- Identify the key problems and issues in the Unlocking Value At Canadian Pacific The Proxy Battle With Pershing Square case study. Why do they exist? how do these issues impact the organization?

It was May 2, 2012, and Susan Smith at GBR Capital, a hedge fund based in New York, was thinking about how she should vote her fund's shares at Canadian Pacific's (CP's) upcoming anmal shareholders meeting in two weeks in Calgary, Alberta. CP had built the country's first transcontinental railroad in the 19th century. Its board of directors was the target of a proxy battle for control of the fum initiated by Pershing Square Capital Management, LP. (Pershing Square) in March 2012. Both CP and Pershing Square had made presentations to proxy advisors Glass Lewis and Institutional Shareholder Services (ISS). Proxy advisors provided voting recommendations to clients such as private funds and institutional investors. As part of their analysis, the proxy advisors received information from management and from the dissident shareholder, Pershing Square. Due to the lack of voting direction by management and CP's high level of institutional ownership, Smith believed that the recommendations of proxy advisors would be key in the proxy contest, but she also needed to perform her own analysis of the intrinsic value of CP shares under the scenario of the status quo with CP's curent management and strategy in place versus a potential shakeup, as suggested by Pershing Square.? One statement in Pershing Square's dissident presentation, which had been sent out on Jamiary 24, 2012, stood out for Smith: "Canadian Pacific is 70 per cent the size of Canadian National, yet has an enterprise value 40 per cent as large, due to its inferior profitability and asset utilization." CLASS I NORTH AMERICAN RAILROADS Railroad companies were ranked by revenues, with Class I railroads being the biggest and Class III railroads the smallest. In the United States, a Class I railroad had at least US$250 million in sales; in Canada, a Class I railroad had at least CA$250 million in sales.' The United States and Canada had six Class I railroads: Union Pacific, CSX, Norfolk Southern Canadi National Railway (CN), CP, and Kansas City Southern (plus BNSF, a wholly owned subsidiary Berkshire Hathaway). Rail was an integral part of the transportation network in North America for good grains, and commodities. For example, more than two-thirds of U.S. coal was carried by rail Railw typically used as pat of intermodal operations, facilitated by the use of standardized containers that cou be moved from trucks to rail to ships. The single most important measure of profitability in the railroad industry was the operating ratio, defin as the firm's operating expenses as a percentage of its total revemies. A lower operating ratio w desirable and firms targeted operating ratios below 80, with a figure in the mid-70s being more desirab Components of these operating expenses included major categories such as labour, materials, firel, a depreciation of operating expenses, labour could account for more than a third and fuel could account a fiAL Operating ratios at these six major railroads had improved as non-core infrastructure was diveste investments were made in more efficient equipment, and new operating procechures were adopted example, CN's operating ratio declined to 63.6 per cent in 2010 from 97.1 per cent in 1992. Overt same period, CP's operating ratio dropped to 77.6 per cent from 95.9 per cent (see Exhibit 1). CANADIAN PACIFIC RAILWAY The Canadian Pacific Railway was incorporated on February 16, 1881, with the intent of building transcontinental railway in Canada. As a condition of joining Canada's confederation in 1867, No Scotia and New Brunswick were promised rail links with Quebec and Ontario. But governme mismanagement resulted in little progress on the project, until a group of businessmen founded CP. century later, in 1986, CP was the nation's second-largest firm, with $15 billion in revenues, and h become a conglomerate, with subsidiaries in energy, commodities, hotels, and ships. With the goal unlocking shareholder value, Canadian Pacific's parent company spun out its five subsidiaries-CP, P Canadian Energy, Fording Coal, CP (later Fairmont) Hotels, and CP Shipsinto separate companies October 3, 2001 CP had a 14,700-mile (23,657-kilometre) network of railroads and intermodal transportation links fic the Port of Vancouver in Canada's West to the Port of Montreal in Canada's East, and to the U. inchustrial centres of Chicago, Newark, Philadelphia, Washington, New York City, and Buffalo. T network transported bulk commodities, merchandise freight, and intermodal traffic. In 2011, CE strategie goal was to become the safest, most fluid railway in North America, "5 focusing on five are: service, safety, productivity and efficiency, people, and growth CP's board included members of the country's business elite. For example. John Cleghorn was the former chairman and chief executive of the Royal Bank of Canada, the country's largest financial services company. Frederic I. Green had been the fium's chief executive officer (CEO) since 2006 (see Exhibit 2). CP faced a challenging first six months in 2011, as a result of disruptions to its operations due to severe winter weather and flooding. These delays limited the speed at which its trains could travel, and productivity had suffered The firm worked in the second half of 2011 to restore service and its reputation for customer focus. Management stated: Despite these challenges, we were able to complete our planned capital program in 2011. Onur continued work on building new sidings and extending our current ones to support our long-train strategy paid dividends: CP set a new full-year record in train weights in 2011. In addition, we set full year records in both terminal dwell and car miles per car day as a result of implementing our First Mile-Last Mile program in Canada. We expect futher improvements as we continue to tighten standards in Canada and roll out the program in the U.S. We completed the second phase of ow Locomotive Reliability Centre strategy, which will reduce the number of major locomotive repair facilities from eight to four highly efficient super shops with improved repair capabilities. These improved efficiencies will allow us to do more with less and to reduce our asset pools and associated costs. CP has signed several commercial agreements with customers, terminal operators and ports that will drive improvements in supply chain performance. In early 2012, we announced a new five- year agreement with Canadian Tire and a ten-year agreement with Canpotex. In addition, CP has worked with its customers, leveraging technology to enhance car request management and implementing new productivity tools. Our scheduled grain program has been successfully implemented in Canada and the U.S. program will be implemented by August 2012. We are also developing new volumes of Powder River Basin coal for export off the west coast of British Columbia. In 2011, CP's accomplishments included Managing overall indebtedness by repaying US$246 million of maturing 2011 debt and by calling US$101 million of 2013 debt; Making a $600 million voluntary prepayment to its main Canadian defined benefit pension plan and Delivering consistent dividend growth by increasing its quarterly dividend to common shareholders byll per cent, from $0.27 to $0.30 in 2011.' CP announced a goal of bringing its operating ratio down to the range of 70-72 per cent for 2014, and continued improvement beyond 2014. It aimed to reduce the operating ratio to the range of 68.5-70.5 per cent by 2016. According to CP's position, much of the difference in operating ratios compared with other railroads was due to external factors such as legacy pension costs; tighter cuves and steeper grades that required slower speeds and more locomotives, respectively, and greater competition along its routes. Between April and September 2011, the trading price of CP's common shares declined from approximately $63 per share to a low in late September of just below $49 per share CP's stock price performance for the 10-year period 2002 to 2012 was roughly similar to a Toronto Stock Exchange index, but fared much lower than CN's performance (see Exhibit 3). PERSHING SQUARE CAPITAL MANAGEMENT With a corporate partner, Leucadia National, William Ackman founded Pershing Square Capital Management (Pershing Square), a hedge fund, in 2004 with US$54 million of his own capital. Pershing Square was known for taking large positions in targeted firms and being actively engaged in their management. Recent activist campaigns included Target Corp., Canadian Tre, Wendy's (forcing the company to spin-off Tim Hortons), and most recently J.C. Penney. Ackman's track record inchided successes and failures. After a months-long debate between Target Corp.'s management and Ackman shareholders voted down Ackman's effort to gain board representation at their annual meeting in Waukesha, Wisconsin In a preliminary tally of voting, more than 70 per cent voted in favour of the company's proposed slate of directors, and the same margin voted to keep the size of the board the same. Target Corp. had urged its shareholders to vote in favour of a proposal to set the size of the board at 12 and to vote for the company's nominees." In a regulatory filing released October 28, 2011, Pershing Square indicated it owned an aggregate 20.7 million common shares (which included 2.65 million common shares underlying a call option) representing 12.2 per cent of CP's outstanding common shares. The fum had begun buying CP shares in September 2011, investing $1.1 billion in total for an average price of $54.46 per common share. Pershing Square's intent, according to the filing, was to discuss with CP's management, its board, and other shareholders ways in which the business could be improved Ackman's chief recommendation was to install Hunter Harrison as CP's new CEO. With an established track record as CN's chief operating officer and then its CEO, Harrison had a reputation for improving CN's productivity and profits. He had reduced staff levels and introduced the concept of precision railroading, which involved putting operations on a strict schedule. His drive for efficiencies had even led to the implementation of penalties for customers who did not load or unload their freight on time. THE ROLE OF BOARDS A board of directors was generally accepted as being necessary to manage the agency relationship created by the separation of ownership and management, and was a legal requirement for incorporation. A board was ultimately responsible to the shareholders for all aspects of the corporation, but would delegate most of the operating responsibility to professional management. Thus, in any fum, a board had specific responsibility for hiring performance evaluation, compensation, and succession of the CEO. A board might also choose to require management to obtain the board's specific approval before proceeding with certain types of initiatives such as strategic changes, major financial commitments, and significant acquisitions. In those areas, management was responsible for initiating proposals and implementing board-approved decisions; the board of directors was responsible for choice among and/or ratification of management recommendations, and monitoring their implementation by management. It was May 2, 2012, and Susan Smith at GBR Capital, a hedge fund based in New York, was thinking about how she should vote her fund's shares at Canadian Pacific's (CP's) upcoming anmal shareholders meeting in two weeks in Calgary, Alberta. CP had built the country's first transcontinental railroad in the 19th century. Its board of directors was the target of a proxy battle for control of the fum initiated by Pershing Square Capital Management, LP. (Pershing Square) in March 2012. Both CP and Pershing Square had made presentations to proxy advisors Glass Lewis and Institutional Shareholder Services (ISS). Proxy advisors provided voting recommendations to clients such as private funds and institutional investors. As part of their analysis, the proxy advisors received information from management and from the dissident shareholder, Pershing Square. Due to the lack of voting direction by management and CP's high level of institutional ownership, Smith believed that the recommendations of proxy advisors would be key in the proxy contest, but she also needed to perform her own analysis of the intrinsic value of CP shares under the scenario of the status quo with CP's curent management and strategy in place versus a potential shakeup, as suggested by Pershing Square.? One statement in Pershing Square's dissident presentation, which had been sent out on Jamiary 24, 2012, stood out for Smith: "Canadian Pacific is 70 per cent the size of Canadian National, yet has an enterprise value 40 per cent as large, due to its inferior profitability and asset utilization." CLASS I NORTH AMERICAN RAILROADS Railroad companies were ranked by revenues, with Class I railroads being the biggest and Class III railroads the smallest. In the United States, a Class I railroad had at least US$250 million in sales; in Canada, a Class I railroad had at least CA$250 million in sales.' The United States and Canada had six Class I railroads: Union Pacific, CSX, Norfolk Southern Canadi National Railway (CN), CP, and Kansas City Southern (plus BNSF, a wholly owned subsidiary Berkshire Hathaway). Rail was an integral part of the transportation network in North America for good grains, and commodities. For example, more than two-thirds of U.S. coal was carried by rail Railw typically used as pat of intermodal operations, facilitated by the use of standardized containers that cou be moved from trucks to rail to ships. The single most important measure of profitability in the railroad industry was the operating ratio, defin as the firm's operating expenses as a percentage of its total revemies. A lower operating ratio w desirable and firms targeted operating ratios below 80, with a figure in the mid-70s being more desirab Components of these operating expenses included major categories such as labour, materials, firel, a depreciation of operating expenses, labour could account for more than a third and fuel could account a fiAL Operating ratios at these six major railroads had improved as non-core infrastructure was diveste investments were made in more efficient equipment, and new operating procechures were adopted example, CN's operating ratio declined to 63.6 per cent in 2010 from 97.1 per cent in 1992. Overt same period, CP's operating ratio dropped to 77.6 per cent from 95.9 per cent (see Exhibit 1). CANADIAN PACIFIC RAILWAY The Canadian Pacific Railway was incorporated on February 16, 1881, with the intent of building transcontinental railway in Canada. As a condition of joining Canada's confederation in 1867, No Scotia and New Brunswick were promised rail links with Quebec and Ontario. But governme mismanagement resulted in little progress on the project, until a group of businessmen founded CP. century later, in 1986, CP was the nation's second-largest firm, with $15 billion in revenues, and h become a conglomerate, with subsidiaries in energy, commodities, hotels, and ships. With the goal unlocking shareholder value, Canadian Pacific's parent company spun out its five subsidiaries-CP, P Canadian Energy, Fording Coal, CP (later Fairmont) Hotels, and CP Shipsinto separate companies October 3, 2001 CP had a 14,700-mile (23,657-kilometre) network of railroads and intermodal transportation links fic the Port of Vancouver in Canada's West to the Port of Montreal in Canada's East, and to the U. inchustrial centres of Chicago, Newark, Philadelphia, Washington, New York City, and Buffalo. T network transported bulk commodities, merchandise freight, and intermodal traffic. In 2011, CE strategie goal was to become the safest, most fluid railway in North America, "5 focusing on five are: service, safety, productivity and efficiency, people, and growth CP's board included members of the country's business elite. For example. John Cleghorn was the former chairman and chief executive of the Royal Bank of Canada, the country's largest financial services company. Frederic I. Green had been the fium's chief executive officer (CEO) since 2006 (see Exhibit 2). CP faced a challenging first six months in 2011, as a result of disruptions to its operations due to severe winter weather and flooding. These delays limited the speed at which its trains could travel, and productivity had suffered The firm worked in the second half of 2011 to restore service and its reputation for customer focus. Management stated: Despite these challenges, we were able to complete our planned capital program in 2011. Onur continued work on building new sidings and extending our current ones to support our long-train strategy paid dividends: CP set a new full-year record in train weights in 2011. In addition, we set full year records in both terminal dwell and car miles per car day as a result of implementing our First Mile-Last Mile program in Canada. We expect futher improvements as we continue to tighten standards in Canada and roll out the program in the U.S. We completed the second phase of ow Locomotive Reliability Centre strategy, which will reduce the number of major locomotive repair facilities from eight to four highly efficient super shops with improved repair capabilities. These improved efficiencies will allow us to do more with less and to reduce our asset pools and associated costs. CP has signed several commercial agreements with customers, terminal operators and ports that will drive improvements in supply chain performance. In early 2012, we announced a new five- year agreement with Canadian Tire and a ten-year agreement with Canpotex. In addition, CP has worked with its customers, leveraging technology to enhance car request management and implementing new productivity tools. Our scheduled grain program has been successfully implemented in Canada and the U.S. program will be implemented by August 2012. We are also developing new volumes of Powder River Basin coal for export off the west coast of British Columbia. In 2011, CP's accomplishments included Managing overall indebtedness by repaying US$246 million of maturing 2011 debt and by calling US$101 million of 2013 debt; Making a $600 million voluntary prepayment to its main Canadian defined benefit pension plan and Delivering consistent dividend growth by increasing its quarterly dividend to common shareholders byll per cent, from $0.27 to $0.30 in 2011.' CP announced a goal of bringing its operating ratio down to the range of 70-72 per cent for 2014, and continued improvement beyond 2014. It aimed to reduce the operating ratio to the range of 68.5-70.5 per cent by 2016. According to CP's position, much of the difference in operating ratios compared with other railroads was due to external factors such as legacy pension costs; tighter cuves and steeper grades that required slower speeds and more locomotives, respectively, and greater competition along its routes. Between April and September 2011, the trading price of CP's common shares declined from approximately $63 per share to a low in late September of just below $49 per share CP's stock price performance for the 10-year period 2002 to 2012 was roughly similar to a Toronto Stock Exchange index, but fared much lower than CN's performance (see Exhibit 3). PERSHING SQUARE CAPITAL MANAGEMENT With a corporate partner, Leucadia National, William Ackman founded Pershing Square Capital Management (Pershing Square), a hedge fund, in 2004 with US$54 million of his own capital. Pershing Square was known for taking large positions in targeted firms and being actively engaged in their management. Recent activist campaigns included Target Corp., Canadian Tre, Wendy's (forcing the company to spin-off Tim Hortons), and most recently J.C. Penney. Ackman's track record inchided successes and failures. After a months-long debate between Target Corp.'s management and Ackman shareholders voted down Ackman's effort to gain board representation at their annual meeting in Waukesha, Wisconsin In a preliminary tally of voting, more than 70 per cent voted in favour of the company's proposed slate of directors, and the same margin voted to keep the size of the board the same. Target Corp. had urged its shareholders to vote in favour of a proposal to set the size of the board at 12 and to vote for the company's nominees." In a regulatory filing released October 28, 2011, Pershing Square indicated it owned an aggregate 20.7 million common shares (which included 2.65 million common shares underlying a call option) representing 12.2 per cent of CP's outstanding common shares. The fum had begun buying CP shares in September 2011, investing $1.1 billion in total for an average price of $54.46 per common share. Pershing Square's intent, according to the filing, was to discuss with CP's management, its board, and other shareholders ways in which the business could be improved Ackman's chief recommendation was to install Hunter Harrison as CP's new CEO. With an established track record as CN's chief operating officer and then its CEO, Harrison had a reputation for improving CN's productivity and profits. He had reduced staff levels and introduced the concept of precision railroading, which involved putting operations on a strict schedule. His drive for efficiencies had even led to the implementation of penalties for customers who did not load or unload their freight on time. THE ROLE OF BOARDS A board of directors was generally accepted as being necessary to manage the agency relationship created by the separation of ownership and management, and was a legal requirement for incorporation. A board was ultimately responsible to the shareholders for all aspects of the corporation, but would delegate most of the operating responsibility to professional management. Thus, in any fum, a board had specific responsibility for hiring performance evaluation, compensation, and succession of the CEO. A board might also choose to require management to obtain the board's specific approval before proceeding with certain types of initiatives such as strategic changes, major financial commitments, and significant acquisitions. In those areas, management was responsible for initiating proposals and implementing board-approved decisions; the board of directors was responsible for choice among and/or ratification of management recommendations, and monitoring their implementation by management