The Calpers machine: for many public company executives, the nation's toughest audience resides in a concrete building on Sacramento's P Street.

As a shareholder revolt gained steam ahead of Walt Disney Co.'s annual meeting in arch, Chief Executive Michael Eisner made a last-minute trip to Sacramento to try to garner support from Calpers, California's giant pension fund.

He pretty much botched the performance.

Eisner, who would be stripped of his chairman's title several days later, kept steering the conversation toward Disney's movies and the invincibility of its theme parks. But Christianna Wood, senior investment officer at the California Public Employees Retirement System, kept trying to steer it back to the Burbank-based company's flagging operations and its weak financial results.

Wood said she came away from the two-hour meeting unimpressed with Eisner, who was accompanied by Disney director Judith Estrin (other directors participated by phone). Like other institutional investors, Calpers ended up withholding its support of Eisner and several, other directors--part of the 43 percent no-confidence vote at the Philadelphia meeting.

"I thought, here's another guy who doesn't get it. And his board doesn't get it either," Wood recalled. "When you have a company where financials are poor and the CEO talks about creative stuff--putting up 'moats' around the business--he's talking about being big but not profitable."

In the world according to Calpers, executives who get it put the interests of shareholders above most every other concern. They also understand how the balance of power between corporate titans and shareholders has changed in favor of shareholders--something that, according to Wood, Eisner hadn't yet come to appreciate.

"I think he thought we'd be caught up in the aura of Michael," she said. "He didn't realize that we were there for financial returns." (Disney officials did not return calls.)

Generally, Calpers is getting solid marks for stepping up the pressure on corporate boards in the wake of accounting scandals that led to bankruptcies at Enron Corp., WorldCom Inc. and elsewhere.

Excessively paid executives have also felt the heat. Last year, Calpers board President Sean Harrigan joined New York State Comptroller Alan Hevesi and others in sparking a public outcry over the pay of New York Stock Exchange Chairman Richard Grasso, who was forced to step down. Several investigations into Grasso's $140 million pay package are ongoing.

But with such power and influence comes the question of whether Calpers now holds too many of the cards, and whether its pro-labor board, along with an unyielding formula for determining corporate correctness, has created its own problems. Such questioning became most pronounced several weeks ago when Calpers withheld its votes for investment guru Warren Buffett as a board member of Coca-Cola Co.

"Our size imposes certain obligations on us," said Sidney Abrams, an actuary in San Francisco who sits on Calpers' 13-member board. "We're looked to asa leader, whether it's in corporate governance of in cutting the cost of health care. Being a watchdog, I think, is a proper role for us. The only question is, where do you draw the line?"

For all its power on Wall Street and in corporate boardrooms, Calpers' headquarters on P Street in Sacramento appears benign enough. It's actually hard to find the six-story gray concrete building surrounded by birch trees and honeysuckle vines. Nothing on the outside even has the Calpers name on it.

Weddings, showdowns

That's just as well. On weekends, the headquarters often gets rented out for weddings and holiday parties. With a circular courtyard and sunroof six floors high, the lobby has the casual elegance of a hotel. (Across the street, Calpers is building a $250 million facility that will extend its footprint to a campus-like setting.)

Calpers employees insist it's a fairly quiet place to work, except during "board week," the four days of every month when the 13 board members descend on the nucleus of power, a 200-seat auditorium that resembles a city council chamber, complete with dais.

The board consists of six elected, three appointed and four state officials with automatic seats. State employees elect two members, and additional members are selected by Calpers members, local government employees, public school employees and retirees. The governor appoints two members, and the state Legislature one member. Ex officio members include state Controller Steve Westly, state Treasurer Phil Angelides, the state personnel administration director and a State Personnel Board representative.

Each board member sits facing the audience with a microphone and red electronic buttons labeled "yes," "no," or "abstain," although votes are usually tallied by raised hands or a verbal "aye" or "nay."

The auditorium can be a scene of considerable drama. On April 21, when the Calpers board was set to vote on whether to keep its $65 million investment in the Philippines, Filipino activists arrived in buses from San Francisco, packing the auditorium.

The Philippines' U.S. Ambassador, Albert del Rosario, took the podium and urged board members to keep its investment, despite Calpers' concerns about tax laws covering banking, child labor and securities.

After the Calpers board voted not to divest, President Gloria Macapagal Arroyo broke the news to her country in a Manila radio interview. The Philippine stock market hit a 12-week high.

'They have changed society'

But that's during the public meetings. With the Eisner session, as well as that of countless chief executives, the setting is a discreet conference room where about a dozen people sit around an oval table. It is at these gatherings that Corporate America is asked to make its case--and where Calpers board members say they are willing to make certain compromises if the CEOs are willing to move on matters of corporate governance.

"They have changed society in all sorts of ways," said Richard Koppes, former general counsel at Calpers who now works at Jones Day Reavis & Pogue in Sacramento.

Those changes have been most evident on Wall Street during the recent spring proxy season. In response to the Enron and WorldCom scandals, the pension fund's investment committee tightened its guidelines on companies' auditing practices. As a result, Calpers automatically votes against directors and companies that have not separated the auditing and consulting functions of their accountants. Calpers' auditor rules are more far-reaching than what's called for in the federal Sarbanes-Oxley legislation, which allows accountants to serve as tax planners.

Pat Macht, a spokeswoman for Calpers, said staff members are simply conforming to the board's guidelines by checking off appropriate boxes on proxies.

"People probably think we're poring over these proxy things, but we're not," she said. "Just like anytime there's an executive compensation plan that isn't tied to performance, we're going to vote against it. It's automatic."

There's only one problem. The cookie-cutter approach leaves Calpers with little flexibility to factor individual differences among companies when prudence or common sense might dictate another course of action.

The formula led to votes against 2,700 of 3,000 corporate board membership this proxy season, including that of Buffett, chairman of Berkshire Hathaway Inc. Calpers concluded that by being on Coca-Cola's audit committee, Buffett faced a conflict because Berkshire subsidiaries such as Dairy Queen do business with the soft drink company.

The decision grabbed headlines, but some say that Calpers might have diluted its effectiveness by painting so many companies with the same broad stroke.

At Berkshire's annual meeting in Omaha, Buffett compared the checklist approach to an apple picker who is programmed to cut everything round and red. "Most men would rather die than think. Many do," Buffett said, quoting philosopher Bertrand Russell.

Corporate evaluations

Some shareholder activists agree that the system should have room for exceptions.

"Everybody should be pushing to get more Warren Buffett, not less," said Robert A.G. Monks, a longtime shareholder activist. "Calpers is a bureaucracy and they're taking a real policy stand so there's no deviation from that formula because there's no one person in Calpers to make those exceptions."

While the withholding of 2,700 proxy votes has gotten the most attention, more extensive research goes into the annual "Focus List," targeting a handful of underperforming companies.

Each summer, the pension fund's corporate governance unit, with a staff of nine, begins whittling down a master list of 1,800 publicly traded companies, searching for the most egregious underachievers. Computer models screen for three key issues: lagging stock price, poor financial performance and lax corporate governance.

Out of the screening emerge 75 laggards. The staff then begins several months of research, analyzing each company's operations and stock performance, questioning equity analysts and distilling the findings into a 25-page report on each. Staff members then recommend whether the company should become one of the 40 or 50 final candidates for the infamous focus list.

Because 75 percent of its holdings are in passively managed index funds, Calpers uses the list process to nudge companies into adopting better policies, such as adding independent directors or separating the roles of chairman and chief executive.

"The goal of the focus list is not to beat up companies," said Bill McGrew, an investment officer in the corporate governance unit. "If I can get 30 to 40 companies to change their ways and take credit for it themselves, it's a great benefit, because if their competitors see them doing it, they'll do it and there will be a ripple effect."

Generally, companies will do anything to avoid being named on the final list.

By November, each of the 40 to 50 finalists receives a letter from Calpers explaining that they have been targeted for their poor performance. They are then invited to meet with the company to discuss how they might make changes that could boost their stock price and performance.

"There are executives that when they get a letter from us, the bristles go up on the back of their necks," McGrew said, adding that only a few companies, such as Gateway Inc., have flatly refused to respond to any queries. It was placed on the list. (As of last week, the 2004 list was due out any day.)

Others make the pilgrimage to Sacramento, and promise to make various changes to keep from being named.

"The object is not to lob a news bomb into the middle of the market, though it may seem like that at times," said William Crist, who served a decade as Calpers' board president. "The whole object is to increase the value of your holdings by having the company do a better job and having the market respond by rewarding the company."

'Calpers effect'

The focus list is so widely watched that some Wail Street money managers consider it a "buy" signal for investors, dubbing the potential stock lift the "Calpers effect." It has pushed up issues by between 1 percent and 40 percent.

Ironically, Calpers has shown relatively modest portfolio returns, even as it avoided some of the worst damage in the market's recent declines.

Like most large institutional investors, it took a beating during the bear market. The portfolio fell 7.2 percent, to $156 billion, for the fiscal year ended June 30, 2001, and dropped another 5.9 percent in fiscal 2002, before rising 3.9 percent in fiscal 2003. Last year's rebound helped recover much of those losses. In the current fiscal year, its portfolio was up almost 16 percent through Feb. 29, to $166 billion.

Indeed, the most contentious battle is not likely to be in the equity markets, but in the political arena.

The way actuarial assumptions are factored into the system, payments by the state to fund employee pensions lag market events by two years. While Calpers' returns were so strong that state agencies didn't have to pay into retirement benefits for several years, the state's obligations to the pension fund have ballooned to $2.6 billion for the upcoming fiscal year, from $144 million paid in 2001.

Gov. Arnold Schwarzenegger has proposed repealing a law passed in 1999 that granted police and firefighters fat pensions when they retired at 55. He has also proposed floating bonds to fund the $2.6 billion, and having state workers cover the cost with a 1 percent increase in their contributions.

"We're going to fight like hell because they're essentially proposing a 1 percent pay cut for our members," said J.J. Jelincic, president of the California State Employees Association, the state's largest employee union. "In the normal course of events, I don't think it would go through but in this budget environment, it has a chance."

It certainly wouldn't be the first time a governor has tried to tap into the pension fund to close budget gaps.

Former Gov. Pete Wilson made the boldest attempt by trying to redirect $1.6 billion in cost-of-living increases away from pensioners to the state. Wilson also floated a bill that would have abolished Calpers' board and replaced it with nine governor appointees. The bill didn't pass.

"The fact is that politicians have always set their sights on Calpers," said Monks. "At the same time, Calpers has always held the line on investing the money for pensioners."

RELATED ARTICLE: Fun facts.

History

Created in 1932 to provide retirement benefits to state employees, Calpers now manages the pension savings of 1.4 million public employees, retirees and their families. The fund serves three main constituencies: state employees, 2,400 public agencies, and school districts that include the Cal State University system. Holdings totaled more than $166 billion at the end of February, after peaking during the Internet bubble at $172 billion. Calpers has between a 1.2 percent and 1.5 percent stake in each of more than 2,500 U.S. companies listed in the Wilshire 2000.

How Big?

Processed $7 billion in retirement, death and survivor benefits to its members last year, including 45,529 requests for direct deposit of retirement checks.

Major Holdings

Perhaps the biggest individual investor in California-based assets, with $19.1 billion, or 11.5 percent of its total fund, invested in-state as of Jan. 31, 2004.

Minding the Money

Hires 44 external money management firms to run stock and bond funds for the nearly 30 percent of its portfolio not tied to internally managed index funds. The pension fund has 300 active fund investments.

Worker Bees

Employs 1,600 people at its headquarters in Sacramento. Another 50 employees are scattered in eight regional offices throughout the state, including San Francisco, Glendale, San Bernardino and Fresno. The investment staff totals about 180.

Best Performing Assets

California real estate, with average 20.23 percent annual returns since Calpers began investing in the sector a decade ago.

Worst Performing Assets

Alternative investments in private equity, venture capital and hedge funds posted negative 10.6 percent for the year ended June 2003.

Best Single Investment

Microsoft Corp. As of June 30, 2003, shares of the software giant had racked up $838.6 million in paper profits on an investment of $381.8 million.

Worst Single Investment

Bankrupt telecom provider Worldcom Inc. are up more than $104 million.

Smallest Holding

Digital Lighthouse Corp. ($231 for 700 shares purchased at a price of 33 cents each). The entire investment is now worth a grand total of 7 cents.

Fees

Traded 54.2 billion shares in fiscal 2003 through thousands of brokerage firms, generating $70.7 million in commissions and fees. S.G. Warburg Securities, Citigroup Global Markets Inc. and its unit Salomon Brothers International executed the most trades.

Largest Stock Holding

General Electric Co., with 38 million shares valued at $1.09 billion as of June 2003. (As of mid-April, GE remained Calpers' top holding, despite a gain of only 8.1 percent between June and last week). Pfizer Inc. has moved up to No. 2 on the list, replacing Microsoft.

Other Expenses

Hundreds of professional consultants for everything from retooling its Web site to staff training to video production. Calpers spent $58.7 million on consulting and professional fees in fiscal 2003.

--Kate Berry and Karey Wutkowski

Voices

Nell Minow

Editor

Corporate Library

"Calpers has been a leader on certain issues that have become central to the lives of institutional investors. It pioneered work on CEO pay issues and in putting the focus on boards and independent directors. And it's been involved in the whole issue of shareholder litigation.... If there is a serious issue that needs to be addressed, like the ties with auditors, then it's worthwhile for them to bring it up."

William Crist

Professor of Economics

California State University, Stanislaus (former president of the Calpers board of administration)

"In the 1990s, Calpers had some storied encounters with the likes of General Motors and Westinghouse, where there was an outright refusal to discuss corporate governance issues. Now that never happens. Or it's rare. Calpers doesn't whistle a tune and then a company dances to it. The objective is to increase the value of the company and to start a dialogue."

Thomas Higgins

Principal

Loral Co., a private equity group

"Where Calpers has taken a stand, they tend to be principled stands in which they're looking out for stakeholders, who are their retirees. The implication of the criticism against them is that we should go back to the cozy, go-along era that has led to these excesses at Tyco, Cendant and Enron that defy description. These were overwhelming betrayals of shareholders."