Canada'S Two National "Railroads"

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W14108
SHAREHOLDER ACTIVISM AT CANADIAN PACIFIC RAILROAD 1
Professors Charles McMillan (Schulich School of Business) and Jeffrey Gandz (Ivey Business School) wrote this case to provide
material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation.
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Copyright © 2014, Richard Ivey School of Business Foundation Version: 2014-04-08
In the middle of January 2012, the board of directors of Canadian Pacific Railroad (CP) had to decide
how to respond to an escalating attempt by Pershing Square Capital Management Inc. (Pershing) to gain
control of the company. In the summer of 2011, Pershing had started to accumulate shares in CP and
currently held about 14 per cent of outstanding common stock. In recent weeks, Pershing had ratcheted up
the takeover rhetoric in an attempt to win over dissident CP shareholders and those who might be “on the
fence” with respect to who should control CP — its current board and CEO or a new slate of directors and
a replacement CEO being proposed by Pershing. CP was a widely held 2 public company listed on both
the Toronto and New York stock exchanges (TSX and NYSE). The question facing the CP board was
whether it should make further concessions to Pershing or risk an all-out proxy fight 3 that it may, or may
not, win.
CANADA’S TWO NATIONAL “RAILROADS”
In many ways, the history of Canada’s two national railroads was the business history of Canada. One
company, Canadian National (CN), started as a Crown corporation owned by the federal government and,
while supposedly operating at arms-length from the government, was required to adopt policies and
practices that furthered government interests such as serving the needs of small communities even if this
required building and operating uneconomical routes. The second, Canadian Pacific (CP), founded in
1881, dated from the very history of Canada as an independent country, founded in 1867. CP built a
national railway from east to west, binding together the disparate British colonies of Canada and
1
This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives
presented in this case are not necessarily those of Canadian Pacific Railroad or any of its employees.
2
CP shareholding was widely dispersed, held mostly by institutional investors. At the end of 2010, only one group had over
4.5 per cent (Blackrock Inc., 4.75 per cent), six owned between 3.2 and 3.9 per cent, three between 2.3 and 2.69 per cent
and six between 1.0 and 1.17 per cent. Another 15 had shareholdings between 0.5 and 9.46 per cent, 20 investor groups
owned between 0.10 and 0.19 per cent, and over 200 owned less than 0.10 per cent.
3
A proxy fight occurs when a group of shareholders in a particular company attempts to get a majority of other shareholders
to join together to effect major change in a targeted company. The issues in the fight may be a change in board composition,
management, share structure, dividend policies, mergers, divestitures or overall strategies. Typically, the fight is led by a
shareholder activist, such as Pershing, that tries to get other shareholders to pledge their shares to them to be used in a
shareholder vote.
This document is authorized for use only by Aayush Agarwal in SGMT 3000 D FALL 2021 COURSE KIT taught by TAMMY IRWIN, York University from Sep 2021 to Dec 2021.
Page 2 9B14M035
providing the transport means to bring immigrants to Canada to populate the vast acreage of the Western
prairies.
The two railways, each with easy access to finance, using similar technologies, railway stock and other
infrastructure such as locomotive engines, had parallel corporate strategies to grow and prosper. Both
were effectively vertically integrated. CP was more than a railway: it diversified into intermodal transport,
trucking and port terminals, airlines and shipping, plus telegraphs and resort hotels in Canada’s major
cities and national parks. Similarly, CN, starting as a portfolio of bankrupt rail entities, was government-
owned and operated; also had a conglomerate structure, with hotels, ferries and joint ownership in
telegraphs (with CP); and owned Trans-Canada Airlines, which eventually became Air Canada.
In one sense, CP, the first transcontinental railway in North America, had competitive advantages against
its later rival, CN. Headquartered in Montreal, CP had well-connected managers and experienced
executives from Canada, the United States and London, with board members having close access to the
London capital markets and political ties to the national government in Ottawa. CP’s senior managers and
the board fully understood its public mandate as a national railway, along with its subsidiary companies
such as the shipping lines, the hotel chain and national communications network, to fulfill public policy
goals such as immigration and the sale of Canadian commodities (i.e., wheat, lumber and coal) to foreign
markets, along with maintaining strong links through the major railroad cities across Canada
By contrast, CN started as a conglomeration of bankrupt or nearly bankrupt local and regional railways
under federal government control and ownership and was required to provide services to remote areas
even if this resulted in losses, often linked before privatization to patronage employment and lacking the
market discipline of the private sector.
When the federal government accepted the deregulation framework of the railway industry in the 1970s,
and enacted it in the 1980s, CN and CP started the slow but politically controversial process of closing,
abandoning or even removing money-losing branch lines. Thousands of miles of track were closed, and
CN actually removed rail service in Newfoundland and Prince Edward Island. Obsolete or money losing
mixed freight-passenger trains were scrapped, as were numerous branch lines in rural areas across
Canada. Some rights-of-way were converted into a national system of “rails for trails,” that is,
recreational bicycle and trailways operated by local municipalities. In the United States, bankrupt railway
firms owned a fifth of rail mileage, and the term “standing derailment” referred, somewhat sarcastically,
to stationary freight cars when the track had been so neglected that it gave way beneath their wheels.
Privatization of CN, and the removal of Air Canada as an associated company in 1977, coincided with the
deregulation of the transportation sector in North America, starting with deregulation of trucking and
airlines and the passage of the U.S. Staggers Rail Act of 1980 during the Carter administration. This
legislation, allowing freedom for price setting, long-term contractual agreements and selling or closing
unprofitable branch lines to smaller, more focused short-haul railways, started railway industry
consolidation. Of the 40 local or regional railways in North America, only seven became Class I railways,
based on gross revenues of freight. In addition to CN and CP in Canada, the U.S. Class I railways
included, with 2010 revenues, Union Pacific ($17 billion), BNSF ($16.8), CSX ($10.6), Norfolk Southern
($9.5) and Kansas City Southern ($1.86).
Other innovations at CN included replacing the 40-foot box car, capable of carrying 40 to 50 tons, by
larger 100-ton cars and special purpose cars — for example, refrigerated cars — often handled in unit
trains moved directly from shipper to customer without intermediaries like trucking. The railways learned
a lot from the airline sector and began employing centralized traffic control, microwaves and radios for
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train control and information technology (IT) applications for financial and demand forecasting.
Innovations in the iron and steel industry allowed modern metallurgical and continuous welded rails and
totally automated rail-laying machinery, as well as automatic car identification.
CN, in particular, was well-placed to focus on rail freight, including the shift to container traffic from
ocean ports. At CN headquarters in Montreal, the strategic focus became railway freight, with senior
managers advancing aggressive cuts to its bloated management structure, closing inefficient rail lines and
focusing on its most profitable customers. CN's railway network in the late 1980s consisted of the
company’s Canadian trackage and U.S. subsidiary lines operating through the central corridor of North
America, from Michigan and Indiana to Chicago and Illinois, southward along the Mississippi past Ohio,
Minnesota and eventually to its terminus in Memphis, leading to the Gulf; it was the only North
American railway operating east-west as well as north-south. In 1995, the CN Commercialization Act was
passed by the Parliament of Canada, enacted into law on July 13, 1995. Four months later, the federal
government transferred all of its shares to private investors with an initial public offering (IPO), one of
the largest ever in Canada.
Preparation for an IPO allowed senior management, including the CEO and finance officers drawn from
Ottawa’s civil service, to take a bottom-up view of CN’s overall structure, including its operating ratio
(operating costs as a percentage of revenue), the key to productivity improvement. Unlike many U.S.
railroads, CN had discarded its passenger services to a federal Crown corporation, Via Rail. Non-related
areas such as hotels, landmark properties (e.g. the CN Tower in Toronto), ferries and CNCP
Telecommunications, a legacy venture from the former railway telegraph network jointly owned with CP,
were sold and monies received were used to reduce CN’s debt load. From 1978 to 1992, CN reported
profits for 11 of the 15 years, paying $371 million in cash dividends (profit) to the federal government.
Meanwhile, other factors were forcing a fundamental strategic shift by the Canadian railroads, which had
felt the impact of the U.S. deregulation of transport, potentially a forerunner of general policies of
deregulation, privatization and free trade agreements, either bilaterally or multi-laterally. Political leaders
such as Prime Minister Margaret Thatcher in the United Kingdom and U.S. President Ronald Reagan had
called into question not only big government, but big bloated enterprises. In Canada, there was huge
momentum to reorganize Canada’s vast web of Crown corporations and, where possible, to privatize
certain industries or those firms without a true public mandate, such as broadcasting and the post office. A
related factor was the growing unease within government of Canada’s long history of conglomerate
enterprises dominating corporate boardrooms, where a mix of about 10 to 12 firms controlled most
industries. 4
Two other issues had an impact on the rail operations of CP and CN. The first was the widespread use of
containers, which fundamentally changed the nature of railroads by extending their operations to ports for
overseas shipping, and the use of trucks for short haul routes. The second factor took North America by
storm, when the Japanese car companies Honda and Toyota began massive investments in car plants in
U.S. states and the province of Ontario. The Japanese introduced “Just-In-Time” (JIT), a novel form of
car production that dispensed with the vertical integration employed in Detroit assembly plants. Toyota’s
lean production system, first designed in 1956, became the model for car assembly, associated with
4
Large Canadian firms such as CP, Argus, Brascan, Molsons, Labatts, Power Corp. and Bell Canada controlled a
bewildering array of companies and subsidiaries such that the takeover of one by another would lead to a concentration of
assets by a few managers, forcing Ottawa to intervene. Indeed, when Power Corp., controlled by Paul Desmarais of
Montreal, attempted to acquire Argus Corp., controlled by Conrad Black, Prime Minister Pierre Trudeau called a Royal
Commission on Corporate Concentration, and the findings revealed the full extent of the concentration of corporate assets to
Canadians. For background, see P.K. Gorecki and W.T. Stanbury, Perspectives on the Royal Commission on Corporate
Concentration, Butterworths Canada, Toronto, 1979.
Page 4 9B14M035
specialized car parts firms that delivered parts and components just in time for assembly. Widely heralded
in such books as The Machine that Changed the World, 5 and totally changing the necessary
organizational infrastructure and supply chain systems, lean production was soon copied by retailers,
especially by Wal-Mart. In car assembly, Japanese manufacturers brought huge changes to container
shipping, with domestic plants located close to deepwater ports. Japanese container ships soon
revolutionized ocean transport and contributed to the rise of huge automated ports such as Nagoya and
Yokohama in Japan, Long Beach in California and Rotterdam in Europe. 6
CN was one of the first railways in North America to understand these profound changes taking place in
manufacturing logistics and supply chain management. Unlike CP, which relied on bulk shipments of
commodities where weight, car length and locomotive power were central in the varying climates of
Canada, CN’s strategic focus was on Central Canada and the manufacturing base of the central North
American corridor. Shippers such as appliance makers, car companies and retailers faced different sets of
issues, summarized simply as time management. JIT principles were spreading rapidly, and time as a
competitive weapon, pioneered by firms such as Toyota and Wal-Mart, was changing the face of
railways, each encumbered by over-capacity, labour problems, slow growth and weak financial returns.
Equally important was the evolving system of global production and distribution, partly influenced by
U.S. military experience in Vietnam and the Gulf War, where ocean shipping and associated deepwater
ports were the first links in global supply chains. Japan learned this lesson well, as a country that,
although far distant from markets in North America and Europe, was capable of moving cars and
electronics by ocean freight cheaper than overland trucks or rail. Overseas factories, exporters and
deepwater ports became parts of global supply chains linking domestic maritime gateways, importers and
retailers, with railways as the critical resource link in the middle. Rising Asian imports in containers had
been the fastest growing segment of rail freight, rising from three million in 1980 to 12.3 million in 2006
as intermodal traffic became the norm. 7
CN headquarters, recognizing that its traditional business model had to be updated, invested massively in
back office IT systems and logistics infrastructure and opened offices in Rotterdam and Shanghai. CN
was one of the first railways to see this profound change, in part because its chief operating officer (COO)
at the time, Hunter Harrison, an American from Memphis, had witnessed first-hand the development of
intermodal transport at FedEx. 8
CN’s U.S. operations accounted for about 19 per cent of total revenue in 2007. Through market expansion
and acquisitions, CN became the only North American railroad that connected the Pacific Coast, Atlantic
Coast and the Gulf Coast. Despite CP’s large operations in Western Canada, and its new headquarters
5
James P. Womack, Daniel Roos and David Y. Jones, The Machine That Changed the World: The Story of Lean
Production, Free Press, New York, 1990.
6
Frank Broeze, The Globalization of the Oceans, Nimbus Press, St. John’s, 2002; Marc Levinson, The Box, Princeton
University Press, Princeton, NJ, 2006.
7
Levinson, The Box, Ch. 14.
8
Hunter Harrison, an American from Memphis, Tennessee, home of FedEx, was a college dropout who worked in railways
all his life. He introduced Bill Gates to CN, and the Gates Foundation became one of the railway’s largest shareholders.
Gates’s book, Business @ The Speed of Thought, Warner Books, New York, 1999, celebrated “technology-driven
shortening of time to market,” the “speed of delivery” and changing the “perceptions within a company about the rapidity with
which everybody has to move.” Harrison served as the chief operating officer at CN, working with CEO Paul Tellier, before
becoming CEO in 1999, when he pushed the philosophy of precision scheduling, i.e., operating freight locomotives like
passenger trains and airplanes on a strict schedule. Although trains generally run at 28 miles per hour (mph) through CN's
network, Harrison felt the next frontier for growth would be freight trains operating as fast as 90 mph (today the maximum
speed is 60 mph), although they would average out at the slower speed because of bottlenecks such as long waiting times
at logistics centres. See also Emily Thorton, “Canadian National Railways Timely Profits,” Business Week, October 23,
2008.
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located in Calgary, it was CN, not CP, that invested in the new Prince Rupert, BC container terminal (the
only new port opened in North America in 40 years) to provide shipment of containers from Asia, mostly
from China.
CP’s airline, Canadian Pacific Airlines, or CP Air, operated from 1942 to 1987 and was based in
Vancouver, serving national, European and Asian routes (Tokyo and Hong Kong). It was purchased by
Pacific Western Airlines to create Canadian Airlines and later merged with Air Canada. These
reorganizations, mergers and divestments forced headquarters and senior management to focus on the
domestic and North American transportation sector, including passenger trains, urban commuter trains
under contract and icebreaking ferry services, without fully recognizing the profound changes taking
place in its core business, railways. In 2001, CP’s parent company, Canadian Pacific Limited, reorganized
itself into five separate subsidiaries, including CP, with independent boards and senior management.
Canadian Pacific Railway formally (but not legally) shortened its name to Canadian Pacific early in 2007
and moved its head office from Montreal to Calgary, dropping the word “railway” to reflect more
operational flexibility.
The two railways were now competing on a level playing field as two publicly listed companies. Consider
the mission statements at CP and CN, as set out in their in their 2007 annual reports: 9
CP: Our vision is to become the safest and most fluid railway in North America. Through the
ingenuity of our people, it is our objective to create long-term value for our customers,
shareholders, and employees. We seek to accomplish this objective through the following three-
part strategy: (1) quality revenue growth . . . in bulk, intermodal and merchandise business lines;
(2) improving productivity by leverage strategic marketing and operating partnerships; (3)
continuing to develop a dedicated and professional and knowledgeable workforce and sustainable
financial performance . . .
CN: CN has a unique business model, which is anchored in five corporate values: providing
quality services, controlling costs, focusing on asset utilization, committing to safety, and
developing people. Employees are encouraged to share these values and promote them in their
day-to-day work. Precision railroading is at the core of CN’s business model. It is a highly
disciplining process whereby CN handles individual rail shipments according to a specific trip
plan and manages all aspects of rail operations to meet customer commitments efficiently and
profitably. Precision railroading demands discipline to execute the trip plan, the relentless
measurement of results, and the use of such results to operate execution improvements, Precision
railroading increases velocity, improves reliability, lowers cost, enhances utilization and
ultimately helps the Company to grow the top line.
By 2010, faced with the same union constraints, government regulation, rules of the game and
competitive forces, CN had grown to three times the market capitalization of CP, had far better operating
ratios and asset utilization and had better records of safety and accidents in the competitive North
American marketplace (see Exhibit 1).
9
Reference to CP Annual Report 2007, p. 6, www.cpr.ca/en/invest-in-cp/Financialreports/attachments/88/cp-aif-2007;
Reference to CN Annual Report, p. 32, www.cn.ca/-/media/files/investors/investor-annual-report-
archives/english/2007/2007%-%20CN%
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BOARD GOVERNANCE AND LEADERSHIP AT CP
By many measures of board governance, CP’s board ranked highly at the time of Pershing’s very public
attack. CP had captured the 2009 Governance Gavel Award for Director Disclosure from the Canadian
Coalition for Good Governance. ISS Proxy Advisory Services, one of CP’s harshest critics, conceded that
“the board has demonstrated good stewardship of investors’ interests regarding executive-compensation
practices.” CP ranked twenty-fifth on the Corporate Knights’ “Top 50 Corporate Citizens in Canada” 10
for social responsibility. In the Globe and Mail’s tenth annual review of corporate governance practices in
Canada, published in November 2011, CP was ranked fourth out of 253 companies whereas CN was
ranked fifteenth. A listing of CP and CN’s boards of directors in 2011 is in Exhibit 2.
Furthermore, the CP board and management had plans to improve corporate performance and believed
that they were on the right road to execute them. In the 2010 Annual Report, published in early 2011,
CEO Fred Green noted: 11
These results were achieved in a year that brought its own unique challenges. The rate of
economic recovery in 2010 exceeded the expectations of most of our customers, which was
obviously excellent news. But the limited visibility into near term customer demands placed on
CP resources created a challenge of coordination between CP’s capacity and the capacities of the
many North American and global supply chains in which we participate. CP responded well,
however there were times when CP and the supply chains did not perform optimally and this is an
opportunity we will address.
In 2011, CP will benefit from our 2010 resource actions on people and equipment and expects to
meet customer demand with a level of service, and at a level of efficiency, necessary to achieve
its marketplace and financial objectives…
…I am proud to say, that for the fifth consecutive year, Canadian Pacific remained the industry
leader in train safety performance. The Company has now been the safest railway in North
America 11 out of the past 13 years – a testament to the dedication and diligence of our
employees and to the effectiveness of our underlying safety management process….
Turning to 2011, CP enters the year with the balance sheet strength and liquidity necessary to
execute the elements of its strategy without delay. This is best evidenced by a $1 billion capital
plan that is focused squarely on providing capacity to grow with an improving economy,
leveraging the customer service and efficiency benefits of technology and realizing the potential
of market development initiatives carefully nurtured over the past few years …
The first half of 2011 was challenging as CP experienced significant disruptions to its operations across
its network. These disruptions were mainly due to unusually severe winter weather and the impact of
subsequent flooding, in one case causing a mainline outage lasting for three weeks. These extraordinary
conditions resulted in slower train speeds, reduced productivity and asset velocity and lower than
expected volumes in the first half of the year. In addition, customer confidence had been undermined and
needed rebuilding. While results for the whole of 2011 were not yet in, it was clear that the early
estimates for net income, return on capital and operating ratio were not going to live up to original
expectations. The first nine months of 2011 had seen a reduction in operating income of 18.8 per cent on
10
www.corporateknights.com/report/2011-best-50-corporate-citizens-canada
11
Janet McFarland, ”Board Games: Corporate Canada Sees a quiet Revolution in Governance,” Globe and Mail, November
25, 2011.
Page 7 9B14M035
slightly increased sales of 2.2 per cent, although this was heavily influenced by a 33 per cent increase in
fuel costs that accounted for 22 per cent of all operating costs. Net income for the first three quarters of
the year was off by 25 per cent at $2.04 per share (diluted) versus $2.75 for the first nine months of
2010. 12
On the other hand, progress had been made toward the end of the year in improved service reliability, and
the planned capital program had been completed. CP set a new full-year record in train weights and
expected to improve productivity by, among other things, reducing the number of major locomotive repair
facilities from eight to four highly efficient super shops with improved repair capabilities.
THE FIGHT FOR CONTROL OF CP
The board of CP first realized that there was going to be a fight for control of this iconic Canadian
company in the early evening of October 28, 2011. Paul Guthrie, vice-president, law and risk
management at CP, was travelling across Canada with a senior management team, touring facilities along
the route. One of CP’s legal advisory firms called him about a rumour that an activist hedge fund,
Pershing Square Capital Management (Pershing), was actively buying CP stock and had certainly passed
the 5 per cent threshold requiring it to notify the Securities and Exchange Commission (SEC) in the
United States that it was doing so.
William Ackman’s Pershing was a private U.S.-based hedge fund company founded in 2004 with an
initial capital of $54 million and had averaged 24 per cent annualized returns, with $7.78 billion in assets
under management. It employed extensive research and thoroughgoing due diligence and focused on
taking positions in companies whose shares it considered to be undervalued relative to their potential or
where there was a good “short” position — the company was headed for serious share declines and
Pershing could profit from the decline. Pershing had made previous investments in Target, Fortune
Brands, General Growth Properties, Family Dollar, Lowes Companies, BEAM Inc., Kraft Foods,
Wendy’s — where Ackman forced the sale of its Tim Hortons operations — J.C. Penney and Citigroup.
Pershing had made money on some and lost on others. At the end of 2011, its portfolio included just 10
companies and included an estimated 11 per cent stake in CP that it had started to accumulate in early
2011.
As further media reports would reveal, the origins of the CP proxy fight came from a meeting of a group
of 20 portfolio managers from different capital market firms at Benoit’s, a trendy, private, oak-panelled
restaurant in New York. The topic of the dinner was “financial opportunities in the transportation sector.”
The warm evening and luxurious surroundings started pleasantly over pre-dinner cocktails, but this
convivial atmosphere was short-lived as one of the portfolio managers present initiated a tirade against
CP and its CEO, Fred Green. As one participant recalled, the disgruntled investment manager “expressed
disdain that the CEO couldn’t execute his way out of a wet paper bag” and suggested that only an activist
investor could “pressure the board to do what should have been done a long time ago.” 13
It turned out that a close associate of one of the portfolio managers present at the meeting was Paul Hilal,
a partner at Pershing, who knew quite a lot about CP. Through a flurry of phone calls and discussions,
Pershing quickly gathered key information, the numbers were crunched (over five years CP had a
negative return on investment of 18 per cent) and a battle plan set in motion. As one report added, “by
12
CP Annual Report 2007, www.cpr.ca/en/invest-in-cp/Financialreports/attachments/88/cp-aif-2007
13
For background, see Scott Deveau, “Corporate Culture Shift Underway after CP Rail Proxy Fight,” National Post,
December 5, 2011.
Page 8 9B14M035
fall, that seemingly random discussion had led Pershing Square to its biggest play yet: an eventual $1.4-
billion bet on CP paired with a plan to replace Mr. Green with Hunter Harrison, a retired industry legend
in his own right and former head of rival Canadian National Railway Co.” 14
Pershing had begun accumulating common shares of CP at prices near the lower end of its two-year
trading range of $68.08 on February 18 to a low of $48.09 on September 30, 2011. By October 18, 2011,
Pershing had acquired over 5 per cent of the outstanding CP shares, thus obligating Pershing to file a
Schedule 13D report with the SEC. By the time that report was filed, on October 28, 2011, Pershing’s
holdings actually exceeded 10 per cent, resulting in it filing an early warning report with the Canadian
Securities regulators, submitted five days later. Under U.S. law, such a filing was required within 10 days
of crossing that 5 per cent threshold, but by the time Pershing notified the SEC, it actually held over 12
per cent of the 160 million shares outstanding. The CP stock price had jumped to $64.57 on the NYSE at
close of trading on October 28, 2011, no doubt influenced by the publicity surrounding the Pershing move
on the company and the market’s anticipation of a proxy battle. On January 17, 2012, CP stock closed at
$69.18 (see Exhibit 3).
Over the next few months, both Pershing and CP held numerous meetings, some open to the public, to
advance their cause. Pershing’s main focus was on CP’s performance over the last few years reflected in a
simple statistic, the operating ratio (operating costs as a percentage of revenue) as a measure of efficiency.
CP’s number was 81 in 2011, in contrast to the North American leader, CN, which was 63 — a target that
Pershing argued could be achieved by CP by 2015 under Harrison’s leadership of. A second Pershing
argument was that the CP board of directors didn’t have enough members with railway backgrounds, and
they added Stephen Tobias, who had four decades of railroad experience as former CEO, COO and vice-
chairman of Norfolk Southern Corporation, to its proposed new slate of directors.
During these many discussions, Ackman had pushed for greater representation on the CP board with
himself and one of his close colleagues to be appointed as directors and for the ouster of Fred Green as
CP’s CEO. The CP board had only agreed to the appointment of Ackman as a director subject to a
standstill agreement that prevented him from accumulating more shares or conducting a proxy fight, a
demand that Ackman refused.
In his Q3 2011 report to Pershing shareholders, Ackman stated: “On nearly every operating measure, CP
underperforms its closest competitor Canadian National Railway Company (CN) as well as the other
North American railroads. We believe the discrepancy in performance at CP is generally not attributable
to structural factors and can largely be resolved.” 15 A key demand of Ackman’s was to replace Fred
Green, CEO of CP for the last five years, with Harrison (see footnote 8). 16
During the fourth quarter of 2011, various members of the CP board met several times with Ackman to
discuss his interest in CP. Ackman had been offered a seat on the board on the condition that Pershing did
not increase its share ownership beyond the 14 per cent (approximately) that it already held. CP had also
addressed its own governance situation in its soon-to-be-published 2011 annual report. John Cleghorn —
former chairman and CEO of the Royal Bank of Canada and current or former director of several large
Canadian corporations, including Nortel, Finning International and SNC-Lavalin, and also a member of
14
Ibid.
15
William Ackman, Pershing Square 3Q 2011 Shareholder Letter, November 22, 2011.
16
CN was not an idle bystander in these events. When Harrison, its former CEO, participated in a Pershing town hall
meeting in Toronto, and announced his willingness to become CP’s new CEO, ending his retirement living in Florida, CN
suspended his pension and other lucrative payments, saying he had violated his non-compete clause. Harrison through his
lawyers disputed this non-compete clause in a Chicago court, saying it had expired on December 31, 2011.
Page 9 9B14M035
the Order of Canada and a 2008 inductee of the Canadian Business Hall of Fame — noted in his
Chairman’s “Letter to Shareholders:” 17
CP’s independent Board is composed of directors with extensive, relevant experience in railroads
and complementary industries including energy, natural resources, food and agriculture, as well
as leaders from the fields of law, government, banking and finance. During the past year, the
Board was pleased to announce the addition of Rick George. Mr. George is the Chief Executive
Officer of Suncor Energy, Canada’s largest integrated energy company, a position he has held
since 1991. Rick has had significant experience with the rail industry, as Suncor is both a supplier
of fuel to the industry and a shipper of petroleum products by rail.
In 2011, the Board also announced the addition of Tony Ingram and Ed Harris, seasoned railroad
executives who served at four of the seven Class I railroads in North America and together bring
over 80 years of rail experience. Mr. Ingram and Mr. Harris have joined the Safety, Operations
and Environment Committee, tasked by the Board with monitoring the progress of the Multi-Year
Plan developed by management and fully endorsed by the Board. The additions of Rick, Tony
and Ed have significantly strengthened our Board, and we look forward to benefiting from their
broad range of experience for many years to come.
Under the close oversight of the Board, CP’s management team has been aggressively and
successfully executing on the Plan and its core pillars of driving volume growth, expanding
network capacity to safely and efficiently support higher volumes, and controlling costs. The
disciplined implementation has led to materially enhanced operational efficiency and further
increased service quality and reliability, setting the stage for additional meaningful improvements
of key operating and financial metrics going forward. These improvements will translate into
enhanced value for shareholders.
The Board as well as the Safety, Operations and Environment Committee are encouraged by the
Plan’s most recent successes and will continue to hold CP’s senior management fully accountable
for reaching an Operating Ratio of 70 to 72 per cent for 2014 and delivering further
improvements thereafter.
On January 4, 2012, John Cleghorn received an e-mail from William Ackman: 18
From: William A. Ackman

Sent: Wednesday, January 04, 2012 7:22 AM
To: John Cleghorn
Subject: War and Peace
John,
I woke up early this morning thinking about my favorite Canadian railroad and it is causing me to
become more interested in military history. We have had what the historians would likely call a
border skirmish. It is not clear who fired the first shot, but a few people have been hurt, some
17
“Chairman’s Letter to Shareholders”, Canadian Pacific Annual Report 2011, p. 1. Used with permission.
18
“War of words: The e-mails that touched off a battle at CP,” The Globe and Mail, Monday, January 16, 2012, 6:00 AM
EST, www.theglobeandmail.com/globe-investor/war-of-words-the-e-mails-that-touched-off-a-battle-at-cp/article1358767/.
Used with permission.
Page 10 9B14M035
egos have been bruised, and the arms dealers (the media) are calling for and attempting to gin up
a fight. They of course sell more papers if a fight occurs so their motives are clear.
When a border skirmish takes place, sometimes it leads to full out war and other times, things die
down, borders are redrawn and peace can remain in both lands.
The choices from here as I see them are (1) representatives from our side and your side sit down
and work this out promptly. Working it out, in my view, is the quick addition to the board of two
representatives from our side, and Hunter’s hiring as CEO. The second alternative is that we will
be forced to launch a proxy contest for the upcoming annual meeting where we will seek to
replace a greater number of the existing directors with extremely highly regarded business
executives who share our belief that management and board change is necessary at CP.
In the proxy contest, as a first step, we will take the largest public hall you have available in
Toronto and will make a presentation to shareholders and the public (which will be simulcast on
the Internet) about management and board failure over the last 10 years at CP. We will examine
management’s and the board’s track record and history in CP and in previous career experiences.
Among other issues, we will go into detail on the real reasons behind Ed Harris’s departure 19 and
compare it with what the company said publicly at the time. While we will only do this in the
most high-minded manner possible — we will not make any ad hominem attacks on anyone —
the process is inherently an uncomfortable one for all parties involved. It is all also expensive in
time and money and a distraction for management, particularly at a time when their focus is
needed on operations (most importantly, when it is snowing or flooding).
This proxy contest will not go well for the board and Fred. The track record is very poor,
shareholders are disgruntled, and we are offering an alternative with a legendary reputation. An
analyst at Morgan Stanley, your advisor in this matter, is now writing of a “super-bull” case if
Hunter is hired. I have attached a copy of the report to this email. We will win the election likely
by a landslide vote. Don’t rely on my opinion on this, just ask your proxy advisors.
Based on yesterday and my not receiving a return call from you, the probability of war occurring
has gone up meaningfully. War is not my preference and it has been extremely rare for us. We
have had only two proxy contests in 25 or so active engagements with public companies over the
last eight years.
War is also not inevitable.
I think the failures so far have been largely ones of communication. As a result, I think it is useful
to review why we are where we are. When we first met, I explained to you the importance of
resolving things quickly and getting on the same page as quickly as possible. We were delighted
with the way our first meeting ended. After pulling me off the plane, you explained to me that
“Fred agrees with the logic of your presentation” and clearly implied that he was prepared to step
down. You explained that his principal motive for allowing Hunter to replace him was to get back
at Canadian National because he hates them so much. You then said, “Welcome to Canadian
19
Ed Harris had been appointed executive vice-president of Operations in April 2010 after a 30-year career with CN. There
had been speculation in the press about friction between him and Fred Green, the CEO, and some suggestion of
disagreement about how to make productivity improvements at CP. At least one analyst, Walter Spracklin of RBC Capital
Markets, had cut his price target on CP stock from $80 to $75 as a result of Mr. Harris’s departure. See Scott Deveau,
“Harris Departure Raises Risk at CP Rail: RBC,” Financial Post, March 4, 2011.
Page 11 9B14M035
Pacific!” and shook my hand in a warm embrace. You told me that you had a board call set for
the following day and that you would get back to me no later than Friday morning, but probably
earlier on Thursday.
We viewed the meeting positively, largely because often the biggest barrier to replacing a failed
CEO is the CEO himself. With Fred apparently on board with the plan and with your welcome, I
believed we were well on our way.
Things began to go awry when you did not call me on Thursday or Friday. When we finally
spoke on Saturday as a result of my reaching out to you, things apparently had changed
meaningfully since our Wednesday meeting. On the call, you asked me to arrange a meeting with
Hunter that Kathryn McQuade [CFO of CP] would attend. When I explained that I thought it was
inappropriate for a CEO candidate to meet with the CFO of the company rather than the full
board who should be doing the job of hiring the CEO, you told me that the board did not have a
lot of railroad industry expertise and that Kathryn could help the board evaluate Hunter’s plan for
turning around CP. I then explained that even if the board were willing to meet with Hunter we
did not believe he could do so in light of constraints in his non-compete arrangement. You then
asked me to have our counsel speak with yours about the non-compete agreement.
In light of the necessary delay in meeting Hunter, I then suggested that the best approach would
be to get Paul Hilal and myself on the board right away so we could assist the board in the
management decision. You expressed surprise that we were interested in board seats. When I
reminded you that we had requested “a couple of board seats” at our Wednesday meeting, you
said that you had no recollection of that request. When I reminded you that at the meeting, I had
given the JC Penney analogy where two of our representatives were invited to join the board
without being required to sign a standstill, and we then worked with the board in private to recruit
a new CEO, you seemed to remember that, but not a specific request for board seats. I then
reiterated the request for board seats. You explained that you would have to talk [to] the board
about that.
Two weeks or so passed without a communication from you. I called to find out when we would
have an opportunity to meet with the board. You then explained that while you were
recommending that the board meet with us to consider our candidacy, you would not be able to
hear whether the board would be willing to do so until after Thanksgiving because of travel
schedules. On the Friday after Thanksgiving, you called and said that [the] nominating committee
would be willing to meet and that the lawyers should talk to schedule such a meeting.
Your side proposed December 11th, Sunday night, in Calgary and we flew there for the meeting.
While I very much enjoyed meeting the directors and thought I could work well with them on the
board, I took it quite negatively that the committee was unwilling to meet with my proposed
director, trusted partner and good friend Paul Hilal particularly in light of the fact that he left his
newly born baby girl and beautiful wife to travel a fair distance on a Sunday night. I also felt that
you were perhaps attempting to run out the clock on us. I didn’t completely understand the
Canadian proxy rules at the time, and had been erroneously told that we had to file proxy
materials shortly. When I learned that we could file materials up to nearly the day of the meeting,
it took some of the time pressure off.
While I was happy to hear from you later that the board had unanimously approved my
nomination, I told you that I was disappointed you would not consider Paul as a director. You
Page 12 9B14M035
explained that Paul was not a CEO, that I was “the man” at Pershing Square, and as such the
board would not consider him. You also told me that the board had appointed two other directors
with railroad industry expertise and that you would ideally like to announce us together in one
coordinated press release. You then told me that the lawyers would talk about customary
arrangements. When I asked what you meant by that, you explained that the company would like
to review confidential information with me that would help me understand the company’s
business performance and that I would have to sign a confidentiality agreement. I asked whether
the other directors had signed such a document and you told me they had done so. You
encouraged me to let the lawyers handle it.
When the document finally arrived a day or so before I left town for holiday, it was clear that it
was a standstill arrangement rather than a confidentiality agreement. I was disappointed by the
proposed agreement principally because I had explained at our very first meeting how we were
able to work with the board in the JC Penney situation without signing a standstill, and I had
expressed both through our counsel and to you directly that we would not sign such an
arrangement.
Two months have passed. We are still left out in the cold. I have been accused by you in a public
letter of making false and misleading statements. We are not in a great place.
In order to improve communication, you and I need to speak more often. If you don’t like dealing
with me, I am happy to speak with someone else on the board. The fact that you have been
unwilling to give me your contact information doesn’t send a good message about your desire and
interest in working with me (the only numbers I have are from times that you called me on my
cell phone and the number was listed). Alternatively, in cases like this, most companies set up a
special committee tasked with working with us. One of the biggest issues we have had is that
weeks go by between communications, perhaps because you need to poll all of your directors
every time a decision needs to be made. From our side, it appears that you are delaying
responding, and perhaps it is simply the logistics of getting the board together. If you could
designate a small committee of directors who have the time to be responsive to this matter, it
would be a good idea in my view. I encourage you to ask your advisors about this.
My impression of you when we first met was quite favorable. You seem like a solid, good man. I
would like to resolve this situation amicably in the best interest of shareholders as I am sure you
would.
To throw out alternative ideas, I am open to not serving on the board as long as I am comfortable
that we are adequately represented by directors that we designate (that of course you have to
approve) and we are comfortable with the composition of the rest of the board.
Let’s avoid having a border skirmish turn into a nuclear winter. Life is too short.
Please call me when you can.
Sincerely
Page 13 9B14M035
NEXT STEPS FOR THE CP BOARD
The fourth quarter 2011 results, to be released to the media at the end of January 2012, showed income
had increased by $196 million while operating expenses had increased by $345 million, operating income
declined and net income was $570 million, a decline of $81 million. Despite these disappointing bottom
line numbers, the company believed that it had made meaningful progress on the three pillars of its multi-
year plan: driving growth, expanding network capacity to safely and efficiently support higher volumes
and controlling costs. During the fourth quarter, it had delivered record asset velocity, a direct link to
better service, positioning it for a lower operating ratio.
To date, while Pershing had been accumulating shares in CP and had seen its shareholdings increase
substantially in price from their acquisition cost, it had not launched a formal proxy fight, though
Ackman’s e-mail clearly indicated that he was prepared to do so unless his demands were met. What, if
any, further concessions should CP make to Ackman to avoid a proxy battle before the upcoming annual
general meeting in May?
Page 14 9B14M035
EXHIBIT 1: CP AND CN PERFORMANCE IN 2010
CP CN
Annual Sales $4,081 million $8,207 million
Revenue/ton miles 126,428 179,232
Gross Ton Miles (GTM) 242,767 341,210
GTM/Employees 000s 17,491 15,533
Operating Expenses/(GTM) 0.59 cents 0.51 cents
Operating Ratio 79.1% 63.6%
Employees 13,619 22,297
Carloads 2660 4696
Accident Rate/Million 1.63 2.03
Injury Frequency/200,000 1.61 1.21
Largest Shareholders Various Canadian Funds Bill Gates
Route Miles 14,800 20,560
Market Capitalization 10,933.7 billion 30.441.19 billion
Shares Outstanding 169,200 459,400
Cdn$ Share Price, 2010 64.62 66.35
Source: Authors' analysis based on annual reports.
EXHIBIT 2: CP AND CN’S BOARDS OF DIRECTORS IN 2011
CP Directors and Committees
John E. Cleghorn, O.C., F.C.A. (2) Hon. John Manley, O.C. (1, 2, 5)
Chairman, Toronto President & CEO, CCCE, Ottawa
Tim W. Faithful (2,3,4) Linda J. Morgan (1,3)

Retired President & CEO, Shell Canada Partner, Nossaman LP, Bethesda, Maryland
Oxford, England
Richard L. George (4,5) Madeleine Paquin (3,4)

CEO, Suncor Energy, Calgary President & CEO, Logistec Corp. Montreal
Fredic J. Green Michael E.J. Phelps, Q.C. (2,4,5)

President & CEP, CP, Calgary Chairman, Dornoch Capital, Vancouver
Edmond L. Harris (3,5) David W. Raisbeck (4,5)

Ret’t Exec. VP and COO, CP Ret’d Vice-Chairman, Cargill Inc., Sanibel, Florida
Spring Lake, Michigan
Roger Phillips, Q.C., S.O.M., F. Inst.P. (1,2,5) Hartley T. Richardson, C.M.O.M. (1,3)
Ret’d President & CEO, IPSCO Inc. President & CEO, James Richardson & Regina Sons, Limited,
Winnipeg
Krystyna T. Hoeg, C.A. (1,5) Tony L. Ingram (3,4)

Former President and CEO, Former Executive VP and COO,
Corby Distillers, Toronto CSX Transportation Inc., Jacksonville, Fl.
Richard C. Kelly Committees: Audit, Finance Risk (1)

Ret’d Chair & CEO, Xcel Energy Inc., Denver Governance and Nominating (2)
Safety, Operations, & Environment (3)
Mgt Resources & Compensation (4)
Pension Committee (5)
Page 15 9B14M035
EXHIBIT 2 (CONTINUED)
CN Directors and Committees
David G.A. McLean, O.B.C., LLD. (2,3,4,6,7,8) Hon. Denis Losier, CM, P.C., LLD (1,4,5,6,7)
Chairman, CN, and Chairman, President & CEO, Assumption Life, Toronto
McLean Group, Vancouver
Claude Mangeau, (4,7) Donald Carty, O.C., LL.D (1,2,3,7)

President & CEO, CN, Montreal Ret’d Chairman & CEO, American Airlines
Michael R. Armelino, CFA (4,5,6,7,8) Amb. Gordon Giffin (2,4,5,7,8)

Ret’d Partner, Goldman Sachs Group Senior Partner, McKenna Lang & Alaridge
A. Charles Baillie, Q.C., LLD (2,5,6,7,8) Edith E. Holiday (2, 3, 6,7,8)

Former Chairman & CEO, TD Bank Corporate Director, Former General Counsel,
Toronto US Treasury Dept.
Hugh J. Bolton, FCA (1,5,6,7,8) Maureen K. Darkes, O.C. (1,5,6,7,8)

Chairman of Board, Epcor Utilities Ret’d Group VP, General Motors
James E. O’Conner (1,2, 5, 7) Robert Pace, MBA (1,3,6,7,8)

Former Chair & CEO, Republic Services Inc. President & CEO, The Pace Group
Committees: Audit (1), Finance (2), Governance & Nominations (3), Donations & Sponsorships (4)
Environment, Safety, Security (5), HR & Compensation (6), Strategic Planning (7), Investment (8)
EXHIBIT 3: CP AND CN COMMON STOCK — RELATIVE PERFORMANCE 2002 TO 2011
Source: Yahoo Finance, http://finance.yahoo.com, accessed March 7, 2014.

Canada'S Two National "Railroads"

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SHAREHOLDER ACTIVISM AT CANADIAN PACIFIC RAILROAD 1

Copyright © 2014, Richard Ivey School of Business Foundation Version: 2014-04-08

CANADA’S TWO NATIONAL “RAILROADS”

BOARD GOVERNANCE AND LEADERSHIP AT CP

THE FIGHT FOR CONTROL OF CP

On January 4, 2012, John Cleghorn received an e-mail from William Ackman: 18

From: William A. Ackman

War is also not inevitable.

Please call me when you can.

NEXT STEPS FOR THE CP BOARD

EXHIBIT 1: CP AND CN PERFORMANCE IN 2010

Source: Authors' analysis based on annual reports.

EXHIBIT 2: CP AND CN’S BOARDS OF DIRECTORS IN 2011

CP Directors and Committees

Tim W. Faithful (2,3,4) Linda J. Morgan (1,3)

Richard L. George (4,5) Madeleine Paquin (3,4)

Fredic J. Green Michael E.J. Phelps, Q.C. (2,4,5)

Edmond L. Harris (3,5) David W. Raisbeck (4,5)

Krystyna T. Hoeg, C.A. (1,5) Tony L. Ingram (3,4)

Richard C. Kelly Committees: Audit, Finance Risk (1)

CN Directors and Committees

Claude Mangeau, (4,7) Donald Carty, O.C., LL.D (1,2,3,7)

Michael R. Armelino, CFA (4,5,6,7,8) Amb. Gordon Giffin (2,4,5,7,8)

A. Charles Baillie, Q.C., LLD (2,5,6,7,8) Edith E. Holiday (2, 3, 6,7,8)

Hugh J. Bolton, FCA (1,5,6,7,8) Maureen K. Darkes, O.C. (1,5,6,7,8)

James E. O’Conner (1,2, 5, 7) Robert Pace, MBA (1,3,6,7,8)

EXHIBIT 3: CP AND CN COMMON STOCK — RELATIVE PERFORMANCE 2002 TO 2011

Source: Yahoo Finance, http://finance.yahoo.com, accessed March 7, 2014.

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