Why CEOs Are More Vulnerable

Wall Street was shocked by the resignation of Citigroup’s Vikram Pandit after a long standing dispute with the board over a series of missteps and reverses. After five years since Pandit took control in April 2007, Citi’s share price melted from $510.50 to $37.25—a negative return of 89 percent. By contrast JPMorgan’s and HSBC’s share price has been relatively flat over the same period. The failure of the group to pass Federal Reserve bank stress tests earlier this year coupled with the announcement that third quarter profits would be sharply lower than last year, signaled for board members that it was time for him to go.

But even CEOs whose number have been less unkind than Citi’s have found themselves under fire. Activist investors have been, well, active, due in no small part by depressed valuations. Trian Fund Management, the activist fund run by Nelson Peltz, took a 7.1 percent stake in industrial conglomerate Ingersoll-Rand in May of this year.

Pershing Square, run by Bill Ackman, has installed a new slate of directors at Canadian Pacific Railway. And Elliot Management has been agitating for a sale of BMC Software, in which it has a 6.5 percent stake. Ackman, has also accumulated a $2 billion position in Procter & Gamble. Although he hasn’t declared it officially his intent, his actions suggest that he wants to try to oust P&G CEO Bob McDonald.

The consumer-goods giant has been struggling for some time now. Bob McDonald has been CEO of P&G for three years, and in the past two years, share prices have increased modestly. By contrast, the share prices of rivals Unilever and Colgate-Palmolive have soared 18% and 27%, respectively.

Ackman believes McDonald has mismanaged the company and missed opportunities. He is also insisting on further cost cuts. However, with a market capitalization of more than $179 billion, P&G is a whale that will be hard to land. Pershing Square’s $2 billion stake—about 1 percent—won’t yield the same leverage it would at a smaller company. But there is always the possibility of his attracting other activists or other Wall Street money to his cause.

When activists take investment positions in target companies, demands usually follow. Navistar International capitulated to investors led by Icahn Capital’s Carl Icahn and appointed to its board two of Icahn’s choices with a third to follow. Relational Investors, based in San Diego and run by Ralph Whitworth, has successfully agitated for changes at many major corporations, such as Genzyme and Home Depot. (At Home Depot, Whitworth called for the company to exit its commercial building supply business.)

Not all activists intend to start a bruising fight for board seats or change of management control. Barry Rosenstein’s hedge fund, Jana Partners LLC, which has $3.5 billion under management, and who took a position in Charles River Laboratories told the Wall Street Journal that he gets more from CEOs “by not embarrassing them publicly.” He contacted CRL CEO James Foster and urged him to drop a $1.6 billion acquisition. The conversation was the first of several discussions between the men about how to improve the drug research company and boost its stock. CRL decided to abandon the deal and announced a stock buyback. Its share price later improved.

So the moral of the story is to talk to your insurgent investors. Seven years ago Bill Johnson of H.J. Heinz had an initial encounter with Nelson Peltz of Trian Group that was anything but cordial. Peltz insisted on coming on the board bringing with him four other directors. “Yes, the initial encounter was anything but cordial, ” Johnson told Chief Executive at the time. “But as he began to understand what we were doing, and I began to understand what he was doing, a grudging mutual respect emerged. ”

Johnson went on to say, “You have two choices. You either recognize the changed circumstances and deal with it and move forward, or you try to live in the past. The market had spoken to us. ” Johnson would put two of Peltz’s people on the Heinz board, but continues to lead the Pittsburgh-based food giant.

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