TORONTO/BOSTON (Reuters) - Hedge fund manager William Ackman just got more ammunition in his battle to shake up Canada's No. 2 railroad.
Institutional Shareholder Services Inc., a leading advisory firm on proxy contests, on Thursday endorsed the activist investor's entire slate of seven nominees to sit on Canadian Pacific Railway Ltd's (CP.TO) board.
It also recommended to withhold votes from the railroad's chief executive and its board chairman, saying they failed to provide effective leadership and accountability to shareholders.
The recommendation is noteworthy because proxy advisers rarely support an entire slate and because it gives Ackman and his New York-based Pershing Square Capital Management new power to oust the railroad's current chief executive.
Ackman has long argued that Canadian Pacific's CEO, Fred Green, should be replaced by Hunter Harrison, who used to run the railroad's more successful rival, Canadian National Railway (CNR.TO).
"There could not have been a stronger endorsement of Pershing Square," said Ken Squire, founder of proxy research firm 13D Monitor. "I cannot remember another time where a dissident group nominated seven directors at a large cap company and got all seven directors recommended by ISS," Squire added.
ISS said Ackman and Pershing Square, who own a 14.1 percent stake in CP, showed that the board has let the company lag its peers and fail to live up to its potential. "It seems clear that change on the board is needed," ISS wrote in the report.
A recommendation from Glass Lewis, another advisory firm, is expected shortly.
Ackman said he was "delighted" with the report, but CP said it feels the proxy adviser had reached the wrong conclusion.
Now both sides have only a few days left before this increasingly acrimonious fight is brought to shareholders for a vote at the company's annual meeting on May 17 in Calgary.
The battle lines hardened earlier this week when Ackman, a veteran of tough proxy fights, put the chances of reaching a settlement before the meeting at "very close to zero." At the same time CP has refused to consider Ackman's preferred CEO candidate Hunter Harrison.
But the odds now seem to favor Ackman as he pushes for better performance, better leadership and a better corporate culture at the railroad only three years after having lost a similarly prominent battle at retailer Target.
"We sense that the strong endorsement by ISS reflects the consensus view amongst shareholders and underscores the need for change," BMO Capital Markets analyst Fadi Chamoun said.
One flashpoint in this proxy fight has been the railroad's lackluster operating ratio, which measures how much revenue is required to maintain operations, and stood at 80.1 percent during the first quarter. Ackman says Harrison could improve CP's ratio to 65 percent within four years.
Since Ackman became involved in the railroad in October, CP's shares have climbed about 24 percent and his fund has turned in some of the hedge fund industry's best returns this year, rising 10 percent in the first three months of 2012, an investor in his fund said.
Indeed 13D Monitor's Squire said that the ISS' endorsement may prompt the railroad to shift tactics and appeal to Ackman to strike some sort of deal.
"Right now, the CP CEO and board chairman stand to lose their seats and if this goes the distance to a vote, the dissidents would be able to clean house. So maybe the company would want to be seen as being part of the solution and pave the way for a settlement," Squire said.
Additional reporting by Nicole Mordant in Vancouver and Susan Taylor in Toronto; Editing by Peter Galloway and Leslie Gevirtz