Communicating smartly to your shareholders.

There is an important opportunity awaiting corporations that forge effective models for communications with their institutional investors.

In addition to the GM Board Guidelines (presented earlier in this edition of Directors & Boards), another important document that was released this year is the report, "Improving Communications Between Corporations and Shareholders." The report was prepared on behalf of the New Foundations Working Group, an assemblage of unusual diversity in expertise which has been brought to bear on the critical question of how to bring corporations into closer and more fruitful contact with their investors. As the Group notes, "Many of the changes that [we recommend] in this document may well prove inevitable, given the changes that have occurred and continue to occur in capital markets. "Here is their report.

There have been significant changes in the dynamic of corporate governance and investment. Share ownership has become more concentrated among institutional investors, with many now holding larger, long-term stakes in American corporations. In addition, there has been a continuing rise in index funds, which do not typically move in or out of individual companies' stocks but instead hold long-term stakes. These changes have led some institutional investors to become more active owners and seek more responsiveness from some corporations in which they hold investments.

These developments may create significant challenges for some corporations whose practices and policies for relating to their investors sprung largely from an era in which most institutional investors rarely demanded such ongoing interaction. Even those who suggest that substantial benefits can be derived from an active corporate response to this challenge acknowledge that achieving the right balance is a difficult task. How should corporations respond to these new pressures yet maintain the flexibility and autonomy that they need and are accorded under law and tradition?

These issues have been at the center of a year-long set of roundtable discussions held by the New Foundations Working Group. The Working Group is a Harvard University-based group of over 30 individuals with experience and expertise in corporate governance, investment, and corporate policy. Represented among the New Foundations membership are large institutional investors, board members and board chairmen, CEOs, active investors, senior corporate staff, legal experts, experts on the proxy process, and academic researchers. The goal of New Foundations is to suggest new approaches to governance problems that reduce confrontation and promote a more effective corporate governance process.

Overall, the members of New Foundations agree that there is an important opportunity awaiting corporations that forge effective models for communications, and that establish better working relationships with their institutional investors. The Group believes that benefits can be attained without changes in laws or regulations or in the rights accorded investors or reserved to management. Instead, the Group sees an opportunity for the development of practices that bring corporations into closer contact with their investors and permit a better flow of information to occur. This interaction would involve commitments by corporations to an expanded role for informal communications and relationships among themselves and leading investors. In addition, the Group believes that boards of directors can benefit from the regular provision of information that summarizes the broad views of investors and the broad performance of the corporation in the capital markets.

The Group believes that the development of such practices can be of significant benefit to corporations over the long term. Not only can such practices help ensure that corporations receive feedback from the market but these kinds of practices can also give corporations the opportunity to build a better-informed, more stable shareholder base. This in turn can create enhanced support for corporations pursuing sound long-term policies and ensure that new policies are properly understood and valued by the market.

The Group also believes that the development of long-term communications between investors and corporations requires a significant set of commitments by institutions and other investors. Investors desiring to establish such dialogues should commit to becoming sufficiently expert to conduct a meaningful exchange of views, and should also commit to a process and protocols that ensure a constructive dynamic with corporations.

The Goals and Effects Of Enhanced Communication

Corporations and investors have an opportunity to build positive, long-term relationships with one another. Improved communication between investors and corporations can provide a working partnership and a supportive, long-term environment for the formulation of corporate policy. The result can be a more stable, long-term-oriented investor constituency and, in some cases, enhanced access to long-term investment capital.

Keeping fully abreast of, and responding to, the messages sent by investors can create major benefits for corporations. A fuller understanding of the perspective of major investors and the broad opinion of the market can help senior managers and corporate directors to identify both sources of market support, and sources of concern, and the underlying causes of those concerns. This can help corporations to respond to serious problems earlier and more effectively. An understanding of capital market concerns can also give corporations the opportunity to respond to misunderstandings that are present in the market. This in turn can help ensure that the market is educated about good policies, particularly those involving long-term objectives, and that these policies receive understanding and support.

In large, publicly held corporations an investor perspective can sometimes be missing from the boardroom. Expanded communications with investors and the provision of information on the company's capital market performance can help to ensure that an accurate, current investor perspective is represented in corporate decisionmaking.

Corporations should seek to identify serious concerns held by major investors. Such issues deserve substantive, serious corporate response. An open posture with respect to communications can help facilitate a more effective filtering of important and unimportant views and ensure that important concerns that are widely held are responded to while concurrently isolating unpopular ideas.

Changes in ownership structure and market dynamics can create new opportunities for enhanced, direct communication between corporations and long-term investors. Previous patterns of stock ownership, which involved more highly diffuse ownership and higher levels of turnover, created less chance to gain real feedback from systematic communication between corporations and investors. Now this situation has changed, and corporations have an opportunity to develop new systems and capture the benefits of a more informed investor base.

Most larger corporations have a few major institutional holders who maintain their positions for multi-year periods, offering the opportunity for ongoing communication. In addition, many companies have significant index fund ownership. Index funds, which hold a portfolio chosen to mimic the market, do not buy and sell individual corporations' stocks based on changes in corporate prospects but instead hold for the indefinite long term once a stock is added to the portfolio. These funds are thus governed by a different investment philosophy and may be well suited to developing long-term communications with corporations.

Guidelines for Improving The Communications Process

New communications processes can be structured to allow investors to offer constructive and substantive input on matters of corporate policy. As a practical matter, a particularly important focus of new communications mechanisms is generating feedback from institutional investors. Some institutions represent an informed long-term professional investor constituency and are qualified to provide direct feedback to corporations. The establishment of mechanisms to take advantage of institutions' viewpoints can also potentially benefit other smaller investors, because institutions can serve as a channel for the interests and concerns of more dispersed investors. New communications channels should not be established in a way that dissuades communication with other, smaller investors; instead, the goal should be to add a new venue for effective information-gathering from the new class of larger investors.

Investor viewpoints and broad market concerns should ultimately be channeled to senior corporate management, including the CEO, and to the members of the corporate board. Ultimately, it is the CEO, the board, and senior managers who set long-term policy. It is thus at this level of the corporation that broad investor opinion should be available to be incorporated into debates about future policies. The opinions and concerns of shareholders, and of major long-term shareholders in particular, should be heard by the senior members of management and should be known to the board of directors.

Direct communications can be enhanced by the provision to senior managers and the board of summary data that reflect the corporation's performance in the capital market. Data on the corporation's overall market standing, such as valuation, stock performance relative to peers, and analysts' reports, can be a part of the information provided to directors and to senior managers on a regular basis. Such data can create a critical performance benchmark, revealing the overall judgment of capital markets about a corporation's past and present policies. This information should be reviewed regularly, and can be brought to bear when formulating and debating future plans and projects.

Corporate officials and institutional investor personnel engaging in communications should typically be senior personnel. Direct communications are only credible when those engaged in them -- both investors and corporate representatives -- have an understanding of the corporation's strategy and clear seniority in their respective organizations. Communications should be structured so as to signal a serious commitment to seeking (on the part of the corporation) and to providing (on the part of investors) high-level feedback that can potentially have a direct impact on policy.

Management, the board, and investors should demand honest feedback. Those who gather information should communicate back the full truth, even if it includes significant dissatisfactions with current performance. Indeed it is precisely these kinds of messages that may be the most important for the CEO and the board to hear. Failure to communicate these messages, or an atmosphere that discourages real substantive feedback, can hurt the corporation, its incumbent managers, directors, and investors in the long run.

There should be a mutual flow of information among investors, management, and the board of directors. In communications, the corporation and investors should not only provide an open and consistent flow of factual information about performance and prospects but should in turn listen to ideas and concerns. Detailed discussions with large individual holders can provide important clues about market concerns about corporate strategy, and clues about what the market may not understand.

Institutions involved in serious discussions with corporations should make commitments to maintain the integrity of the process that has been established. Corporations agreeing to seek enhanced communications with their major investors have the right to request good-faith pledges from major investors in response. Such pledges might include a commitment to a continuing level of informed, expert discourse; certain agreements or understandings about the process governing dialogue; and a pledge to play a constructive role. Once corporations have made the commitment to open up their process and seek new kinds of input, the onus is on investors to respond responsibly and positively.

Specific Examples of New Communications Mechanisms

The first focus of enhanced communications should be a comprehensive, modern investor relations process. Such a process is a primary vehicle for ongoing communications with shareholders, both large and small. The investor relations process should be led by a member of senior management and should focus on providing ongoing analysis of the corporation's valuation profile and capital market position to the CEO and the board. An optimal investor relations program can include a series of structured communications with market participants that are then translated into feedback for management and the board on valuation and on specific corporate policies that can achieve valuation goals. Investor relations programs of this type typically incorporate ongoing individual meetings with analysts, institutional investors, and other shareholders, group presentations, daily telephone contact, and formal feedback and reporting processes.

Informal pre- or post-board-meeting meetings with institutions. Some corporations have enhanced communication and interaction between their board members and shareholders by scheduling informal meetings between directors and shareholders on the same day as a limited number of regularly scheduled board meetings each year (e.g., two to four). At this time, board members are already on site and it is logistically easy to meet with interested institutions. This can provide a logistically realistic way to initiate informal contact between institutional investors and board members.

Regular meetings with groups of shareholders and selected board members. Several corporations have set up a series of more formal, regular meetings between designated board members, particularly outside board members, and large shareholders. This approach, which may be particularly useful in times of capital market uncertainty, can help to ensure that key board members hear the concerns of key shareholders directly at important points in the corporation's evolution. Such meetings can also involve key management personnel and counsel to ensure that SEC and other rules are abided by. Such communications need not involve every member of the board, but corporations should consider having some board members who feel sufficiently comfortable with capital markets to conduct such meetings.

Meetings between large shareholders and the full board of directors. In response to major shifts in strategy or structure, several corporations have held meetings involving the entire board and one or more outside shareholders who have expressed a desire to communicate ideas to management. These meetings have proven effective in situations where corporations have undertaken complex transactions or restructurings that can benefit from enhanced investor understanding and feedback. Such meetings can provide unique interaction and perspective for both shareholders and the board as a group, and can galvanize a closer link between owners and board members.

Shareholder relations or corporate governance committee of the board. Several members of New Foundations suggested that certain individuals on the board could be designated to serve as the focus of shareholder communications, and that a formal committee could be established as the focus for these activities. Such a committee could include key outside directors and key senior members of management. The establishment of such a committee could focus the communications process on a few outside board members willing and committed to serve as monitors of the communications process, and on the most appropriate management personnel. Such a group could also provide a natural focus for the ongoing feedback of any corporate officials engaged in ongoing contact with major holders, such as a shareholder ombudsman.

Regular briefings for board members on capital market progress. Some corporations have begun to take a more active approach to ensuring that directors and senior managers receive regular information on capital market performance. One approach that has been employed is to designate an individual, such as the member of management responsible for investor relations, to brief the board on issues including valuation, the concerns raised by analysts in recent reports, and performance relative to peers at regular board meetings. Some Group members favor the provision of written information on capital market performance to board members at regular intervals, including analysts' reports, summary data on market performance and valuation, and any other information that might indicate sources of significant investor support or concern.

Shareholder ombudsman. Several corporations have appointed full-time, high-level individuals who regularly meet one-on-one with major shareholders and members of the analyst community and communicate their findings to the CEO, other senior members of management, and the board of directors. This may prove to be an effective and practical approach for enhancing communications.

Setting bounds on the communications process. The purpose of expanded communications is the creation of a serious high-level dialogue between investors and the company pertaining to important matters of corporate policy. It is the responsibility of both corporations and shareholders to work together to ensure that communications center on issues of importance and relevance to the corporation and involve a constructive, value-added exchange of ideas.

Substantive Areas Of Communication

Broad feedback on market perceptions and overall corporate structure and strategy. Corporations can seek from shareholders broad feedback on corporate structure and strategy. Shareholders should not attempt to manage the corporation. But many institutional investors and other informed market participants are concerned with the corporation's long-term structure and goals and how these factors appear to be affecting its capital market performance. Capital markets can therefore provide an important comparative perspective on the corporation's competitive position and prospects. In communications with shareholders, corporations can seek to identify broad patterns of concern and/or support, as they pertain to overall strategy and major corporate policies.

Discussion of new policies, particularly in the capital market sphere. Some corporations have solicited from major institutional investors ideas on prospective capital market policies, such as the disposition of cash flow and share repurchase programs, before such programs were implemented. Such communications can provide valuable information that can have a direct impact on the formulation of these policies, if care is taken to avoid selective disclosure.

Baseline information on market performance. Corporations can seek from investors and analysts independent appraisals of the company's recent market performance and its performance as compared with peers. Such comparative baseline performance information can reveal differences in perspective between those inside the corporation and those among investors. It may sometimes be the case, for example, that members of senior management perceive the corporation to be performing well in the capital market while major investors, focusing on a different peer group, perceive it to be performing poorly. Soliciting analysis and performance evaluations from shareholders can reveal these kinds of differences in perception and thus help to focus both management and investors in their evaluation of past and present performance.

Consultation on director nominations. Several corporations have consulted some of their major institutional investors on suggestions for new outside board members. This process can result in a positive interaction with investors and in valuable suggestions for new board members. Informal consultation on this topic may involve shareholders directly in a critical area of increasing concern to some investors, while not creating new legal rules or a new mandatory role for investors in the nomination processes. In the long term such consultations could prove to be among the most important components of an enhanced corporate communications program. Using this process can engender a more responsive relationship between shareholders and board members over the long term and promote enhanced communication in the future.

CEO succession. Times of CEO succession are among the most important and critical in the life cycle of the corporation. Consultation and communications between interested institutional investors and the board can help to ensure a process that reflects shareholder viewpoints and is understood by the market. Institutions may typically be concerned with whether, as a broad matter, there is a specific plan for the succession process. Corporations should consider soliciting institutional input during periods of succession and using this input to assess performance and the need for new policies.

Corporate governance. Some institutional investors are concerned with the rules by which corporations operate and the structure of the internal decisionmaking process. No one corporate governance structure is appropriate for all companies. But open and serious discussions among managements, boards, and institutions about corporate governance can reduce the risk of confrontation over governance concerns, lead to enhanced mutual understanding, and ultimately result in a better set of governance choices for the particular corporation and its investors.

Compensation. Enhanced communications can ensure that investors understand the rationale for compensation plans and that management and the board are aware of institutions' and other investors' broad concerns on compensation issues. Communication can thereby reduce the risk of confrontation.

Institutional policy statements. Concurrently, institutions which wish to communicate about broad matters with corporations should consider developing broad statements of policy that outline their overall views, so that corporations know in advance the broad nature of their views before engaging in more detailed communications.

Conclusion

By improving communication, corporations and institutions can develop a more serious and supportive relationship. This can be achieved through changes in practice that respond to the rise of more active and more expert long-term institutional investors and the increased desire of shareholders, analysts, and other capital market participants for serious, substantive input.

The Working Group does not recommend that any one approach be followed by all corporations. Instead, it suggests that as a general principle, enhanced communications can be beneficial to corporations and their investors. The various specific suggestions for achieving this goal detailed above represent a set of specific templates that have been used by some corporations in practice. They show that many approaches to improved communications are possible. There is no single solution to improving communications but, rather, a rich variety of available alternatives, all of which can materially improve corporations' relationships with their investors.

Finally, the Working Group notes that many of the changes that it recommends in this document may well prove inevitable, given the changes that have occurred and continue to occur in capital markets. Corporations embracing these trends and undertaking change may find that they reap significant positive benefits. This is an opportunity that should prove attractive to many corporations in a time of shifting markets and increased competitive uncertainty. Mechanisms that make capital markets willing partners, rather than an additional source of pressure, may allow managers and boards to meet future challenges more effectively.

The Fundamental Starting Point 

John Pound, Chairman of the New Foundations Working Group, discusses the origination of the report, "Improving Communications Between Corporations and Shareholders."

It is hardly a revelation to say that the corporate governance process, and the relationship between investors and corporations, is changing dramatically. In the past few years we have witnessed the rise of a new class of active institutional investors, a new emphasis on active, expert corporate boards, and a resulting, profound shift in the dynamic of the governance arena.

The shift in the dynamics of governance that has been occurring is one that many observers applaud. The old corporate governance dynamic too often involved years of silence and shareholder apathy, broken only by episodic, disruptive contests for corporate control. The new dynamic, instead, is focused on a more constant, informed dialogue between corporations and investors. This kind of dialogue is arguably what should in theory underlie and form the foundation of a good corporate governance system. Such a dialogue allows shareholders, directors, and managers to understand one another and allows corporate policy to be set with informed input from the market.

However, many of the changes that have occurred in recent years have also involved their own kind of controversy and tension. It has been a different kind of controversy than that associated with the old governance process -- takeovers, LBOs, and other such devices. Instead, the controversy has, in a real sense, moved from the external market to inside the corporate boardroom. The new activism of shareholders and boards has seemed at time to be breeding a new kind of contention in corporate governance and to be leading to a new series of vivid clashes between shareholders and corporations.

The question thus remains: Can corporations and institutional investors, over the long term, develop a new kind of relationship that reflects the new reality of institutional activism and results in constructive, positive long-run relationships between corporations and investors?

In late 1992, a group called the New Foundations Working Group was formed at Harvard University. The Group was comprised of a consortium of institutional investors, corporate CEOs, senior managers, board members, and legal and economic experts on governance. The charter of the group was to train their assembled expertise on a search for new approaches to governance that would allow corporations and investors to capitalize on the new realities of the market to develop positive, constructive long-run relationships.

The first focus of the Working Group's attention was the issue of communications between shareholders and corporations. The Group believed that in an era of concentrated ownership, communications between investors and corporations constituted the fundamental starting point for restructuring the corporate-shareholder relationship. Good communications, it was felt, could not only improve the governance process in and of itself but also was a necessary foundation for any more formal kinds of relationships or mechanisms that might arise in the marketplace

In four off-the-record meetings in 1992 and 1993, the New Foundations Working Group exchanged viewpoints about the operation of the governance process, the problems and shortcomings with the process, and the nature of the corporate-shareholder relationship.

Out of these discussions has come the document that is presented here. It contains a series of broad recommendations for improving the communications process and the relationship between shareholders, managers, and boards. It does not propose any single solution to the problem of creating relationships but instead focuses on enunciating a series of board principles. In addition, it offers a series of specific suggestions that have been implemented by some companies and may be appropriate for others in the market.

The members of the New Foundations Working Group hope that the document is a useful contribution to the corporate governance debate. It is unusual in the depth with which it examines this critical issue and the inventiveness of the solutions that it suggests. In addition, it is unique in the breadth of experience and viewpoints represented by the co-signatories who have lent their support to its recommendations. The document is published here in the hopes that it will prove useful to corporations wrestling with the need to recast their corporate governance process.

In Concurrence: The New Foundations Working Group

Listed are members of the New Foundations Working Group who have reviewed, offered comments on, and concur with the overall recommendations contained in the Group report, "Improving Communications Between Corporations and Shareholders." In endorsing the report's conclusions, these individuals represent themselves and their own views and not necessarily those of the organizations with which they are affiliated.

Robert Clark Dean Harvard Law School 

Martin Coyle Executive Vice President, General Counsel, and Secretary TRW Inc.

John Cullinane President The Cullinane Group Inc. Former Founder, Chairman, and CEO Cullinet Software Inc.

Judith Dobrzynski Senior Editor Business Week

Darius Gaskins Partner High Street Associates Former Chief Executive Officer Burlington Northern Railroad 

Ronald Gilson Charles J. Meyers Professor of Law and Business Stanford University Law School

Robert Glauber Fellow and Adjunct Lecturer Center for Business and Government John E Kennedy School of Government Harvard University Former Undersecretary U.S. Department of Treasury

Lilli Gordon President Gordon Group Inc.

James Herron Senior Executive Vice President and General Counsel Ryder System Inc.

Robert Kirby Director Capital Guardian Trust Co. Senior Partner The Capital Group Partners LP

Thomas Knight Former General Counsel Avon Products Inc.

Richard Koppes General Counsel California Public Employees Retirement System

Reinier Kraakman Professor of Law Harvard Law School

Patricia Lipton Executive Director State of Wisconsin Investment Board

Philip R. Lochner Jr. Senior Vice President Time Warner Inc. Former Commissioner U.S. Securities and Exchange Commission

Roland Machold Director New Jersey Division of Investment

James Melican Executive Vice President, Legal and External Affairs International Paper Co.

John Meyer James W. Harpel Professor of Capital Formation Center for Business and Government John F. Kennedy School of Government Harvard University

Ira Millstein Senior Partner Weil, Gotshal, & Manges Chairman, Board of Advisors Institutional Investor Project, Center for Law and Economic Studies Columbia University School of Law

Thomas Pandick Director of Investor Affairs New York State and Local Retirement Systems

Lawrence Perlman Chairman and CEO Ceridian Corp.

John Pound Associate Professor of Public Policy John F. Kennedy School of Government Harvard University Chair New Foundations Working Group

Robert Pozen Managing Director and General Counsel FMR Corp.

David Redlick Senior Partner Hale & Dorr

Benjamin Rosen Chairman Sevin Rosen Management Co. Chairman Compaq Computer Corp.

John Seidl Former Chairman Kaiser Aluminum Corp.

Walter Skowronski Vice President and Treasurer Lockheed Corp.

Christopher Steffen Senior Executive Vice President Citibank Former Chief Financial Officer Honeywell Corp.

Louis Thompson Jr. President National Investor Relations Institute 

Sidney Topol Fellow Center for Business and Government John F. Kennedy School of Government Harvard University Former Chairman and CEO Scientific Atlanta Corp.

John White Director Center for Business and Government John F. Kennedy School of Government Harvard University Former Vice President and General Manager Integration and Systems Products Division Eastman Kodak Corp.

Nancy Williams Deputy Executive Director and General Counsel Colorado Public Employees Retirement Administration