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The shareholder advisory committee.

The Shareholder Advisory Committee

Who owns GM? What about IBM? Xerox? The chances are that, with any given major U.S. company, the answer to this ownership question is found in two words, two words that are creating shockwaves throughout Corporate America - "Institutional Investors." The emergence of institutions as the predominant investor in today's market is undisputed. According to Carolyn Kay Brancato, chief economist for the Columbia Law School's Institutional Investor Project, institutions owned only about 8% of outstanding corporate equity in 1950; by 1981, this percentage had increased to 38.5%, and by 1990, it rose to 45%.

What is even more amazing is the concentration of this growing level of ownership in fewer and fewer institutions. Pension funds, both public and private, represent over 40% of the total assets controlled by "institutions." With control of over $2.5 trillion worth of assets, pension funds own more than 25% of all publicly traded equity in U.S. companies. Moreover, the 20 largest of these pension funds account for more than 25% of all pension assets, thus controlling at least 7.7% of the outstanding stock of America's 10 largest companies.

But what does this concentration of stock ownership mean? Certainly, as institutions control more equity, individual investors will have a declining ownership stake in our corporations. Some have contended that this changing shareholder body represents something negative for America's businesses, global competitiveness, and economy.

Such a view, however, does not consider what - or who - an institutional investor really is. Particularly in the case of pension funds, the institution is the retirement system that provides benefits (e.g., death, disability, and/or retirement) to this country's workers and their dependents. In a manner of speaking, the concentration of share ownership in pension funds is simply a way of dispersing America's wealth among those whose efforts are instrumental in earning it - a form of "socialism," if you will, that is as American as apple pie.

While we may debate the advantages and disadvantages of this phenomenon, such a debate will not alter reality. The reality is that institutional investors are growing in size and will continue to control larger and larger blocks of outstanding equity. This size, coupled with the current trend toward utilizing an "index" method of stock selection, results in a shareholder group that is profoundly different than the group that existed a mere 20 years ago.

Contrary to some assertions, today's institutional investor is a long-term holder of equity; since large institutions cannot easily buy and sell huge blocks of stock without negatively affecting the value of their entire portfolios, institutions have become almost a permanent shareholder. As such, these investors, to comply with their own fiduciary duties to invest prudently, must have the information necessary to evaluate the performance of the directors to whom they have delegated managerial responsibility. While some may yearn for simpler days when disatisfied shareholders merely "took the Wall Street Walk," those days are gone. It is the wise corporate official who seeks to understand, rather than ignore, this new shareholder.

Understanding, and successfully dealing with, institutional investors will require a change in the traditional ways in which shareholders and their corporations (via the managers and directors) communicate with one another. Existing models of communication evolved when the actors in the play were different; with the cast changed to include institutions in a major role, the play obviously needs to be re-written.

|Beauty contest'

Proxy contests represent one mode of shareholder/corporation communication, a mode that certainly will continue to be appropriate - in some limited circumstances. Proxy contests cannot, however, be the sole means for shareholders, either individually or as a group, to express concerns to corporate management. The exorbitant costs, along with adversarial nature, of such challenges often threaten to destroy a company rather than benefit it. Furthermore, recent proxy challenges have appeared to disintegrate into "beauty contests" - mere competition between clever "sound bites."

Informal agreements to communicate, similar to the agreement recently reached between the California Public Employees' Retirement System (CalPERS) and General Motors Corp., are also appropriate under some circumstances. When a shareholder has a specific concern regarding a specific major investment, it is appropriate that the shareholder and corporate management meet together to attempt to resolve differences, all for the betterment of the company. But these efforts can be successful only on an "ad hoc" basis; no shareholder, not even one as large as CalPERS (with over $61 billion in assets), has the resources necessary to seek and participate individually in meetings with every company that may be performing below expectations.

An emerging model of shareholder/corporation communication also has some role, but not an exclusive one, in this dialogue. Certain types of "restructuring" funds are being created (most notably, Corporate Partners Fund, established by Lazard Freres & Co.) that combine the resources of several investors for the purpose of taking large, influential ownership stakes in companies. The funds then retain business experts to assist the target companies in improving performance; individual fund partners need not be involved.

Potential for abuse

While this vehicle has the advantage of being a structured and organized method for accomplishing changes desired by the shareholders (or at least desired by the fund), it has the potential for extreme abuse. When used as an antitakeover device, this mechanism can thwart positive, constructive change in favor of maintenance of the status quo. Furthermore, the universe of American corporations is simply too large to make this a viable model for shareholder/corporation communications in any but the smallest, or poorest performing, or most vulnerable, institutional holdings.

Another possible communication model has the potential for a much broader application - the Shareholder Advisory Committee (SAC). SACs have been proposed by CalPERS to at least three companies - Texaco Inc., Avon Products Inc., and Sears, Roebuck & Co. In last year's proxy contest between Lockheed Corp. and Harold Simmons, Simmons promised to promote the creation of a SAC if his slate of director nominees was elected.

Since it is an evolving concept that has yet to actually be implemented, there is no definitive composition of a SAC. As proposed by CalPERS to Avon, a SAC could be comprised of at least nine members. The board would have the discretion to establish appropriate procedures for selecting members willing to serve, provided that: * Each member is a beneficial owner of at least 1,000 shares of the company's voting stock for the entire period of membership; * No member has any affiliation with the company other than as a shareholder; and * At least five members are selected from the 50 largest beneficial owners of the company's voting shares.

Each membership term would be limited to one year, and no member would be eligible to serve more than three consecutive terms.

In any form, the SAC must be limited to providing nonbinding, advisory counsel to the company's board of directors. Under historic principles of corporate law, the shareholders have delegated to their elected directors the responsibility for managing the company; any shareholder forum that attempts to usurp that responsibility will be destined to defeat. However, an advisory body is neither a new nor particularly revolutionary concept. In many industries (e.g., health care), advisory committees are fairly routine ways for decisionmakers to obtain the views of interested parties not within the company's employ. A SAC is simply a variation on this theme.

The possible topics that would fall to the members of a SAC also have not been defined with precision - nor is such precision necessary. CalPERS proposed that Avon's SAC, if created, be able to provide advice to the board of directors "regarding the interests of shareholders on principal policy considerations relevant to the company and its business, such as major restructurings or acquisitions, mergers, compensation issues, and other matters on which the board may choose to consult the committee" (emphasis added). This flexibility, along with discretion in the hands of the board of directors, is the key to a SAC; to be successful, the SAC should be able to provide a helpful resource to the board.

It is this ability to act as a resource that constitutes the SAC's greatest benefit. Boards, and particularly independent directors on a board, simply do not currently have ready access to shareholder views. Very few could seriously contend that annual meetings provide a viable forum for shareholder/corporation communication. In their most common format, these meetings are simply orchestrated "events" with no spontaneity or opportunity for dialogue.

Similarly, "shareholder relations" staff provide information to management but do not necessarily report directly to the board. In addition, there is some tendency to use shareholder relations personnel for "public relations" or "sales" purposes, rather than for a sincere solicitation of shareholder opinions and concerns. For example, it is fairly certain that Honeywell Inc. management would not have proposed several antitakeover devices in 1989 if it had known that its shareholder body would react so negatively. This was a company that did not have its thumb on the pulse of its shareholders. With a SAC, a company can avoid such embarrassing votes of no confidence.

A true |relationship'

Another great benefit of a SAC is the opportunity it provides to build a relationship between a company and its largest providers of capital. Simply being a shareholder does not create a true "relationship" (other than perhaps a purely legal one) between the investor and company; holding a stock certificate does not form the basis for mutual trust, loyalty, or confidence. Participation on a SAC, on the other hand, affords both the investor and the company's directors and officers the chance to get to know one another, to understand varying perspectives, and to develop at least a degree of trust and loyalty.

At least one commentator has opined that SACs would be a waste of time, since institutional investors have "financial" rather than "business" expertise and would, therefore, be of little value in helping a company improve performance.

Availability of expert resources

Such an opinion represents an extremely myopic view of institutions, pension funds, and the resources available to them. In addition to having the means of retaining some of the country's most renown economic and managerial consultants, it certainly does not take an expert in the cosmetic industry to conclude that Avon has made some drastic strategic errors; even civil servants can express the opinion that Avon might do well to listen to some of the suggestions put forth by Chartwell Associates.

A possibly more well-founded complaint about the proposed structure of the SAC is that is would create a "second tier" of shareholders - a tier for the large and wealthy. This is certainly not the intent. Picking five of the members from the company's 50 largest beneficial owners is simply a means of ensuring that those with the greatest economic stake in the company and, assumably, with the greatest resources to devote to SAC participation, carry their proportionate responsibility. Membership by four "smaller" shareholders would ensure that all shareholder interests are fully represented. Additionally, the short (one-year) terms and term limitations would act as a check to prevent permanent SAC membership.

With this said, it is also true that other structures for a SAC could certainly be suggested and may well be preferable. The key point to be made, however, is that the SAC represents a new concept in shareholder/corporation communications, a concept that would appear to have little risk to the company and yet the potential for great rewards. In this new era of the institutional investor, it is the ideal time to launch a cooperative effort between shareholders and management - an effort to improve America's corporations and their competitiveness in the global market. [Tabular Data Omitted]

Richard H. Koppes is General Counsel, and Kayla J. Gillan is Assistant General Counsel, of the California Public Employees' Retirement System.
COPYRIGHT 1991 Directors and Boards
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Chairman's Agenda: Balancing Shareholder Interests
Author:Koppes, Richard H.; Gillan, Kayla J.
Publication:Directors & Boards
Date:Mar 22, 1991
Previous Article:Governance lessons from abroad.
Next Article:Take the high ground on director selection.

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