Toronto Ontario - In 2011, Pershing Square Capital Management, an activist hedge fund founded by William (Bill) Ackman, acquired some 14.2 percent of Canadian Pacific Railway's outstanding shares and proceeded to require several changes in the management and governance of the company.
 
The CP board resisted fiercely his entreaties.
 
A memorable proxy fight ensued, which was won by Pershing and resulted in a new CEO, new board members, and a new strategy for CP.
 
Results of this palace revolution were, in share price terms at least, remarkable, astounding, actually.
 
From September 2011 to 31 Dec 2014, CP's stock jumped from less than $49 to north of $220, a compounded annual rate of return of 62 percent (including dividends).
 
Why was the CP intervention such an apparent success, when, in several other instances, Pershing's brand of activism was far less successful?
 
Mr. Ackman's forays into J.C. Penney, Target, and Borders gave results ranging from mediocre to abysmal.
 
A close examination of the CP saga reveals a number of differentiating features absent from other less successful interventions.
 
First, this was a rare case of perfectly transferable managerial talent.
 
The recently retired CEO of Canadian National Railways (CN), the best performing railroad company in North America, was soon to be freed from the legal (if not the ethical) constraints on his joining a direct competitor.
 
This man, Hunter Harrison, is acknowledged as a highly skilled and innovative railroader and he was ready and willing to take over as CEO of CP.
 
In the Canadian context, such behaviour is not quite gentlemanly.
 
Imagine the high performing CEO of Royal Bank Canada who, soon after retirement, would join the Bank of Montreal as CEO.
 
But both Ackman and Harrison are Americans who could not care less about the mores and values of the Canadian business world.
 
In several other instances, Pershing's brand of activism was far less successful.
 
So, an "activist" hedge fund unhappy with the performance of the current CEO of a targeted company calls on the recently retired CEO of its best-performing, direct competitor who happens to be ready to jump ship and hit the ground running.
 
How rare is that?
 
Second, the North American Railroad Industry is extremely well defined.
 
The same companies have been serving this market for decades, their networks are well-established.
 
Performance measures are standard across the industry, which makes for easy comparability across firms.
 
Thus, it is a simple task for management, the board of directors, and investors to benchmark any company against its peers.
 
Unfortunately for CP, its score was substantially lower than its peer group, and the gap was widening year after year.
 
But, it was generally acknowledged and accepted (including by financial analysts following the industry) that there were structural factors which explained a good part of this inferior performance.
 
As for the part under the control of management, vigorous action plans were being implemented to bring CP's performance much closer to its peers within five years.
 
That was certainly the firm conviction of the CP board.
 
Next, the board of CP had a nec plus ultra membership drawn from the Canadian business elite, former CEOs of the Royal Bank, Cargill, Ipsco, Shell Canada, and Corby Distilleries, current CEOs, scions of old families, a former minister in the Government of Canada.
 
These people had a wealth of business experience and were proud to serve on the board of an iconic corporation whose history is enmeshed with the very history of Canada.
 
They surely did not lack confidence in their ability to govern the corporation.
 
Indeed, their collective wisdom and governance skills had been recognized repeatedly by various agencies making it their business to rate the governance of corporations.
 
Here comes an upstart "hedge fund" manager from New York who has the gall to criticize their stewardship and to pretend he knows what CP should do to improve its performance.
 
His bright insight involves, first of all, the disgraceful suggestion that the CP board chairman go and try to persuade the former CEO of a rival Canadian company to jump ship and join CP!
 
There is here more than a whiff of cultural clash between American and Canadian business practices, or perhaps more accurately, a clash between the loyalty-stakeholder model of yore and the business model of contemporary times with its fixation on maximizing shareholder value.
 
The traditional model had some admirable features, some of which have been retained in modern corporations, such as the policy of promotion from within.
 
This policy is still alive and well at many large corporations, from GE, Johnson and Johnson, Procter & Gamble, to Canadian banks, and certainly CN Rail and CP.
 
Not only was Ackman arguing for CP to drop this policy of strict "promotion from within" but was urging CP to hire someone from a direct competitor.
 
Of course, it is also plausible that a prestigious board, a board made up of experienced former or current executives would be more likely to reject out of hand any suggestion coming from a "financial" sort of player.
 
We believe these three features of the CP saga are collectively rather unique.
 
Yet, the proof is in the pudding.
 
Under a new leadership, CP has quickly and remarkably improved its performance.
 
What did not seem achievable was achieved.
 
Structural impediments to CP's performance seem to have vanished.
 
How come the CP board at the time, presumably savvy and experienced, did not spot inefficient management, did not challenge the common assertion that structural factors explained CP's mediocre performance?
 
How come no one seemed to notice that the CP performance had been deteriorating?
 
Why was the board of directors satisfied with the level and rate of progress proposed by management?
 
The initiatives that Harrison was able to implement swiftly after taking over as CEO constitute a damning indictment of the board (and management) of CP at the time.
 
In the singular case of CP, an activist investor was able to benefit from a providential alignment of circumstances that resulted in sustained (thus far) value for shareholders.
 
On 1 Oct 2014, the beginning of CP's day with financial analysts, Harrison pointedly reminded those analysts that they cannot understand what a true railroader knows.
 
"Railroading is all about execution," says Harrison.
 
Well, hedge fund activism is rarely about execution, most of the time, it is about some form of financial engineering producing a boost in stock price but often at a cost in longer term flexibility and growth for the targeted company.
 
The CP saga is not a cautionary tale but an exception.
 
Indeed, if the board of CP had not been inhibited by such "trivia" as ethics and corporate values, it could have jumped at the opportunity to hire Hunter Harrison.
 
No need then for Pershing Square!
 
Yvan Allaire and Francois Dauphin.