of institutional investors as well as shareholder activists. Regular planning for matching the board's needs for various skills and diversity with additions to the board can and help to blunt an activist attack that focuses on the need for "fresh perspectives" among the directors.
Finally, depending on conditions at the company, there may be an opportunity to evaluate and pursue transactions that make sense in light of current circumstances, including the broader market declines. For many companies, there will be substantial opportunities to deploy capital on favorable terms, including through acquisitions and repurchases of securities.
In all of this, board unity, cohesiveness and mutual respect are paramount. Board discussions should be frank and rigorous but stay inside the boardroom. No director should speak for the company unless explicitly authorized to do so.
Takeover Defenses. As mentioned, many companies eliminated most, if not all, of their structural protections over the past 10 years, including dismantling classified boards. However, most companies still have the ability to adopt a stockholder rights plan (also known as a "poison pill"). Recent weeks have seen a modest, though significant, uptick in the implementation of stockholder rights plans. Although it is too early to tell if this trend will continue, now represents an ideal time to refresh the board's understanding of the operation of a stockholder rights plan and the circumstances that would warrant adoption. Putting a stockholder rights plan "on the shelf" (meaning the plan is drafted and ready to be used, but is not actually implemented) may also be appropriate and represent an opportunity for director education and to demonstrate a proactive approach. The decision to implement a stockholder rights plan involves a number of considerations—including an evaluation of the likely reactions of proxy advisory firms and the company's major institutional investors—that should be thought through carefully. As such, adopting a rights plan is a facts-and-circumstances decision that will vary by company.
Companies with significant net operating losses (NOLs) should evaluate whether a stockholder rights plan focused on preserving the value of the company's NOLs—often known as an "NOL rights plan" or a "Section 382 rights plan"—would be appropriate. Tax reform in 2017 reduced the value of NOLs generally but such a plan may still make sense for some companies. In addition, tax rate increases in the future have the potential to restore some or all of the pre-2017 value of NOLs. Although not strictly a takeover defense, an NOL rights plan can be effective in serving that purpose.
Stock Price and Valuation. The market sell-off attributable to COVID-19 suggests that current stock prices are driven more by uncertainty than a long-term shift in valuation. Nevertheless, stock performance is almost always the first factor that attracts shareholder activists. Undoubtedly some activists will use a low stock price to establish (or add to) a position in order to initiate an activist campaign at a later date. Stock watch programs can provide an important early warning sign of unfriendly accumulations; they are a basic element of every public company's preparedness efforts. Companies that do not have a stock watch program should put one in place, and those that do should carefully scrutinize changes in ownership.
Maintain Shareholder Engagement. Now more than ever companies should focus on maximizing the value of their shareholder engagement efforts. Institutional investors are already stretched as the calendar moves into the heart of a proxy season of unprecedented complexity. Travel restrictions and mandatory work-from-home policies increase the need for companies to be targeted and impactful with the limited attention that they can get from their institutional investors. Keep engagement focused on the long-term business plan and what the board is doing to support that plan, both right now and the months ahead. If there are changes to the long-term business plan coming out of this crisis, consider how they should be presented to investors. Make sure that investors understand why the current mix of directors is the right one for the company, including the unique skills that each director brings. Environmental, social, and governance (ESG) issues will remain an important topic of shareholder engagement. Also be prepared for investors to be curious about how the board is functioning and responding during this period.
