Southwest Airlines had no choice but to bow to activist pressure

Southwest Airlines hasn’t had an easy time since the pandemic. Now, the company has made a major corporate governance decision to please an activist investor, completely changing its leadership trajectory and heralding a new era for the struggling American low-cost airline. 

If corporate success nowadays centres on how well a company bounces back from the pandemic and manages the many hurdles since, Southwest would not get close to top marks. 

It is one of many businesses where the board and other leaders have failed in a primary corporate duty: to ensure the continued health of the business, even when things get tricky. 

Unfortunately for Southwest, it hasn’t looked healthy for three years. Its strategy just isn’t working. And now its board has no choice but to bow to activist pressure for changes, even if that means several directors are out of a job.

After meetings with Elliott Investment – an activist investor targeting Southwest for underperformance – Southwest has agreed to the following changes:

• Six of its board members will leave during the Autumn.
• Executive chair Gary Kelly will leave after the company’s next AGM. Kelly had served as CEO of Southwest from 2004 to 2022. 
• Four replacement directors will be appointed. Three could be candidates nominated by Elliott, but nothing is confirmed.

Very big. Activist investors have become more influential in governance decisions over the past ten years. Sometimes, they don’t have their desired impact or have to settle for less, but with Southwest, they have succeeded in forcing a complete change of leadership. 

It’s a common theme with activist investors. They acquire enough stake in a company because they believe it can be more successful with a different strategy; inevitably, this means tough discussions with executives and directors if their influence grows powerful enough. 

Boards often have a tough relationship with activist investors because many of their members could easily be in the line of fire based on their records or areas of expertise. Six of fifteen members, including the executive chair, are now leaving amid this activist pressure. It’s as clear a sign as any that the company acknowledges the serious need for new blood at the top.

The biggest conundrum for board members when dealing with investors is how much they need to engage and respond. Could you get away with doing nothing? Are you so backed into a corner that you have agree to big changes? Are you somewhere in the middle? 

This depends on many factors, including the number of problems the organisation faces, the growth forecasts, the amount of influence the activist investor has, and the number of other investors who support each narrative. 

Based on that, Southwest had little choice but to fully engage with Elliott’s demands for a strategic overhaul. A change like that is never easy to carry out and difficult to negotiate, but Southwest’s options were severely limited. 

Here are the main factors explaining why Southwest had no choice but to engage. 

• Southwest’s share price dropped to a five-year low in late October 2023. Don’t forget that those five years include the height of the pandemic when airlines worldwide suffered huge slumps in value; Southwest’s recent drop eclipsed even that. 
• The airline’s technological vulnerabilities were exposed in December 2022, when the airline took far longer to recover (and cancelled many more flights) than competitors in the wake of a massive blizzard in the US. Its entire employee scheduling system suffered a meltdown. 
• The airline only buys Boeing aircraft. Boeing – with its own severe governance problems – can only deliver a fraction of the jets that it promised to Southwest, leading to lower growth projections. 
• Elliott has an estimated $1.9 billion stake in Southwest, or around 11% of the company’s market capitalisation. Activist investors have found success with much less control. 

Ultimately, yes. The board has a crucial role in strategy, and it is abundantly clear that the organisation’s strategy since the pandemic has not shown positive results. 

It hasn’t handled external setbacks well, its growth projections were wrong, and its business model – which may have worked well last decade – just doesn’t cut it anymore. 

Some of the airline’s most unique policies, such as the free-for-all, unassigned seating during boarding, are now being done away with in acknowledgement that customer preferences have long changed and the airline needs to catch up. 

In June 2023, Elliott accused Southwest’s board of having an “insular culture” that allowed few insights from the wider aviation industry to influence decision-making. 

Whether Southwest’s board would agree with that or not, it’s not an accusation you want from a key stakeholder. It signals that, at best, key decisions just aren’t translating, and at worst, the governance culture has serious flaws.

Southwest is in the middle of a leadership restructuring, and the next steps are to monitor how the airline adapts to the aviation market of the 2020s – something that other airlines have had much less difficulty doing. 

With new viewpoints on the board, we will need to wait and see what their priorities are and how much of an impact they will make.