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Much, much more than investors.

Why does CalPERS do what it does? "We're activists," CEO Hanson says, short and sweet, and if you own stock you should be, too.

Long before my arrival at the California Public Employees Retirement System, the members of the CalPERS board concluded that they weren't simply investors; they were owners. An analogy we like to use is this: If we buy an office building and the property manager isn't properly maintaining it, we don't sell the building--we change the property manager. In other words, once you select and buy a stock, you should remain diligent.

This certainly isn't a new concept in owning stock. In 1934, Graham and Dodd observed that as much care and attention should go into owning stock as into selecting stock. It's taken some of us a little longer than others to come to that realization, but we're better off because we have.

So what makes CalPERS decide to focus on a company? Each year, we target 12 firms in our portfolio for our "hit list." We make the selection based on total shareholder return over a five-year period and not on return on equity, return on investment or earnings growth because, in the final analysis, total shareholder return is what's most important to us as investors. Then we'll visit those companies that tend to be at the lower end of the spectrum on total return. We used to look at the S&P 500, but now we look at the top 1,000 companies based on capitalization. We'll target 12 of those firms for specific action and communicate with another 50, advising them that we're concerned about their long-term performance.

But shareholder return isn't all we consider in compiling our list. We also study how the companies compare to their peers within their respective industries. If a company is experiencing poor returns and the affliction is industrywide, that company won't necessarily become the subject of our attention. Instead, we focus on the companies that are doing poorly while their peers in the industry are doing well.

We also look for a high level of institutional ownership in companies. Why? Because if we're going to file a shareholder resolution, we know institutions vote their proxies and that becomes very important. We also prefer for CalPERS to have high ownership in the companies we're targeting, which is typically 1 to 3 percent.

One change in CalPERS' focus is that we now concentrate totally on a company's performance and its board of directors. We no longer focus on such "sins" as poison pills, green mail and the lack of confidential voting. A firm's board is our representative to management. I think eventually many activists will make the same shift that CalPERS is making, focusing increasingly on performance.

We've changed some other things at CalPERS since we've become involved in shareholder activism and corporate governance. For instance, we used to publish a press release about our target list. Often, a company on the list found out it was a target at the same time the public did. Now, we write to the company ahead of time, asking to sit down with its leaders and talk about performance. Initially, we ask the CEO and then eventually members of the board.

Five years ago, if I would have said I want to sit down with members of the board of a company in our portfolio, the firm's leaders would have been horrified and they would have said, "Oh, my gosh, you can't talk to a board member." Today, CEOs and board members are very willing to talk with shareholders.

When we meet with a company, we bring with us one, two, or even three studies on that company. Conducted by outside organizations, these studies focus on the firm's strategies, how they're executed, and industry conditions. After all, managers manage their assets, both capital and human, and how well they manage these assets drives performance. Once we've met with the companies, we ask each for comments on the studies we provide, because we want that kind of feedback.

Then we decide if we're content with the company's game plan for getting itself out of the box. If we're not, our next logical choice is to move to a shareholder resolution.

The best way to describe our activism, then, is as four prongs. The first prong is dialogue, which is how we begin focusing on poorly performing companies.

The second is shareholder resolution. This is becoming more difficult as we gravitate away from resolutions that say, for example, redeem your poison pill to ones that say improve your performance.

The third is in the regulatory area. Proxy reform is one example CalPERS initiated requests for a review of the proxy process in November 1989. And recently the SEC has adopted some rules with which we're fairly satisfied that give owners a little more freedom to communicate with each other, or a "safe harbor."

The last approach, which is used rarely, is litigation. For example, we brought legal action against Occidental Petroleum's management and directors for wasting corporate assets in building the late Armand Hammer Museum of Art.


Here is how CalPERS assets are allocated: On the domestic side of our investment portfolio, 40 percent of our investments are currently in fixed income, such as bonds or securitized, real estate-backed mortgages; 32 percent are in domestic equities; 11 percent are in international equities (although our target is 12 percent); 7 percent are in real estate (while our target is 10 percent); 5 percent are in cash or cash-equivalent, short-term investments; a little more than 4 percent are in international fixed income; a little more than one-quarter of 1 percent is in private equity, a new asset class for us that I think will eventually be a large asset class; and approximately 1 percent is in alternative investments.

We passively manage, or index, 80 percent of CalPERS' stock equities, representing a little more than $22 billion of the portfolio. Nineteen outside equity managers actively manage the other 20 percent.

The annual turnover in our stock portfolio, including the work of these 19 outside managers, is 10 percent. That's exactly one-half of the annual turnover for the New York Stock Exchange in 1960. The turnover for the NYSE in 1987 was almost 95 percent, but it's now down to a more reasonable level. We're proud of our turnover record and like people to know we're long-term investors.

We probably are investing domestically in about 1,300 companies, where our percentage of ownership typically runs from 1 to 3 percent as I mentioned earlier, depending on the market capitalization of a company, although in some companies we hold much larger positions. If I had my way, we would hold fewer companies and have larger positions, not so much to have a stronger corporate governance stance, but to identify those companies that are better investments for us in the long term.


Today, only about 15 shareholder organizations are steadily involved in shareholder activism, and at least half of these are, like CalPERS, focusing on performance rather than social issues. We stay away from such campaigns as pro-life, pro-choice and "save the whales" because we've concluded we can't articulate a position on these issues for one million beneficiaries. We'd rather focus on issues that will contribute directly to the bottom line-total shareholder return.

Of the activists, very few are from corporate pension funds and very few are from mutual funds, although Fidelity has been a very responsible mutual fund, contributing a great deal to the body of knowledge on corporate governance. But most of the activists are from the public funds, such as CalPERS and CalSTRS (the California State Teachers Retirement System). The state of Wisconsin was one of the early initiators of corporate governance issues. Colorado, Florida, the state of New York and New York City are also very active. Even the relatively small Houston Fireman's Fund has done some very exciting things in corporate governance.

United Shareholders, with 60,000 members (I refer to them as the "killer bees"), is especially powerful. Each one of its members can make a resolution, whereas CalPERS, as an institution, is limited to one resolution. United Shareholders has used this multiple-resolution strategy very effectively in the last couple of years.

The Council of Institutional Investors is an organization representing about 69 funds. Surprisingly, a number of corporations have joined the Council on behalf of their own pension funds. I think they've probably come to the conclusion that it's better to be in the tent to find out what's going on with the activists than to be on the outside looking in.


CalPERS totally supports the SEC's efforts on executive compensation disclosure, but that's as far as we want the federal government to go.

We don't support governmental initiatives to set limits on how much companies pay executives or to establish pay ratios that compare executive pay to that of the lowest-paid employee in a firm. Those responsibilities belong to the board of directors and the executive committee.

Having said that, we are interested in executive compensation as it ties to performance. For us, that means total shareholder return. When a company's executive compensation is going north and its performance is going south, that company is going to hear from us. You'll never hear CalPERS criticize Disney's highly compensated chairman and CEO, Michael Eisner, for instance, because Disney shareholders have made a lot of money. He has probably one of the most risk-sensitive contracts in this country.

Will we see an end to the public titillation over executive compensation? I don't think so, because as long as we're in a recession and people are losing jobs, executive compensation is a fair target. Also, probably the most important reason compensation remains a hot issue, corporations have implemented some silly incentives within their firms and they must get rid of them. For example, some companies have as many as four different long-term incentives for their executives--so if their key people don't make it on one, they'll make it on another. These are the types of firms on which we'll also focus.


I'm upbeat about the future. In the last five or six years, I've seen activist shareholders mature and, conversely, companies more readily accept shareholders as owners.

One thing you can expect to see more of is the empowered shareholder resolution. This is when a shareholder advisory committee, with a budget of about one cent per share, is organized. The resolution can become an enormously powerful tool and was previously filed at Exxon.

Another hot topic is the issue of separating the CEO and the chairman. Today, approximately 83 percent of the CEOs of the S&P 500 are also chairmen of the board of their companies. That's down about 2 percent from three years ago.

Another trend will be to provide the compensation committee of a company's board with more independence and perhaps even access to their own consultants, especially since under the new SEC rules committee members are required to sign off on compensation.

Activists will increasingly try to block state laws that attempt to insulate boards of directors from liability. For example, CalPERS fought long and hard to prevent such stakeholder legislation in Pennsylvania. But I think this trend is subsiding as the leveraged buyout mania of the 1980s has at least temporarily gone away.

Also, CalPERS, as well as other funds, will be re-examining indexation. I make no bones about the fact that I don't like indexation, because we do it based primarily on capitalization. I'd rather we follow a more thoughtful process in picking stocks, but we have staffing problems that limit us.

You'll see more shareholders "just saying no." If they don't like what their company is doing or the performance is lousy, they'll withhold their votes on directors. A vote of no confidence sends a very powerful message to a board.

On a positive note, I think shareholders and corporations are increasingly identifying areas in which they have a common interest, such as tort reform, health insurance and workers' compensation. All of these areas need change, especially if we want to be truly competitive in a global economy. At CalPERS, for instance, we pay an annual premium of $1.5 billion for the 800 employers who participate in our health care program, so I'm very interested in health care reform. That's why we're working with several corporations in California on the health care issue.

Finally, I think companies will use their shareholders more often when they need help in the state or federal legislative arena. TRW, for instance, asked CalPERS to get involved in some amendments to the Clayton Act, which we did, and the amendments ultimately passed.

All in all, I'm encouraged by what I've seen in the last five years. Once shareholders got off their soapboxes and actually started talking with corporations, we all made some very positive moves forward. I hope we'll build on that in the future.

Inside CalPERS

What is CalPERS? CalPERS is the largest public employee retirement system in the United States and the fourth largest in the world. The system covers approximately 950,000 active and retired beneficiaries from about 2,500 employers. CalPERS employs 800 people, 48 of whom manage the system's $70 billion of assets. We have outside managers, but we do 70 percent of our asset management in-house.

CalPERS is comprised of one-third state employees, one-third public agency (or city and country) employees, and one-third nonteaching school employees, such as cafeteria workers and groundskeepers.

A 13-member board of administration governs the system. I refer to the board as a labor management or constituency-driven board because six of its membership. Three come from those employee groups mentioned above, two come from statewide elections, and one represents retirees. Five of these six elected members are either current or past presidents of major, statewide, public-sector unions--that's why I call it a labor management board. Name recognition means a great deal in running for these seats.

The state controller and the state treasurer are on the board, and they also sit on the California State Teachers Retirement System board, CalSTRS. They're the only two members who sit on both boards.

The governor appoints four members to our board: one from the Department of Personnel Administration, one from the state's Personnel Board, a life insurance representative and a locally elected official. The legislature adds the final member, recently appointing someone from the AFL-CIO, who joined the CalPERS board in December of 1992.

Mr. Hanson is CEO of the California Public Employees Retirement System (CalPERS).
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Title Annotation:Coporate Governance; includes related article; California Public Employees Retirement System
Author:Hanson, Dale M.
Publication:Financial Executive
Date:Mar 1, 1993
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