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CEOs need a 'healthy paranoia' of activist investors

The upsurge of shareholder activist campaigns in recent years has been a hot topic for corporate America. It broke through into the broader public discourse a few weeks ago when Hillary Clinton ridiculed "hit-and-run" activist investors looking for quick financial wins in an economic policy stump speech.

Bill Ackman at Delivering Alpha 2015 in New York.
David A. Grogan | CNBC
Bill Ackman at Delivering Alpha 2015 in New York.

Are activist investors a force for good or only focused on short-term gains? There are compelling arguments on both sides of the debate, but one thing has become clear: Shareholder activists are increasingly associated with boosts in share value and as a result, the amount of activist activity has continued to rise dramatically. A remarkable 344 companies were targeted by activists in 2014, up almost 20 percent from the year before.

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Regardless of your views on their intent or the actual value activist shareholders bring to the table, the important reality for companies is that there has been a secular shift when it comes to the influence and power shareholders can wield. No public company is immune.

The perception that activism creates greater value for all shareholders has won the sympathy and support of major institutional investors that traditionally have remained passive when it comes to engaging with the companies in their portfolios. Just this week, the Wall Street Journal looked at how activists leveraged the support of major mutual-funds to gain a seat on Microsoft's board, one of several examples of such investors supporting activists. Furthermore, proxy advisory firms like ISS have grown supportive of activist positions, adding to the rosy picture for celebrity activists such as Bill Ackman and Carl Icahn.

This new mentality has penetrated the corporate ecosystem: Shareholders are holding companies more accountable for value creation, demanding explanations and action if they feel that management teams aren't getting the job done.

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CEOs who aren't already thinking about their companies as potential targets for activism should develop a healthy paranoia. Companies can no longer operate as if they are invulnerable to potential advances or demands from activists. From under-the-radar small cap companies to multibillion-dollar corporate giants, examples of high profile activist attacks are easy to come by.

Companies also have to know their shareholders. Keeping investors at arms' length is a risky approach in today's environment. Actively engaging with the investor base in a meaningful way and understanding their perception of the business is a valuable preventive measure that may seem obvious, but we see companies overlook it time and again.

Proactive steps are required to avoid becoming the next unsuspecting target. First, companies should "listen" to shareholders by conducting regular perception surveys. These are rather easy to compile and can provide the most timely, unfiltered feedback about the business, financial performance and other potential topics of relevance. Second, companies should regularly assess weaknesses or potential exposure, evaluating the business from an activist investor's perspective. Third, companies need to take control of engagement with shareholders and maintain relationships with the corporate governance groups to be able to spot issues before they arise.

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Today, it's in a management team's best interests to have a "when" rather than "if" mentality, and to think deeply about vulnerabilities that could draw an activist's attention. However, beyond just identifying chinks in their armor, companies have to take meaningful action to shore up areas of concern or risk an activist volunteering to do the job for them.

Commentary by Don Duffy, president of ICR and co-head of the firm's shareholder activism and transaction practice.