The challenging economic environment is exposing chief executive officers who are not up to the job. Removing them from office might be easier than these troubled CEO’s think – shareholder activists have been practicing all year.

As of November 10, 2022, activists have made public demands to “remove personnel” at 56 US-headquartered companies, up from 36 at the same time in 2021 and the highest levels since 2017.

Walt Disney announced that Bob Chapek resigned, to be replaced by returning CEO Robert Iger. The move comes weeks after Disney reached an agreement with activist investor Third Point Partners for a board seat and is now reportedly under pressure from Trian Fund Management for another. And on November 8th, struggling retailer Kohl’s announced the departure of Chief Executive Michelle Gass, six weeks after activist Ancora Holdings called for her dismissal.

In other cases the removal of notable CEOs was stipulated as part of a settlement agreements with activists. US Foods’ CEO Pietro Satriano resigned as part of an agreement with Sachem Head while Southwest Gas push out John Hester to make peace with Carl Icahn and Tabula Rasa HealthCare ditched Calvin Knowlton in a deal with Indaba Capital Management.

Vulnerable CEOs

While there are more demands to remove personnel, the success rate of those demands remains relatively low. Activists targeting U.S. companies were at least partially successful with only 29.7% of demands, versus 32.4% in 2021, and more than 50% in 2018.

Cases where activists do succeed tend to share common factors that make CEOs especially vulnerable, according to Andrew Freedman of Olshan Frome Wolosky, who primarily represents activists.
“First and foremost, there is a failure to perform or execute a strategic plan, along with poor capital allocation” he told Insightia in an interview.

Ancora Advisors held Gass, along with Chairman Peter Boneparth, responsible for failure to execute a new business plan during the pandemic. In a letter to Kohl’s board, Ancora said it had withheld public critiques “to provide Kohl’s time to bounce back from the COVID-19 pandemic, conduct a productive review of strategic alternatives, and produce a viable standalone plan that investors could rally behind. Much to our disappointment, Kohl’s has failed to deliver on each of these critical priorities.

Heavy turnover in middle and upper management is another red flag. “Being able to attract and retain executives more often than not, that’s symptomatic of a troubled CEO,” said Freedman.

Sachem Head made this point in its campaign at US Foods, noting that the company has had four different chief supply chain officers over the last few years, including a year-long period during the COVID-19 pandemic when the company had no full-time supply chain executive.

Compensation mismatch

The amount of ‘skin in the game’ a CEO has, both in terms of executive pay and equity held in the company, is another critical factor that could fuel activist engagement, according to Freedman. “If the CEO’s pockets are being lined while shareholders are suffering, it shouldn’t be any surprise that an activist is going to surface,” he said.

Carl Icahn’s feud with SouthWest Gas started out as a dispute over mergers and acquisitions and capital allocation. But after the board implemented a poison pill and other defense measures the focus shifted to the CEO. Indeed, the top three bullet points in Icahn’s proxy presentation single out the CEO.

“We believe Hester’s agenda was not to enhance value for stockholders, but rather to empire build,” Icahn wrote following his resignation, adding that he would not have entered into any settlement that did not include Hester’s retirement.

Between 2019 and 2021, Hester saw his base pay and stock awards increase despite the fact that Southwest’s stock price fell around 10% during the period.

Getting ready

Lawrence Elbaum, who co-heads the activism practice at law firm Vinson & Elkins, says chief executives who want to avoid being targeted by activists need to be “intellectually honest” with themselves about the challenges they are facing and communicate that with the market. “The ones that were patting themselves on the back because their 2021 results compare well to 2020 are the ones that are in the most trouble right now,” he told Insightia in an interview.

A case in point might be US Foods (which Elbaum did not represent). In the last stages of its proxy contest with Sachem Head, the food distribution company on April 21 issued an unscheduled earnings report touting strong performance.

Satriano took center stage in the announcement, commenting that the company had delivered “one of our strongest quarters since the pandemic began,” that underscored “confidence in the 2022 outlook, as well as our long-range plan.”

Proxy advisor Institutional Shareholder Services (ISS) disagreed, issuing a report on May 9 recommending shareholders support Sachem Head’s three candidates, adding that “because the problems identified by the dissident are related to execution, the board may need to evaluate whether this CEO, who has been in that role for almost seven years, is the right fit.”

Satriano resigned the following day as part of a settlement giving the activist three seats.

Rebound effect

Both Carl Icahn and Scott Furgeson of Sachem Head have publicly defended their past efforts to remove chief executives at portfolio companies, arguing that fresh leadership can reinvigorate a stock when little else will. The performance of their latest targets has been mixed, however.

Kohl’s stock is up around 18% since Gass announced her resignation, though it remains down around 34% year to date. Southwest Gas’s shares rallied more than 30% in the weeks after Hester stepped down but lost most of those gains after announcing it would not be put up for sale.

And after several months of underperformance, US Foods saw its share price rally Monday after it named Dave Flitman, former chief executive of building products provider Builders FirstSource, as its new CEO, effective in January. The stock is now up around 7% from the date Satriano resigned.

The delay in finding a new CEO may have been justifiable given the vital role the chief executive plays, especially when installed by an activist.

“You have to be really careful about the fit and the vision,” said Elbaum, who warned that the typical activist preference for hiring CEO’s externally can lead to culture shock. “You have to measure many times and cut once.”