“Corporations determine far more than any other institution the air we breathe, the quality of the water we drink, even where we live. Yet they are not accountable to anyone.”
Those words were on the 1991 cover of Power and Accountability: Restoring the Balances of Power Between Corporations and Society by Robert A.G. Monks and Nell Minow, long before 2010 when the United States Supreme Court ruled that the First Amendment prohibits government from placing limits on independent spending for political purposes by corporations in Citizens United v. Federal Election Commission. It was a great awakening. Many more began to realize how much power over our government we had ceded to corporations.
In 1987 Time magazine estimated that “of the 170 countries that exist today, more than 160 have written charters modeled directly or indirectly on the U.S. version.” More recently, David Law and Mila Versteeg compared constitutions world wide and found ours losing influence. ”Nobody wants to copy Windows 3.1,” says Law. Our constitution fails to protect entitlements to food, education and health care and is considered by many to be “frozen in amber.” In contrast, the Canadian Charter is seen by those in developing countries as “more expansive and less absolute.”
Many are now engaged in a movements, such as “We the People,” to “end corporate rule” and “legalize democracy.” While I support those efforts, a multi-pronged approach aimed at “legalizing” democracy both within our governments and within our corporations is needed. While many have written a great deal about political democracy, fewer have drawn attention to the need for corporations to be more democratic. Since corporations have so much control over our governments, we can’t take control of our government without a higher degree of control over how our corporations are governed. It is a symbiotic relationship.
What would you do if the company in which you’ve invested your hard earned dollars frittered it away so that an investment of $20,000 is now worth $3,000? David Monier, a shareowner at Princeton National Bancorp, Inc (PNBC), decided he wasn’t going to sit by idly. He utilized model United State Proxy Exchange language and reports his proxy access proposal will be included on PNCB’s proxy. If adopted, it would allow:
- 1. Any party of one or more shareowners that has held continuously, for two years, one percent of the Company’s securities eligible to vote for the election of directors, and/or
- 2. Any party of shareowners of whom one hundred or more satisfy SEC Rule 14a-8(b) eligibility requirements ($2,000 worth of stock held for a year),
This is significant because shareowners don’t have access to place their nominees on corporate proxies. Their proxies are treated as management proxies. If shareowners want to nominate directors they must hire a soliciting firm and mail out their own proxies. Since costs can be in the millions, only hedge funds can generally afford to do it and they are often looking to break up the company and sell off the parts. Monier will also be nominating Steve Bonucci from the floor of the annual meeting, so there is a real opportunity for change. Let’s hope CalPERS, PERA and other institutional investors at PNBC support this move initiated by a retail shareowner.
Some proposals, like Monier’s, are driven by shareowners who believe their companies retain substantial value but that value is jeopardized by poor corporate governance… often poor oversight by corporate boards. Others, especially after Citizens United, are concerned their corporations are donating to bad political causes or should just get out of politics. Many have turned to the Center for Political Accountability for assistance in filing proposals seeking disclosure of corporate spending. Still other investors are concerned with social or environmental issues like hydraulic fracturing. They are requesting greater disclosure of measures the company has taken to manage and mitigate the potential community and environmental impacts. Like political campaigns, those attempting to democratize corporations from the inside also face a Sisyphisian task.
The reality is that if you don’t like the way management handles your business, you have traditionally had two choices: hold your nose or sell out. The message is usually the same whether dispensed by Barron’s, Merrill Lynch or the manager of many “socially responsible” investment funds. Selling out is taking the “Wall Street Walk.”
Dumping stocks compounds the short term investment horizon plaguing Wall Street. The average stock is now held for 22 seconds, according to some. Although such high speed trading guarantees “liquidity” (buyers and sellers are always there), it has moved us from an ownership to a casino economy. The Wall Street Walk is often wrong for the investor, the quality of our products and environment, the treatment of employees, our balance of payments, and society-at-large. The real issue is often not last quarter’s balance sheet but the company’s strategic direction and the integrity of its management.
The Politics of Corporate Governing
This rather dry history has been overtaken by a series of high-profile, hot button debates swirling around the role of the corporation in society. Issues of corporate governance — corporate takeovers, downsizing, executive pay, the rise and fall of pension funds, the corrupting influence of corporate money in politics– are discussed daily in the press. So what has changed and how can it lead to more effective and responsible, corporate leadership?
In the 1960s, empire building by CEOs led to a kind of merger madness, as conglomerates gobbled up unrelated companies. When many of these conglomerates lagged in price in the 1970s, it heightened the realization that CEOs needed oversight. Accountability, of a sort, came in the 1980s when corporate raiders using “junk bonds” took many companies private, disassembled them and sold them back to the public in parts. The results to employees and communities were often devastating in the form of plant shutdowns and lost jobs. While workers and communities struggled with massive layoffs, CEOs invented golden parachute severance packages and designed poison pills which made takeovers less attractive through stock dilution mechanisms which hit new shareowners.
By the late 1980s, a backlash set in. The “junk bond” market imploded. An irate public and corporate boards began to demand a more active role in corporate governance. They recognized that their intervention could soften the impact of corporate restructuring on workers, communities, operations, and profits.
These developments led to the modern field of corporate governance which examines the legal, cultural and institutional arrangements that determine the direction and performance of corporations. Practitioners primarily include: (1) the shareowners, who usually hold one vote per share of common stock owned, (2) the board members, whom shareowners “elect,”and (3) the management of the firm, which is usually headed by a CEO appointed by the board. Other participants include advisors, creditors, employees, customers, suppliers, government and its citizens. Each party can influence the firm’s direction.
Pension Fund Power
Between 1955 and 1980, the institutional investor share of outstanding stock rose from 23% to 33%. In 1990, it had risen to 53% and now stands at more than 60%. Pension funds, as a subset, experienced even more rapid relative growth. Their share of the market rose from 0.8% in 1950 to 9.4% (1970), to 18.5% (1980), to 28% (1990) and stands above 30% today. This shift set the stage for the rise of a subtler form of corporate governance which has yet to be fully realized. Instead of waiting for corporate raiders to impose dramatic changes through hostile takeovers, pension funds have the opportunity to become long-term “relational” investors, working with boards and CEOs to make needed adjustments earlier and less painfully. Corporate governance would then move from revolutions and palace coups to the smoother transitions characteristic of democratic governments.
While legal impediments and conflicts of interest largely preclude mutual funds, insurance companies, and banks from holding large blocks of stocks, fewer such prohibitions apply to pension funds. Most pension funds are free to hold blocks of stock large enough to make monitoring of management feasible, from a cost-benefit standpoint. In addition, the Department of Labor, which governs most pension funds under the Employment Retirement Securities Act (ERISA), has clarified that voting rights are plan assets. It is, therefore, the duty of pension fiduciaries (trustees) to ensure such assets are voted solely in the interest of plan participants and beneficiaries. Unlike individual investors who can just throw their proxies away, pension funds are legally required to follow the issues of corporate politics and to vote.
Ideally, pension funds, who have predictable payouts, should be taking a long term investment time horizon and should be urging the firms they invest in the to do the same. The growth of pension funds dramatically increases the capacity of the financial community to identify and redress agency costs, since they bring the possibility of sophisticated monitoring by professional analysts. Unlike mutual funds or insurance companies, pension funds, especially public pension funds, have nothing to sell their portfolio companies and no intrinsic interest in acquiring operating control.
CalPERS: Leading the Pack
The California Public Employees’ Retirement System involvement with corporate governance issues can be traced back to a morning in 1984. Jesse Unruh, then treasurer of California and a CalPERS board member, read that Texaco had repurchased almost 10% of its own stock from the Bass brothers at a $137 million premium. Essentially, Texaco’s management paid “greenmail” to avoid loss of their jobs in a takeover. CalPERS was also a large shareholder but, of course, was not given the same option of selling its stock back to the company at a premium. Unruh quickly organized a powerful shareholder’s rights movement with the creation of the Council of Institutional Investors (CII — composed mostly of pension funds) to fight for equal and fair treatment of shareholders, shareholder approval of certain corporate decisions, and needed regulatory reforms.
CalPERS has $230 billion in assets, serves 1.6 million members and is administered by a 13 member board. Six are elected by various membership groups; the others are either appointed by elected officials or serve by virtue of their elected office. In contrast to the short time frame of most institutional investors, CalPERS takes along-term perspective. Their average holding period ranges from 6 to 10 years.
CalPERS equity strategy consists of making long-term investments so it can be in a position to influence corporate governance. Many pension fund managers, subject to the “star” system on Wall Street, actively manage their funds with hopes of beating the market. But studies have shown that active management is often not cost effective. After factoring in fees and turnover expenses, “indexing” – owning a representative share of a particular market – is the best strategy for most pension funds (as well as for most individuals through low-cost index funds such as those offered by Vanguard).
Until recently, CalPERS targeted poor corporate performers in its portfolio and pushed for reforms. Those ranged from firm specific advice, such as arguing that Sears and Westinghouse should divest poorly performing divisions and redefine their strategic core businesses, to more general advice. For example, CalPERS believes most firms need to expand employee training and shared managerial authority with lower level employees. Although CalPERS must often bear the full cost of monitoring, and other shareholders get a “free ride,” the sheer size of its investments makes such monitoring worthwhile.
A 1995 study by Steven Nesbitt, Senior Vice President of the consulting firm of Wilshire Associates which was under contract with CalPERS, examined the performance of 42 companies targeted by CalPERS. It found the stock price of these companies trailed the S&P 500 Index by 66% in the five year period before CalPERS acted to achieve reforms. The same firms outperformed the Index by 52.5% in the following five years. A similar independent study by Michael P. Smith concluded that corporate governance activism has increased the value of CalPERS’ holdings in 34 firms over the 1987-93 period by $19 million at a monitoring cost of $3.5 million.
In 2010, CalPERS adopted a new strategy for engaging underperforming public stock companies through confidential company engagements rather than by posting a public “name-and-shame” Focus List. However, some Focus List company engagements will continue to become public information – primarily through proxy actions and shareowner solicitations.
Read Part Three of this 3 part series next week.
To contact James McRitchie directly, please email firstname.lastname@example.org