Archives: June 1998

Chainsaw Al gets sliced. He taught many to think like owners but his tactics crushed morale and his accounting practices reflected an emphasis on salesmanship rather than creating wealth. Press coverage has been widespread, including Time(6/29) and the St. Petersburg Times, (6/21).

Efficient-market theory and a science-based investment strategy has provided the fundamental basis for the investment strategy of Dimensional Fund Advisors. Fortune’s 7/6 issue covers the history of the firm in How the Really Smart Money Invests. Investment in small stocks that also trade at low price-to-book ratios provided the best results of all in Fama and French’s studies, returning an annual 20.2% over 70 years, 8% more than big growth stocks.

Corporate-accountability campaigns, a new tool for the Sierra Club.

Privatization in Bulgaria: Pushing Forward.

Both IRRC and ISS have provided extensive coverage (since April 24th) of a controversial policy adopted by the NYSE on April 8th which allows companies to adopt “broad-based” plans without shareholder approval if at least 20% (the majority of whom cannot be officers or directors) are eligible to participate. Although the rule went through a public notice process, most in the industry failed to take note. Some have expressed concerns since the rule outlines requirements only in terms of eligibility, rather than participation. ISS reports thatCII is “rolling out the troops” in opposition. NYSE agreed to reopen its comment period until July 10th. Contact Stephen Walsh at (212) 656-6240.

Stock options allow top execs to cash in on bull market. (seeSan Francisco Business Times).

The Internet is increasingly popular for launching shareholders actions against publicly traded companies, according to a 6/17 WSJ article, which described message boards and chat rooms as fertile recruiting grounds for potential shareholder plaintiffs. Web sites mentioned included the Motley FoolYahoo!Finance and Silicon Investor. For information on suits filed, see the Securities Class Action Clearinghouse which we have listed under law.

Global Corporate Governance Research Center, released its Institutional Investment Report showing that U.S. institutions topped $14.3 trillion in total assets last year (up from $12 trillion at end of 1996). Pension funds dominate with 47.3% of all assets and 25.8% of total outstanding equity. Public pension fund growth outpaced private funds. Institutional investor’s % of total equities declined to 48% (from 48.8% in 1996). Mutual funds showed the strongest growth (28.7% increase between 1996 and 1997). Total assets of pension funds grew from $5.7 trillion to $6.8 trillion from 1996 to 1997. Mutual funds climbed from $2.4 trillion to $3.1 trillion. To order, call 212-339-0345.

California Public Employees’ Retirement System (CalPERS), the New York State Common Retirement Fund and several New York City pension funds filed suits against Cendant Corp., alleging the business and consumer services company misled investors about its financial results. (cnnfn, no longer in business)

Pensions&Investments reports that pension assets are up 8.7% last quarter (Jan-March, 1998) to $7.5 trillion. CalSTRS staff have been given authority to commit up to $400 million to alternative investment deals without seeking prior trustee approval. San Fransico City & County Retirment System divest $30 million in tobacco stocks held in its S&P 500 index fund. Phil Angelides, candidate for California Treasurer, indicates he would invest a larger portion of CalPERS and CalSTRS funds in California.

Jamie Heard, former Chief Executive Officer of Institutional Shareholder Services (ISS), has agreed to become Chairman and Chief Executive Officer of The Proxy Monitor, Inc. Richard L. Cohen, former Chief Operating Officer of ISS will also join president Arthur Rosenzweig in a senior position. Heard and Cohen are principals of an investor group formed by Breakwater Holdings, LLC, which has acquired an 80% interest in The Proxy Monitor, Inc. After leaving ISS in early 1997, Heard and Cohen, together with Robert Monks and Dwight Allison III, founded Breakwater Holdings, LLC. Breakwater and its affiliates invest in businesses that provide value-added information and services to financial institutions. With offices in New York and Chicago, Proxy Monitor provides proxy research and voting services to pension funds, investment firms, banks, foundations, labor unions, religious organizations and other institutional investors. (contact: Susan Assadi, at 602-860-8792)

Minnesota, the beneficiary of a $6.1 billion settlement of its tobacco lawsuit, will stop investing pension money in companies that get more than 15% of their revenue from tobacco. The decision affects only a fraction of the $43.7 billion in pension funds the state has invested. Secretary of State Joan Growe said tobacco stocks “have consistently lagged. They have consistently under-performed.”

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The Corporate Board’s May/June issue included two provocative articles which deal directly with the question of democratic corporate governance. Both provide arguments which lead in the same direction but both are flawed from the perspective of this editor.

John Vogelstein, president of Warbug Pencus & Company, outlines some of the lessons he has learned in the firm’s “investment banker” role. The firm consistently takes a long term view in these companies, which range from startups to NYSE giants. In most cases they are represented on the boards and Vogelstein believes their presence helps boards face up to problems, such as the need to replace a faltering CEO. With a great deal of capital at risk, their representatives “really do care” and they tend to “pull the nonowner directors along.” One recommendation, stemming from this experience, is that members of the board’s audit committee be paid double fees because these committees tend to uncover the most problems.

Surprisingly, after pointing out how value is added by having a large shareholder on the board, having board members with substantial sums at risk, and after embracing reforms such as the use of nonexecutive chairman or lead director, Vogelstein ends by writing that he would not want to “promote greater democracy in business governance or to empower stockholders further. I do not believe that democracy is an appropriate way to manage a business,” fearing that “increased bureaucracy would be the inevitable result of greater shareholder rights.”

For Vogelstein, much of pension fund activism has been “poorly thought out.” Although he is not explicit in what constitutes increased democracy in corporate governance, he appears to see it primarily as increased government regulation, such as the adoption of tax penalties when executive pay is not linked to pay for performance. However, at the heart of democracy is a system which facilitates representation, not one which necessitates stepping out of its own domain to enforce the opinions of its citizens. I would argue that increasing democracy in corporate governance, by allowing shareholders to more easily nominate and elect board members to represent their interests, would result in less government intervention and fewer poorly framed shareholder resolutions. Greater democracy in corporate governance might lead to a situation where all boards have a majority of directors who behave as responsibly as those of Warbug Pencus. Wouldn’t that be novel? One step in that direction might be to repeal SEC provisions which preclude use of Rule 14a-8 provisions for nominating directors. (see editor’s comments to SEC)

The other article which questions the value of shareholder involvement is by D. Gordon Smith, an associate professor at Lewis & Clark in Portland, Oregon. Smith briefly takes us through changes at Kmart, largely brought about through intervention by the State of Wisconsin Investment Board (SWIB). The main question centers around SWIB’s ability to evaluate the CEO’s competency. Smith argues that Joseph Antonini, Kmart’s CEO, may not have been incompetent and his ouster may have been in error. Placing policy decisions, such as firing the CEO, in the hands of shareholders would likely decrease the value of corporations because “if shareholders can override the discretion of the board, the value of centralized decision making (the primary value of the board) is destroyed.” “Corporate governance reform should strive to construct a system in which shareholders participate actively in director elections but refrain from participating in policy matters.”

Here, I believe, Smith moves toward the right conclusion, but for the wrong reasons. Directors are likely to have more relevant and more timely information concerning the firm than are shareholders. Therefore, board members, not shareholders, are more likely to know what measures should be taken to add value. However, the primary value of the board is not, as Smith claims, its own “centralized decision making” but its function in overseeing that of the CEO by bringing additional information and perspective to bear.

Smith gets it right when he suggests the nomination process be improved to encourage shareholder participation in director elections. However, he fails to provide any evidence or even logic when he asserts that director elections need to be less frequent. He undermines the value of his primary recommendation that less direct involvement by shareholders would probably yield better results.

To this editor, much of shareholder involvement should be seen as a sign of frustration. Even resolutions passed by substantial majorities are often ignored. Shareholders have escalated to binding bylaw resolutions (see “Shareholder Bylaws: A Threat to the Board” in the same issue). However, if shareholders participated in the nomination process and believed they could hold directors accountable each year, there would be little need for most shareholder resolutions and less need for government intervention.

Directorship (May) includes an interview with Ned Regan, former Controller of New York State. Regan reviews the proxy season and compares resolutions as canaries in the mineshaft, a forewarning of shareholder concerns. The current “flashing red light” is SWIB’s opposition to option repricing. Another sign is the growing number of resolutions calling for companies to consider sales, mergers or spin-offs which Regan believes come from newcomers to the proxy process with little interest in board governance matters. Managers can take solice in the fact that both TIAA-CREF and CalPERS seem to have moved to strategy of meeting with boards more privately and from the fact that owners of American businesses “operate only as a modest check on corporate activities. Overall, it appears to be a balance that has worked to the benefit of businesses, the US economy and shareholders.?”

The same issue also includes an article drawn from Ram Charan’s new book, “Boards at Work: How Corporate Boards Create Competitive Advantage.” The article presents solid, but not unusual, observations such as, “boards can do management an invaluable service by viewing the broader business landscape and helping management recognize major opportunities and discontinuities.” The publisher, Josey-Bass Inc., can be reached at 800-956-7739.
Across the Board (June) notes the findings of a survey by the Dentsu Institute on Human Studies. The percent of Japanese who say they live for work has dropped to 28%. This compares with rates of 74% in China, 70 in Thailand, 49% in Indonesia, and 48% in India.

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Ithe Corporate Governance Advisor (May/June) Richard Wagner and Louis Kersten are concerned that in a slower economy 20-25% or more of future value may be siphoned off through dilution from option exercises or through market repurchases. Kurt Schacht, of SWIB, takes on the much lauded State on Corporate Governance by the Business Roundtable (BRT)…”fancy cover, nice presentation but not much there.” Here are a few quotables. “Good corporate governance is not one size fits all…it’s apparently whatever size you want.” “A hint of conflict in the area of cumulative voting quickly relates it to a non-recommended status.” “An outside director, according to the BRT, is essentially anyone the management/board believes can represent the interests of shareholders with appropriate independence.” Their broadest criticism is that “it continues to be the management group being monitored that is setting the terms of its own oversight.”

In the same issue Patrick McGurn, of ISS, discusses SWB’s battle with the SEC over their declaration that option repricing is “ordinary business.” McGurn also describes CII’s new Shareholder Bill of Rights, adopted on March 31st. The definition of boardroom independence has been tightened to include an examination of ties between directors and the CEO, as well as calling for full disclosure of payments and other data necessary, to directors and their families, for shareholders to determine independence, whether or not such disclosures are required by law. The new guidelines recommend a 2/3 majority of independent directors and indexed options. Although it has been a decade since its last revision, CII plans to form a standing committee to update the policies each year.

We received the 3rd issue (Winter 1998) of a new publication by the National Investor Relations Institute, IRQ, which contained several articles which I expect would be of significant interest to our readers. In “Don’t Wag That Dog!” Shelley Taylor reviews a 1996 study which ranked the importance of 95 types of information institutional investors used making investment decisions. In the governance arena, investors want to know management has a significant stake in the company but the don’t particularly care if the firm has adopted a set of corporate governance policies. In “Does Shareholder Activism Make a Difference?” Marilyn Johnson reviews the literature and finds no widespread evidence that activism has made an impact on CEO turnover. Proposals are likely to be triggered by poor firm performance and negative press. They are more often by institutional rather than individual investors and the evidence supports the efficacy of institutional actions; they are successful in getting companies to adopt recommended governance changes. Firms that successfully negotiated settlements with CalPERS experienced a 1% increase in market value. In “Technology and IR” Hank D’Amrosio describes Bell & Howell’s experience with broadcasting its annual meetings over the internet starting in 1996 and allowing on-line proxy voting starting in 1997. “IR on the Net” provides a valuable guide to corporate governance sites on the internet; we thank IRQ for listing CorpGov.Netfirst as a “great starting place” and for noting our current news section.

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May”s “Corporate Governance Today” conference at Columbia Law School’s Sloan Project on Corporate Governance brought together a broad diversity of academics. In his summary introduction, Mark Roe divides the papers presented into the following eight categories: venture capital, hierarchies and boundaries, the boardroom, employees and the firm, abstractions of the American academic view, whether corporate governance systems world-wide are converging, comparisons and differences in national systems; and the corporation in its social and political context. Copies of papers are available from Lisette Lavergne.

Many interesting findings and theories were put forth, continuing to build a strong base of academic scholarship. Arnoud Boot and Jonathan Macey, for example, argue that transparent firms will tend to get diffuse ownership because distant shareholders would get the advantage of objectivity but not need closeness to get good information. Opaque firms would attract block ownership because diffuse owners couldn’t do much without good information. Margaret Blair and Lynn Stout argue the board’s job is to divide the pie up fairly, not to maximize shareholder return. Sanjai Bhagat and Bernard Black find little correlation between independent directors and enhanced value but theorize that independent boards might be better in some settings, such as responding to a hostile tender offer. Roe adds that maybe independent directors need more of a personal or institutional financial stake or stronger ties to shareholders to be effective.

Katharina Pistor finds that managers are the principal beneficiaries of codetermination because they play off labor against capital. Jeffery Gordon looks at United Air Lines and theorizes that employee ownership may be unstable in the long run as employees see the need for diversification. However, it may have critical advantages in managing an economic transition, including facilitating cuts in wages by trading for equity. If a culture of commitment can be built, long-time employee ownership may enhance a firm’s ability to compete and adapt. In looking at Italy, Jonathon Macey notes that derivative suits are not permitted, takeovers don’t happen and institutions don’t hold large blocks leading them to monitor. As a consequence, firms that are large enough to go public in the U.S. stay private where monitoring is easier. In examining pension funds, Jeffrey Gordon finds that employees haven’t benefited much from the run-up in stocks. If they are in a defined benefit plan, the sponsoring firm wins; if they are in a defined contribution plan they tend to lose again because many tend to invest less heavily in equities.

The latest edition of Ralph Ward’s Boardroom INSIDERrecommends the Management Assistance program for Nonprofits. “The Nonprofit Manager’s Library offers solid board links on agendas, job descriptions, and legal issues, plus a helpful discussion board.” He also summarizes a May 25 article by Geoffrey Colvin in Fortune who points to research findings that independent boards exert LESS power over CEOs. Companies whose directors own a lot of stock are often POOR performers. Boards actually DO pay CEOs for performance. Boards are NOT under increasing pressure from shareholders. These anomalies often stem from friends, families, poor performance measures and the fact that “a rising stock tide lifts all boats.”

CEO’s average tenure in the US is about 3 years, says Edward Ryan, managing director of Executive Interim Management, based in New York. (see CEOs need speedy success).

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Europe II’s Programs for Reform in Strategic Markets (IFC-PRISM), has recently been approved to implement a Corporate Governance project in Armenia, in partnership with the Netherlands. They are currently looking for a Dutch expert in Corporate Governance to serve in the capacity of Project Manager in Yerevan, Armenia. Contact: Lynne Soukup, Assistant Privatization Officer, Room F-10P:206, 2121 Pennsylvania Ave, NW, Washington, DC 20433 Fax: (202) 974-4321.

The Social Investment Forum released its second edition of “Tobacco’s Changing Context.” The guide contains new information about tobacco settlements, updated lists of responses by institutional investors, new performance information and more. Call 202-872-5304.

The shot heard round the world? That’s how Sarah Teslik ofCII characterized TIAA-CREF’s victory in ousting the entire board of Furr’s/Bishop’s Inc. (a struggling cafeteria company). “Once one pension fund does it,” others are likely to follow, she is quoted as saying in the 5/29, WSJ. However, the article goes on to describe relatively unique circumstances. TIA-CREF holds almost 18% of Furr’s/Bishop’s. Seven other shareholders own another 66%. It could be the start of a revolution, but the original “shot heard round the world” was soon followed by many more. So far, this appears more like target practice on a sitting duck. In the same issue several had harsh words for Providence Capital president Herbert Denton. Is he a real reformer or just a blackmailer? (see also Be not a wimp, Forbes, 6/2)

Fortune’s Anne Fisher, asked readers if CEOs in the U.S., who now earn 185 times their employees’ average pay (up from a ratio of 142 to 1 in 1992) are worth it. 70% of the 718 respondents said CEOs make too much money at the expense of shareholders and the employees who do the real work. Middle managers seem especially embittered. Others pointed out that entertainers and athletes are the real overpaid Americans, (see “Readers on CEO Pay,” 6/8).

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