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Nell Minow
More important, though, is that governance principles have become the conventional wisdom. Few companies these days ignore shareholder inquiries, or insist that they be made through the formal procedures of a shareholder resolution. Many shareholders raise concerns informally, without filing resolutions, and many who file resolutions negotiate with management and withdraw them. For example, the New York City pension funds were able to persuade companies to adopt 13 of their proposals in 1994, and it is clear that most shareholders, managers, and directors expect to pursue this spirit of cooperation. All three groups have made their other plans and expectations for the next year very clear.
Shareholders
Shareholder activism has evolved very quickly over the past decade. From a way to raise concerns over social policy issues to an outraged response to the abuses of the takeover era, it has become almost exclusively concerned with value. Shareholder activism is no longer a fringe activity for institutional investor fiduciaries. Involvement in governance is now an essential component of investment management. Time and experience have demonstrated that investors, whether large institutions or individual shareholders, can protect and enhance the value of their investments through shareholder activism at least as cost-effectively as they can through trading, and often moreso.
For example, a study by Wilshire Associates in 1992 showed that the investment of $500,000 in shareholder initiatives at underperforming companies by the California Public Employees Retirement System resulted in $137 million in extraordinary (over the S&P 500) gains, a rate of return difficult, if not impossible to match through trading. Significantly, the initiative did not have to be successful -- there were extraordinary gains at every company identified by CalPERS, even when the sponsored initiative received less than a 50 percent vote. Wilshires second study, in 1994, found that the 24 companies identified as underperformers by CalPERS went from 86 percent below the S&P returns to 109 percent ahead, in just two years. The economic evidence is clear enough that no fiduciary can fail to consider activism as an investment strategy, or fail to pursue it, if the likelihood of success seems reasonable. And the returns are compelling enough to persuade those exemplars of economic rationality, the Wall Street analysts and money managers, that activism is a highly competitive investment strategy. The merging of governance into the mainstream of asset management is the real story at this stage of shareholder activism.
The shareholder communication rule changes were also a factor in the record levels of support that shareholder proposals from individuals and institutional investors (still mostly public pension funds) received. For example, five poison pill proposals received majority votes, with the proposal at Advanced Micro Devices garnering 66 percent. Confidential voting proposals won majorities at American Cyanamid and Occidental Petroleum, and several others received votes of 40 percent or higher. A proposal for annual election of directors received an astonishing 82 percent of the vote at U.S. Shoe, while one at Ryder got 54.8 percent. The Labor Departments continued emphasis on the exercise of share ownership rights as a fiduciary obligation was another important reason for the increased levels of support. Knowing that they would have to be able to justify their votes as investment decisions led many more ERISA plans to cast votes contrary to managements recommendation. A third factor in 1995 will be the increased ease of communication through online systems like Bulletin Boardroom, which further reduces the cost to shareholders of sharing information and working cooperatively. Shareholders can not only retrieve information about a companys directors, compensation plans, SEC filings and press releases, but they can send email to the companys management (and even its directors) and to other shareholders, to solicit support or share views.
Public Pension Funds In 1995, the public pension funds will continue to play an important role, as exemplified by the State of Wisconsin Investment Board (SWIB), emerging as an especially innovative and effective group. In 1994 they were able to lead a broad-based coalition of shareholders defeat of K-Marts proposal to issue new classes of stock. This was an unprecedented show of strength, made possible in large part by the 1992 revisions to the proxy rules permitting shareholders to communicate with each other without burdensome filing obligations. CalPERS, now led by Jim Burton, will follow up on their efforts to get portfolio companies to respond to the General Motors corporate governance guidelines. They will also pursue relationship investing, probably with a prominent partner. NYCERS will continue with its policy of filing resolutions, negotiating with management over many, if not most, and vigorously supporting the rest. The Council of Institutional Investors will continue to coordinate efforts and act as a clearinghouse for information. Its new report, Does Ownership Add Value? is an indispensible compendium of 100 empirical studies on the effectiveness of ownership structures and initiatives. Council members will continue to select companies like Westinghouse and Philip Morris as targets. New targets will meet two key criteria: poor performance and governance vulnerability.
ERISA funds Sarah A.B. Teslik, with the strong support of the membership of the Council of Institutional Investors, now has over 50 ERISA funds as members of her group, once almost exclusively the province of public and labor union funds. While some cynics have speculated that this is an effort to stage something of a hostile takeover of the Council, in reality it is more a reflection of an if you cant beat em, join em philosophy, and has resulted in a much stronger and even more credible Council. ERISA funds are being more aggressive in exercising their ownership rights, in large part due to the Labor Departments Interpretive Bulletin 94-1, issued in July of 1994, which provided its most comprehensive guidelines on the "responsibility of ownership" for fiduciaries. The bulletin notes that:
it may be appropriate for a fiduciary to engage in activities intended to monitor or influence corporate management if the fiduciary expects that such activities are likely to enhance the value of the plan's investment. Although, within the corporate structure, the primary responsibility to oversee corporate management falls on the corporation's board of directors, the Department believes that active monitoring and communication with corporate management is consistent with a fiduciary's obligations under ERISA where the responsible fiduciary concludes that there is a reasonable expectation that such activities by the plan alone, or together with other shareholders, are likely to enhance the value of the plan's investment, after taking into account the costs involved.
Active monitoring and communication activities may concern a variety of issues, such as the independence and expertise of candidates for the corporation's board of directors or assuring that the board has sufficient information to carry out its responsibility to monitor management. Other issues might include consideration of the appropriateness of executive compensation, the corporation's policy regarding mergers and acquisitions, the extent of debt financing and capitalization, the nature of long-term business plans, the corporation's investment in training to develop its work force, other workplace practices and financial and non-financial measure of corporate performance. Active monitoring and communication may be carried out through a variety of methods including by means of correspondence and meetings with corporate management as well as by exercising the legal rights of a shareholder.
The increased levels of support for shareholder proposals reflect the Labor Departments efforts to persuade ERISA fiduciaries to vote proxies for the exclusive benefit of plan participants and the rise in companies adopting confidential voting policies. ERISA fiduciaries know that they need to justify their proxy votes in economic terms, and that they will not be pressured by managements for casting a vote contrary to the management recommendation.
Other shareholders It is possible that the SEC will issue some guidance for mutual funds along the same lines as the DOL Interpretive Bulletin, making it explicit that exercise of ownership rights, including proxy voting and evaluating more activist alternatives, must be undertaken as a part of fiduciary obligation.
The United Shareholders Association has folded. In its place, the small but feisty Investors Rights Association of America has taken hold, with a fraction of USAs public profile and an even smaller fraction of USAs budget. Its members have already filed more than 60 resolutions for 1995 annual meetings.
Shareholder initiatives are no longer limited to public pension plans or individual gadflies. In 1994, shareholders in several companies filed proposals asking the board to sell or merge all or part of the company. For example, Channing Lushbough submitted a shareholder proposal at Merchants Group, Inc. requesting that the board begin a search for a buyer for the company. The proposal, which received 30.6 percent of the vote, was a factor in the boards decision to replace the five directors who also served on the board of the parent company. Greenway Partners, L.P. got a 22 percent vote for a shareholder proposal at U.S. Shoe, asking the company to create two new subsidiaries, leaving three divisions in all, LensCrafters, U.S. Shoe, and Casual Corner, with a tax-free spin-off of the common stock to the shareholders. There will be more of this activity in 1995.
Wall Street money managers were quietly active in a number of cases that resulted in major changes, in 1994, including Borden and Alliant. In some cases, they coordinated with more visible activists, and in others they worked more directly with management. Their increased involvement is likely to be the most important development over the next few years. In their own ways, each of the categories of institutional investor has been energized by the a conviction that activism is in their long-term best interest. Active management of ownership rights is an essential, respected, and competitive element in asset management.
Management and Boards
Harvard's John Pound, leader of the New Foundations coalition of shareholders, managers, and academics, has said that in the future CEOs will be more like a politician than a monarch, negotiating agreement with all of the different parts of the corporate constituency. Similarly, long-time counsel to CEOs and directors Ira Millstein advises CEOs to adjust to a more consensus-based corporate governance structure. He wrote, in an article addressed to CEOs:
I ask you ... to determine to what extent the board procedures at your companies encourage independence and hence suggest credibility. After all, if you don't, shareholders, plaintiffs, and the government may."
General Motors showed just how far it had come by releasing its corporate governance guidelines, 28 principles that were applauded by shareholders. Over its history, General Motors has tried out almost as many models of corporate governance models as cars, and with the same variety of results. In the 1920's the CEO of General Motors was forced to resign by Pierre du Pont, representing the Du Pont company's 36 percent stake in GM. Du Pont himself became the CEO for two critical years, before turning the company over to Alfred Sloan, perhaps the ultimate example of shareholder activism and board responsiveness. But in the 1980's, General Motors was at the other end of the scale. After bringing in H. Ross Perot to get his ideas on how to improve the company, GM management decided his criticism made them uncomfortable, and they forced him off the board, paying him $742.8 million for shares that were trading at a little more than half of that. When two large institutional shareholders wrote letters inquiring about the process for selecting a replacement for retiring CEO Roger Smith, management responded with a statement to the press: "Corporate governance, which includes the selection of officers, is the board's responsibility." They never answered the shareholder letters.
The shareholders lost that battle, but won some bigger ones. In 1990 GM board agreed to a shareholder initiative and adopted a by-law prohibiting greenmail. The following year, again in response to shareholder pressure, the board adopted a by-law provision mandating a majority of outsiders on the board. While these concessions were mostly symbolic, the real change in the governance structure at GM was demonstrated a year later, when the board very publicly put pressure on Robert Stempel, Smith's replacement, to take "a more aggressive" approach, and then, six months later, replaced him, coming full circle to the days of du Pont. Again, the board had taken action to resolve a crisis situation.
The new board guidelines issued by GM address for the first time, however, the question of the standard of behavior for the board during time other than crises. Indeed, it is fair to say that these guidelines are designed with the goal of preventing future crises. They provide for executive meetings of outside directors three times a year, selection of new director candidates by the board itself (rather than by the CEO), a commitment to assessing the performance of both the board and the CEO, and at least suggest the possibility of contacts between directors and shareholders. These provisions will be adopted by more boards in 1995.
Both shareholders and management will continue to focus on director stock ownership and director compensation as the best way to align the interest of directors and shareholders. Scott Paper announced it was going to pay its directors in stock, and the market showed its appreciation by taking the stock price up $2.12 to $65.87.
Conclusion Corporate governance is about making sure the right questions get asked, and making sure that they are answered by the people with the best access to information and the fewest conflicts of interest. The players on all three sides, shareholders, managers, and directors, have learned a great deal about their roles and have developed much more respect for each other. In 1995, most companies will find that it is the best of times, as relationships with shareholders are cordial and constructive. For those few whose unresponsiveness to the market is emblematic (or even the cause) of poor performance, it will be the worst of times, as they find ever-broader coalitions of shareholders ready to insist on change.