Attention board members, investor activism and its widening influence are here to stay.

 Activist investors have become an everyday presence in the business news headlines, affecting companies as iconic as Apple and Sotheby's and industries as varied as restaurants (Darden) and pharmaceuticals (Allegan). Nonetheless, many directors may not yet appreciate that such shareowners augur change that is not going away anytime soon.

A favorite story from the pulpit may illustrate this state of affairs. A preacher is seeking to jar his flock into focusing on the big picture. “Everyone in this congregation is going to die!” he declares at the start of a sermon. All are struck silent, except for one man in the front who starts to laugh. Thinking the gentleman may have misheard, the preacher repeats, louder, “Everyone in this congregation is going to die!” Silence rules again, but the man in front laughs even more. The preacher steps off the pulpit, solemnly puts his arm around the gentleman, and quietly explains the message he was trying to deliver. “I understand perfectly, father,” the man smiles back. “It's just that … I'm not a member of this congregation!”

When it comes to activism, we are all in this congregation. Activism is here to stay for a simple reason: It makes money. Academics have been trying with mixed success to determine whether shareholder intervention on governance creates value. The latest research—due this summer from a team led by Henley Business School's Andreas Hoepner—finds strong evidence that it does. But real-world investors haven't waited around for scholars to agree. They've gone out and scored serious returns from activism, spawning a whole new cadre of funds billing themselves as champions of value from governance. Amid all the noise about activism, there are underlying trends and tips to spotlight.

The seeming omnipresence of investor activism is sure to spark attempts to curb it. The JOBS Act of 2012, for example, slipped through Congress with bipartisan support, gutting governance regulations for whole categories of public, or soon to be public, companies. A JOBS Act 2.0 bill is in gestation and, if it advances, could be a vehicle for further restrictions on activists.

The ground-breaking alliance between Valeant Pharmaceuticals and Bill Ackman's Pershing Square to take over Allergan could also ignite corporate—and even some investor—support behind the effort, led by law firm Wachtell Lipton, to require more timely and fuller disclosure of shareholder pacts and stakes, an effort which, until now, has seen little traction. At an individual corporate level, one can imagine a hasty reseeding of poison pills across public companies after a long period of retreat from takeover defenses.

Measures such as these may give corporate boards more space to act, but don't expect regulation to erase investor activism from the market. A recent report from Boston Consulting Group sheds light on why: “More than one third of the S&P 1500's $8 trillion of invested capital does not earn the cost of capital … Misaligned or misguided capital strategies are a primary screen activists use to find targets.” So long as there are so many firms destroying rather than creating value, there will be incentives for savvy investors to intervene. Frankly, that should make for healthy capitalism, though of course activists—like CEOs—can get decisions cockeyed too.  

Activism Goes Mainstream

Activist campaigns have become so common that more and more investors are examining each situation case by case, rather than reflexively siding with or against the activist. The most recent example is the split opinions of two major proxy advisory firms in their analyses regarding Third Point's attempt to elect its nominees to Sotheby's board. Institutional Shareholder Services favored the hedge fund, run by activist investor Daniel Loeb, and Glass Lewis backed management. Such differences of opinion are what make markets.

Other deep, structural changes cement activism as a common phenomenon. Initiatives in Britain (a Stewardship Code, for example) and the European Commission (fresh proposals to force investor disclosure on voting and engagement) are compelling institutions to act more assertively as owners of shares, or be seen as shirking duties. That may aid activists, who can cite those obligations as reasons for so-called “mainstream” investors to side with them, or it may mean that “mainstream” investors will do activism preemptively and perhaps less stridently, and have less need for specialists.

Corporate boards are going to have to learn how to adapt to changes rather than treat them as ephemeral, deny they can happen at their companies, or believe activism can be quashed with regulation or poison pills.

On this side of the Atlantic, U.S. policymakers have been mostly inert in this area. But frontiers no longer act as barriers against practice; expect some of those EU investor behaviors to migrate here.

Homegrown pressures have already stimulated change. Many of the biggest mutual fund complexes have quietly but substantially expanded their internal governance staffs in just the past year. Partly they are motivated by public scrutiny of how they vote shares; partly too by greater responsibilities that they now must shoulder —such as annual say-on-pay votes and more meaningful votes in director elections. There is something of a virtuous circle going on: the more funds improve their governance eyesight on portfolio companies, the more competitors need to do the same or be seen by the market and by peers as lagging.

Evidence of such change in behavior is everywhere. For instance, some big funds voted last month against management's say-on-pay resolution at Coca-Cola even though, remarkably, neither ISS nor Glass Lewis called for ‘no' votes. Mutual funds are also thought to be funneling tips on under-performing companies to activists, then backing efforts by such challengers to improve performance. Such funds increasingly are angry about plurality voting standards still in place at many companies that drain meaning from director elections.

Investor-to-Investor Dialogue

This evolution in mainstream behavior has a profound importance to activism since it powers a shift taking place below the radar screen. For as much as the market is now in thrall to guidance on how boards and shareholders can engage, equally consequential is the growing trend of what we would dub “i2i” engagement: investor-to-investor dialogue.

Not so long ago, the funds we now brand as activists acted as loners; mainstream institutions would commonly shun them as rogues. That's no longer true. Activists who take a minority stake in firms depend on other big funds to maximize leverage; that means they need to develop sturdy, trusted relationships with mutual funds and other shareowners. Equally, those mainstream funds, with their stepped-up attention to governance risk in portfolios, now rely on activists to fix companies topped with ineffective boards and management. So relationships are critical for both parties. Behind the scenes, i2i is transforming the market landscape in the United States.

We predict that in the future, much like in the recent past, defensive measures will have only limited power to ward off activism. Corporate boards are going to have to learn how to adapt to changes rather than treat them as ephemeral, deny they can happen at their companies, or believe activism can be quashed with regulation or poison pills.

Companies will need to devote more director attention and internal resource to intelligence on activists; to identify which are harbingers of broad shareholder dissatisfaction and which are noisemakers with no allies; to shape outreach and governance practice so as to draw goodwill and loyalty from big mainstream funds; and most importantly, to a real examination of their own corporate performance.

One bright red warning flag: If you have not created economic value for some years, chances are you are being analyzed by some activist right now. As the preacher might have reminded, we are indeed all in this congregation now.

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