Shareholder Activism Enters the Boardroom

Over the last month or so, an interesting debate has surfaced
that takes shareholder activism to the next level. As the Deal
Professor column
notes, two hedge funds have initiated proposals whereby
they have promised to pay their nominees, if elected to the board of the
investee company, director compensation linked to the profitability of the
company as if they were executives. The promised compensation has two parts:
one, a fixed retainer/fee; another, a bonus depending upon the financial
performance of the company that could extend to a few million dollars. This has
the effect of treating institutional shareholder nominees on par with
executives for the purpose of compensation. This development raises a number of
legal issues pertaining to corporate law and corporate governance. Although the
details regarding the issue are only beginning to get fleshed out, a post
on the Conglomerate Blog
helpfully provides links to the key debates.
Although shareholder activism has taken off quite strongly in
India (as noted here and here), it
might be some time away before the issue of institutional investor nominees
takes such a deep grounding in the Indian context. Nevertheless, it is useful
to consider some of the key conceptual issues that this gives rise to:
1.         The
first issue relates to who pays the compensation to the institutional nominee
directors. The current trend seems to suggest that the compensation is paid by
the nominator/investor rather than the company itself, which would minimise the
effect of the usual issues pertaining to executive compensation if it were to
be paid by the company itself.
2.         These
appointments could create factions on the board, i.e. between the inside
directors (executives) and the so-called outsiders (nominees), thereby possibly
curbing efficient (if not effective) decision-making. A contrarian approach to
this would suggest that such differing views and perspectives may actually be
beneficial to the overall well-being of the company and the interest of the
3.         There
could be questions regarding the effectiveness of the nominee directors. For
example, given that they are non-executive directors, they may have
difficulties in accessing information regarding the business of the company or
to other officers in the same way as an executive director can.
4.         It
is unclear if the nominee directors may be willing to take on the risk of
facing liability because they may have responsibilities without the accompanying
power or control within the company.
5.         As
these directors are nominated by the institutional investors (who may have a
significant holding in the company), it is unlikely that these directors would
be treated as independent directors. Their appointment on the board may tilt
the balance of independent and non-independent directors which may make it
difficult to comply with the requisite board independence requirements under
the corporate governance norms without appointing more independent directors
maintain the appropriate balance.
6.         Since
the nominee directors would owe fiduciary duties to the company, they are in an
unenviable position whereby they may have to prefer the interests of the
company over those of their nominating investor in case of a conflict between
those interests.

These are only some initial
thoughts, but a number of other issues and concerns on both sides of the debate
are contained in the links provided above.

Update – May 14, 2013: A memo
from Wachtell Lipton provides a strong response to the proposal for offer of incentive
compensation to investor nominees, and a
by the Deal Professor advocates caution in adopting the incentive compensation

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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