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Fighting the good fight.

Fighting The Good Fight

If only Ben Graham were still alive, he might not be so despairing of the investors' cause. There is a powerful bias toward action in the institutional investor community today. That action can manifest itself in everything from assertive communiques with management to headline-making proxy fights. But there is a quieter undercurrent of activity going on, too, which holds promise for achieving satisfying results, and that's the heightened dialogue taking place between corporate and institutional "governors" to reach a clearer understanding and appreciation of their mutual needs and wants.

One such forum for exploring the implications of a more concentrated ownership of Corporate America is the Institutional Investor Project. It was established at Columbia Law School in 1988 in collaboration with the New York Stock Exchange. An advisory board of representatives from the corporate, investment, and academic sectors guides a program of research and seminars on institutional investor issues.

For the following roundtable discussion, Directors & Boards met with a group of the Project's advisory board members and research participants to do a bit of dialoguing of our own on what kinds of Ben Graham-like intelligent action can be anticipated in the years ahead.

Directors & Boards: From your individual perspectives, what are the most important issues facing the institutional investor?

Ira Millstein: We all recognize that institutional ownership either does now, or will shortly in the future, constitute the bulk of the ownership of most major corporations. The issue that we are facing is what kind of owners they will be. Will they be responsible owners? Will they be irresponsible owners? Are they going to be short termers or long termers? Exploring the institutions' responsibility and accountability to the corporations in which they are investing is the single most important issue that we are facing.

Reginald Jones: I think the single most important issue facing the institutional investor is the proper discharge of its fiduciary relationship in gaining the optimum return for those who are beneficiaries of the funds that it is managing. Our interest in this Institutional Investor Project is to see whether we can somehow develop a relationship between the institutional investor and the corporation in which it is investing that works to the benefit of both the investor and the corporation - and to the long-term interests of both. To us, this means that you have to recognize the significance of the institutional investor as a responsible shareowner who is alert to the needs and to the potential of the corporation. Hopefully, we can find ways to enhance communications between the management and board of the corporation and the managers of the investment organizations to achieve that optimum result.

Richard Koppes: At CalPERS, it is our role, and it is our concern, to be good fiduciaries. Most institutional investors are fiduciaries of one type or another. It is our duty to be responsible owners of the shares that we have.

Elmer Johnson: If I were an institutional investor, I would be posing this question: How can I do a much better job than I have so far in serving in my proper role - namely, doing all I can as a stockholder to help create and maintain the most vibrant possible wealth-creating, job-creating institutions in our society to the end of serving my own beneficiaries? As institutional shareowners, we have not thought in nearly as broad terms as we should, have not asked the questions that we should, to that objective. Our time horizon is much too short, and we haven't thought through just how important the long-term performance of the corporation is to our own success as fiduciaries to our beneficiaries.

Louis Lowenstein: I think we take as a given the definition of fiduciary responsibility. But there is a tension in that. From the perspective of a money manager, the tension that I see is the pressure, depending on the of the institution, to achieve competitive performance. That tends to be stock market-focused. In 1987, collectively we spent $25 billion in commissions and indirect costs to do a great deal of trading of stocks, options, futures, and other securities. That was about 18% of the earnings of Corporate America that was, essentially, wasted as each of us was trying to achieve competitive performance.

Second, a major force in the 1980s was the so-called "takeover market." While investors applauded the bids, we could see in many cases that they might not be good for Corporate America's underlying business. At one point, institutions were almost offered $300 a share for their $100 shares of UAL Corp. As a money manager, I thought it was fantastic, although any thoughtful observer knew that, had the deal gone through, we would have left the company with an intolerable burden of debt.

It is one thing to talk about being responsible long-term owners, but I get paid for doing something very different. Instead of focusing on immediate market returns (for which I am paid), and instead of spending all of that money on commissions and other back office costs from trading, I would like very much to think like an owner of a business. The question is, |How do I get from here to there?'

Jonathan Charkham: Different types of institutions have different obligations on different time scales, which may lead them to pursue different policies with different investment mixes. But, without going down that particular track, I think I would want to be conscious of the fact that when you sum the total of investments in the hands of all institutional investors, it now adds up to a very high proportion of outstanding equity, and it will be much higher by the turn of the century. What this is going to mean is that taking an interest in corporate governance is not going to be a luxury, it is going to be a necessity.

Clifford Whitehill: Today, there is not a well-defined consensus on what constitutes good corporate governance and what the relationship is between corporate governance and good corporate performance. Along with that issue is the question of whether institutions will focus on corporate governance as an adjunct to corporate performance and really make their investment decisions on corporate performance, or whether there will be other agendas determining how institutions vote their proxies and their holdings in U.S. companies.

Bernard Black: I might pose the question this way: What is the right balance between giving managers enough discretion to do a complex job in a risky world - giving them enough rope to hang themselves - but hanging onto the end of the rope so that if, indeed, they hang themselves (and do it over and over again), you can jerk on the rope? For a long time, institutional shareholders basically let go of the rope. The attitude was, |If they hang themselves repeatedly, we'll sell the stock; it's otherwise not our problem.' Now, the public funds and certain other shareholders are rather gingerly picking up the rope. But they haven't quite figured out what they want to do once they have picked it up - how hard they want to pull it. The struggle over the next 10 years will be in finding the balance between oversight and over control: Where do the institutions want a say, where do they not want a say, and how much of a say do legal rules allow them to have when they want it?

Michael Useem: Adding a historical footnote, we are coming up on the 60th anniversary of the publication of the Berle and Means book The Modern Corporation and Private Property. Their thesis was that the separation of ownership and control was here to stay, and, if anything, it would widen over time. As historians look back on the 1980s, I think it will be viewed as the decade in which that seemingly inevitable separation was, in certain ways, reversed. As we come into the '90s, leading the "re-fusing" of ownership control is the rise in institutional shareholding. Companies are coming to recognize the potential power of institutional shareholding and are trying to manage their relations with their major shareholders. The motif of the '90s will be regularizing a kind of communication channel between the company and its institutional owners. But we have yet to see how the concentration of institutional shareholding will or will not change what companies do.

Carolyn Brancato: One of the issues that concerns me relates to capital formation. It is clear that the securities markets have been less and less able to provide the capital that corporations need to compete in worldwide markets. A transformation of the securities markets has taken place over the last 10 years. We see very little in the way of initial public offerings coming out of the securities markets. Most of the new issues are mortgage-backed securities and a variety of repackagings of already outstanding securities, which diminish some of the possibility of new funding for corporations. With institutional investors controlling approximately $6 trillion worth of assets at the moment, and growing those assets at about 14% per year, this puts institutional investors in a prime position to be the capital-formation engine for the country. We need to look at what they will do with this potential and how they will interact with the corporations to provide needed long-term capital.

Jack Sheinkman: The statements that I have heard around the table indicate at least some shift within this group, which I don't think has been felt yet throughout the institutional investing market, to the objective of optimization as opposed to maximization. To my mind, maximization means that you invest just for the purpose of return, and if you don't like the way that the investment is going you just pull out of it. In a period of general economic decline, which we may experience, this could have reverberations not only on specific companies but on the total economy. Optimization, obviously, should be the first concern for the beneficiaries. But then we have to look at accountability in a different way - accountability not only to the shareholders but to the society at large. This means a revisiting of the whole culture, the whole outlook, toward what the corporation is in a different world. Corporations in America are not necessarily the same as corporations elsewhere. Particularly, as we compete internationally, we have to revisit what we are and what we are doing.

D&B: We have been using the term "responsible shareholder." Let's talk some more about what that means and how that responsibility is exercised.

Lowenstein: Clearly, much of it is in the eyes of the beholder. For some people it would mean a social agenda. Within this group, there is probably a broad consensus that responsible shareholding means monitoring the management of the business as distinguished from its stock market performance - and not trying to impose on management one's own private social agenda. My own answer, personally, is that one has to monitor management's performance in terms of long-term profitability. Yes, management has to be socially responsible, but the long-term success of the enterprise has to be primary over any other agendas. The world is changing. American industry is threatened - forced to compete on a global turf in a way that we did not have to do before. So we don't have the liberty to focus energies on purely social issues. We have to be concerned about performance.

Koppes: It is the view of our fund that we not get involved with social and political agendas. We are disturbed by any movement in that direction. Responsible institutional shareholders should recognize just what was said here - that we need to focus on the board of directors. CalPERS owns over 1,300 companies. We cannot get out and monitor all of them. We shouldn't be micro-managing in the corporation either. So, we have to rely upon the board of directors. That is why our whole focus now is on the issue of independent outside directors who oversee and hold accountable the management of the corporations.

Black: I want to second Rich Koppes's focus on the board of directors, because I think that is what the action in shareholder activism ultimately will revolve around. We are not going to significantly change the current form of corporate governance in the foreseeable future. What we may see is a move toward even greater independence of the board - where, perhaps, the nominations come from outside the existing board, to some extent from the shareholders - and toward greater scrutiny of who the directors are.

Jones: I would argue that this change to which you have referred is more than just moving from a predominance of inside to outside directors. It has also been a movement to much more responsible, involved, diligent working directors. My experience on boards has been that while the directors are supportive of management, which they should be, they also are questioning management to a greater degree. They are not just accepting the agenda given by management and accepting the answers given by management. They are posing very real questions and are requesting follow-up in the answers to their questions. We are seeing significant turnover of CEOs. While the euphemisms in the press are |leaving to pursue personal interests' and explanations of that nature, we all know that, increasingly, these are the results of management being ousted by very independent and demanding directors.

Brancato: There is confusion about what the institutional investors want from the corporations in the way of performance, and there is confusion on the part of the corporation about what it should be delivering in the way of performance to satisfy institutional investors. An institutional investor might want a certain return on the stock. That would be a typical bench mark of performance. But others might say that to be responsible owners we ought to make sure that we have other elements of the corporation's performance in mind - such as its long-term planning, its market share, its employment. However, these other elements are not necessarily internally consistent. So, what I think we are seeing is a whole series of surrogate measures for performance, such as, |Do we opt in or out of the Pennsylvania antitakeover statute?' Corporations are looking to define their performance in ways that will satisfy institutional investors, but I don't think we have anywhere near a consensus of what that performance actually entails.

Charkham: The question of performance is quite difficult. One sees a number of companies that get into trouble very quickly. By and large, in most markets there are a lot of companies that are going downhill very slowly. It is perfectly clear on any measure of performance that the management has ceased to have a grip of what is going on. Many of these finish up as takeover cases, which is quite unnecessary because all that was really needed was for the top two or three people to have been changed at some significant time. So it seems to me that CalPERS is absolutely correct in focusing attention on the board.

Millstein: One of the main issues in electing a new board or throwing out an old board is, |Why are you doing it?' This comes back to the issue of performance. I agree that we don't yet have an indication on the part of the institutions as to what constitutes the type of performance that is going to cause them to become motivated to throw out the board and look for new management. It is easy enough to tell the companies that are extremely successful, and easy enough to identify those that have failed. But, as Jonathan points out, there is an enormous gray area of companies that are sort of good or sort of bad. The issue is, what do the funds do - when are they going to act and when are they not going to act? At the moment, there is an intense movement on the part of the funds to try to develop performance standards by which to act. I am not sure that the answer is as easy as simply applying some stock performance guidelines or determining whether the board has adopted a poison pill. Therefore, I want to underscore the notion of the need for a good deal of work to determine what is the good or bad performance that is going to cause the shareholder to become motivated to act.

Whitehill: What has not yet been mentioned is the difference in roles that an institution has to take into account as a shareholder vs. a fiduciary. In the role of a fiduciary, its outlook has to be very conservative, very oriented against risk taking. Yet, to act as a responsible shareholder for Corporate America and to do what Elmer Johnson has said, which is to provide a wealth-creation vehicle for future generations of Americans, the institution must participate in the corporation in a way that promotes risk taking. This is a totally different role that it must play in its relationship with the corporation than it must play in its role to its beneficiaries.

Lowenstein: Most money managers are not being paid to be good corporate citizens. They are getting paid for performance. They are getting paid on the numbers. If you are at Wells Fargo running some $60 billion of index funds for as little as two basis points, there is nothing in those two basis points that would compensate you for thinking about whether the management of X company or Y company is doing well relative to the universe of its industry. We have to bridge this gap between how money managers see themselves, how they get paid, and how they accumulate more money to manage, which is what their game is all about. Very few of those techniques are consistent with a focus on long-term interests.

Johnson: Even if we were all in agreement on the performance issue, there is another responsibility issue that I would remind ourselves of - that is, getting the quality of talent required to manage the exploding size of these assets. I worry a great deal about the quality of the human talent allocated to this extraordinary responsibility.

D&B: Do you believe that institutional investors, diverse as they are, should have a position on the board itself?

Lowenstein: Whether it is directly or by surrogate - electing a dean of a business school, for example?

D&B: Right.

Millstein: Delegating constituency board roles is not a good idea. I would hate to see somebody on a board who said, |I am the representative of the institutional investors,' or, |I am responsible to a particular institutional investor.' That would be a mistake. On the other hand, having institutional investors suggest good nominees to the board's nominating committee is certainly something that would be highly desirable.

Lowenstein: With the exception of a handful of people in all of Corporate America, one can't think of many directors who were nominated by the shareholder. That is not the pattern, not the norm. Shareholders elect directors, but they don't nominate directors.

Millstein: Well, up until now it is likely that institutional investors haven't thought that it was possible to nominate or to suggest candidates. With the awakening of the institutions to the way that the process works, it won't be very long before we see suggestions coming.

Jones: I suspect that we may well see the further development of the suggestion approach. I am very concerned about a straight-out nominating approach, because this gets us into some kind of a voting contest. Let us keep in mind that if a board of directors is to be productive, if it is to be influential in the performance of its role - monitoring the management of the corporation - it must be a cohesive, cooperative group, one that is supportive but, yet, questioning of management. If you have nominations coming from various sectors and you get people on the board who are, in effect, representing a particular constituency, then I am very concerned that you would lose this important cohesion.

Black: It might be a very good thing for institutional investors to nominate their own candidates. Yes, there may be some potential conflicts. But, if shareholder interests don't diverge very much, and in many situations they don't, the shareholders have a common interest in seeing the company do well over the long term. We don't know right now how well a system in which institutions nominate some of the directors will work. It will depend in part on whether institutional directors can work quietly and cooperatively with management or whether they end up in pitched battles. But, as long as the institutions pick appropriate people, I don't see why that would necessarily interfere with the effective functioning of the board.

D&B: With the decline of the takeover era of the '80s, and the somewhat self-policing nature of boards and top management that takeover threats brought about, will the issue of institutional ownership and control retain its vitality in the 1990s?

Millstein: With the size of the institutional holdings and the dimension of their position in major corporations, I can't conceive that the interest will decline. It can only increase. These owners are going to be even bigger than they are now, and they are becoming more aware every day of what their responsibilities are. They are not going to go away.

Sheinkman: Nor will they be silent.

Lowenstein: But I would think that they might take a more constructive, less hostile tone. While takeovers were on the front burner, the institutions couldn't help but see that there was a big pot at the end of the UAL-type rainbow. But as takeovers recede, with the drying up of bank financing and the junk bond market and other factors, the role of the institutions has to be to focus less on immediate market gains and more on business fundamentals. That's the only game that's left.
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Title Annotation:Chairman's Agenda: Balancing Shareholder Interests
Author:Black, Bernard L.; Brancato, Carolyn Kay; Charkham, Jonathan; Johnson, Elmer; Jones, Reginald H.; Ko
Publication:Directors & Boards
Article Type:panel discussion
Date:Mar 22, 1991
Previous Article:The director as servant and leader.
Next Article:'The governance system is sound.' (Chairman's Agenda: Balancing Shareholder Interests)

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