Archive | December, 2006

December 2006

Panel to Examine California Pension/Healthcare Obligations

California Governor Arnold Schwarzenegger signed an executive order creating a bipartisan commission to advise him on changes needed to address public pension obligations, particularly rising health care costs. Their recommendations are due in 2008.

Labor groups and their Democratic allies in the Legislature immediately cautioned Schwarzenegger to not overreach as he did in 2005, when he considered pushing for a ballot measure to privatize pensions for new employees. He backed off when public safety unions aired commercials arguing his plan would take money from the widows of firefighters and police.

Finance Director Mike Genest estimated that CalPERS and CalSTRS would need to invest an additional $49 billion right now to cover all of the state’s public employees through retirement. That amount is on top of an estimated $40 billion to $70 billion additional needed to pay health care costs for state workers and University of California employees through their retirements.

The state must assess its unfunded pension and health care liabilities by 2009 under new accounting rules set forth by the independent Governmental Accounting Standards Board. The new commission’s 2008 report will identifying all of the state’s unfunded liabilities and recommend how to pay for them.

Lawmakers have so far decided to ignore the advice of their chief budget expert, nonpartisan Legislative Analyst Elizabeth G. Hill, who has urged them to set aside as much as $6 billion per year to cover the cost of unanticipated retiree healthcare expenses.

Failure to narrow the deficit considerably before the conclusion of the current legislative session in 2008 could create problems for the state on Wall Street. Rating agencies are monitoring the issue closely, and have made clear that they expect the state to devise a concrete plan, reports the LATimes. (Governor creates panel to tackle pension costs, Sacramento Bee, 12/29/06; Governor tackles pension costs, San Jose Mercury News, 12/29/06;Gov. creates panel to study pension costs, LATimes, 12/29/06)

The Governor also released an op ed article in which he wrote, “Last year, in my haste to reform our state’s pension system, I made a mistake. I backed a proposed initiative that was poorly drafted, allowing critics to argue that the families of police or firefighters injured or killed in the line of duty could be denied death and disability benefits if the measure passed.”

He pledges not to make the same mistake again. “I am confident that once we know exactly what we are facing and our best options for addressing it, we can find a common-sense approach that protects California, preserves promised retirement benefits and ensures the Golden State’s economic vitality.” (This time, let’s get state pension reform done right, Sacramento Bee, 12/29/06)

Maybe this time the focus will be on saving taxpayer money instead of on emasculating the power of CalPERS and CalSTRS to shape corporate governance.

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2006 in Review

Broc Romanek’s brief article, And What a Year It Was!, in Blog captures the essence of what “was arguably the most dramatic year of change in recent history” for corporate governance. He left out the fact that Enron executives were finally sent to jail for their role in the corporate scandal that rocked the US and brought about sweeping regulatory reforms meant to protect investors and raise the bar. Also of note were all the options backdating investigations still under way. Momentum continues to build.

SEC Amends Executive Compensation Rules

Last July the Council of Institutional Investors applauded the SEC for approving executive compensation disclosure rules, which “shine a bright light on what has been a dark corner of Corporate America.” “The new rules will help shareowners hold boards accountable for pay that is out of whack with performance.” (Council of Institutional Investors lauds SEC’s new pay disclosure rules, 7/26/06)

In a surprise move, the SEC’s new amendments more closely align the SEC’s disclosure requirements with the accounting dictates of FAS 123(R). The value of stock options and stock grants granted in any one year will now be disclosed on a year-by-year basis rather than as a multi-year lump sum.

Ann Yerger, executive dircctor of the Council of Institutional Investors in Washington, D.C., said “the SEC has given companies the ability to under-represent the value of options grants.” “In general we were extremely supportive of these changes. Unfortunately the latest change is a big step back for the SEC and the inevesting public,” said Yerger, whose organization represents 130 corporate, government and union pension funds. (SEC change on executive pay gets mixed reviews, 12/27/06)

As Floyd Norris explained in the NYTimes (Does S.E.C. Know What It Is Doing?, 12/29/06),

“it is not clear whether the commissioners even understood the ramifications of what they agreed to in a decision that was released late last Friday. But the result is that identical pay packages given to two executives will be reported very differently, depending on the details of a company’s retirement plan. That would not have happened under the July rules.

Say the chief executive of American Widget gets a $24 million option grant on Dec. 1 of this year, with the options vesting — meaning they may be exercised — over four years. He is not eligible for retirement, perhaps because he joined the company only a few years ago, or perhaps because he has not reached the company’s minimum retirement age of 60.

In the summary table, the value of that option will be shown as $500,000. That is because he has worked just one month of the 48 months needed for the option to become fully exercisable.

Over at National Widget, American’s main competitor, the chief executive gets an inferior options package on the same day. It is worth $5 million, with the same four-year schedule. But that executive is eligible to retire, although he has no intention of doing so. The compensation summary will show he got a $5 million option.

The reality is that one man received options worth nearly five times what the other one was awarded. The appearance is very different.”

As Long as CEOs Decide

As reported on Marketplace, the average CEO is paid 369 times as much as the average worker, up 16%, on top of a 30% jump last year. Nell Minow, one of those presenting at the upcoming Directors Forum 2007, calls that “feeding at the executive trough.”

Minow says there’s something wrong with Barry Diller’s pay package, making over $441 million in profit from selling previously granted stock options in the last two years alone and still $167 million worth of stock options he hasn’t cashed yet. Then there’s the severance package of fired CEO Carly Fiorina and Mark Hurd’s “guaranteed bonus,” since his contract provides that all of his first-year goals are “deemed to have been achieved.”

Nice work if you can get it, concludes Minow, and you can “as long as CEOs get to decide who serves on their boards.” (Feeding at the executive trough, 12/26/06) They soon won’t unless the SEC in effect overturns AFSCME v. AIG next month.

Improving Corporate Ethics Indicators

Sir Andrew Likierman, a professor of management practice at the London Business School, where he is working on ways to improve performance measurement outlines how to build a responsibility gauge (Measuring corporate responsibility: Acting ethically – and being able to prove it, Ethical Corporation, 12/14/06):

  1. Clarify the measurement framework. Definition of objectives should also include an explicit statement about the connection between corporate social responsibility and financial performance. Clarification of the assumed costs and benefits is also essential. Finally, there should also be a statement about the risks involved in pursuing the corporate social responsibility agenda, which should be a subset of the company’s main risk analysis.
  2. Find better measures. Any proxies chosen need to be appropriate. Turning the focus from activity to outcomes is also part of devising better measures. Where possible, measures involving comparisons need to be with a peer group or an externally recognised standard, not with purely internal measures, or based on an arbitrarily set target.
  3. Ensure that measurement is credible. Credibility is enhanced by a choice of measures that are clear, not seen as biased, reported consistently and with a run of figures. There should be transparency in setting out the basis by which the scope, objectives, measures, targets and timescales have been decided. Inclusion in one or more of the well-known indices (such as Dow Jones Sustainability Index, FTSE4Good or BITC Corporate Responsibility Index) will also add credibility.
  4. Recognise limitations of the measures alone. The commentary also needs to acknowledge the fact that some costs and most benefits will not be measurable in numerical terms. The commentary also needs to reflect the relative importance of different corporate social responsibility measures. There is a tendency to treat all measures as having equal weight, when some will clearly be more significant than others.

Potential Conflicts Loom at Glass Lewis

Glass Lewis is being acquired by Xinhua Finance. Shanghai-based Xinhua purchased an initial 19.9% of San Francisco-based Glass Lewis in August 2006. Purchase of the remaining 80.1% is expected to close in early 2007. “XF is not well known, but critics are already questioning whether a company assumed to have close ties to Beijing should influence sensitive corporate voting outcomes around the world,” stated the December 15, 2006 edition of Global ProxyWatch from Davis Global Advisors. The newsletter also noted that GL may no longer be perceived as free from conflicts of interest: “Parent XF owns investor relations firm Taylor Rafferty, whose clients are mostly corporates.” (Proxy advisory firm Glass Lewis is being acquired by Xinhua Finance,,12/19/06: subscribe to their weekly news alerts) Press release.

Current policy at Glass Lewis is posted as follows: Glass Lewis will not enter into business relationships that possibly conflict with our mission: serving institutional participants in the capital markets with completely objective advice and services. Accordingly, Glass Lewis does not offer consulting or banking services to public corporations or directors. We are not in the business of advising public companies on their structures or conduct, and we refuse to use our position as trusted advisor to institutional investors to win consulting mandates with issuers.

Public Employee Health Over $1 Trillion

Donald Rueckert Jr., senior vice president and an actuary with Aon Consulting, estimates local governments’ total retiree health bill will probably turn out to be about $1.1 trillion under new accounting rules.

A New York Times article outlines the options as: “tax increases, union givebacks, sales of bonds or public assets, mass-transit fare increases, or increases in the cost of other local services.” New York, estimates future cost of its retirees’ health care is $53.5 billion in today’s dollars.

Mayor Michael Bloomberg says the city will set up a new trust fund, separate from the pension fund, and prime it with $2.2 billion from the city’s current surplus…a start. (Paying Health Care From Pensions Proves Costly, 12/19/06) All this could lead to a greater push for universal health care.

Report From John Chevedden & Associates

Eastman Chemical Company (EMN) eliminated poison pill after Ray T. Chevedden submitted a proposal on this topic on Nov. 5, 2006. All of the rights outstanding under the company’s stockholder rights plan are eliminated, effective as of Dec. 18, 2006.

“We remain focused on enhancing long-term value for stockholders through the continued implementation of our recently announced long-term strategy,” said Brian Ferguson, Eastman chairman and CEO. “Our decision to terminate the stockholder rights plan reflects the board’s ongoing commitment to sound corporate governance.”

According to the company’s press release, “in evaluating the rights plan, the board considered a wide variety of factors bearing on the company and its stockholders including, among other factors, the company’s current stockholder base, stockholder views about rights plans and the company’s other available protections against abusive takeover practices. The board has reserved the right in its sole discretion to take any actions in the future that it determines in the exercise of its fiduciary duties to be necessary or advisable, which could include the adoption of a new stockholder rights plan.”

Charles Miller submitted a majority vote standard proposal to BMY on November 14, 2006, potentially playing a role in the adoption announced on December 5, 2006, when the Board of Directors of Bristol-Myers Squibb Company amended the Company’s Bylaws to provide for directors to be elected by a majority vote. Bylaw number 15 was amended to change the vote standard for the election of directors from a plurality of votes cast to a majority of votes cast in uncontested elections. The Bylaws were also amended to provide that if a director nominee who currently serves as a director is not elected by a majority vote in an uncontested election, the director shall offer to tender his or her resignation to the Board of Directors. The Committee on Directors and Corporate Governance will make a recommendation to the Board on whether to accept or reject the resignation, or whether other action should be taken. The independent members of the Board will act on the Committee’s recommendation at its next regularly scheduled Board meeting which will be held within 60 days from the date of the certification of the election results.

William Steiner and Charles Miller submitted respective proposals on the poison pill and on eliminating supermajority vote requirements to Schering-Plough Corporation on November 17, 2006 potentially playing a role in triggering termination of the poison pill and a major reduction in “supermajority” voting requirements per SGP news release. Mr. Miller’s 2006 eliminate supermajority vote proposal to SGP won 62% support. Mr. Miller’s 2005 declassification proposal to SGP won 75% support and now SGP will accelerate its declassification of the board. According to the company’s press release, “these actions replace long-standing practice that have been in place for many years and existed well before the arrival of the company’s new management team in the spring of 2003.”

Marathon Oil (MRO) will ask shareholders to approve elimination of supermajority voting requirements at its 2007 annual meeting per a Dec. 5, 2006 no action challenge to Nick Rossi’s 2007 proposal on this same topic.  Mr. Rossi’s 2006 proposal on this topic won an 83%-vote at MRO.

IBM eliminated its supermajority voting requirement after the 2006 proposal on this topic by Emil Rossi won a 61% vote and Mr. Rossi submitted a similar proposal for 2007. According to the company’s press release, the four proposals, the Board will recommend to IBM stockholders in the Company’s 2007 proxy statement that stockholders vote to approve four (4) separate management proposals lowering existing statutory supermajority voting provisions. The Company’s 2007 Definitive Proxy Statement will be filed with the SEC in early March 2007.


MIT’s OpenCourseWare offers a free and open educational resource (OER) for educators, students, and self-learners around the world. Once at the site, simply search for your topic by phrase or word, such as “corporate governance” or “shareholder.” A group of partners are working with MIT OpenCourseWare to achieve its publishing goals, and have made in-kind donations of time and resources to help publish 1400 courses.

Greenberg vs SEC

The SEC uses the Securities Industry Conference on Arbitration (SICA) as a sounding board to obtain advice and recommendations on the securities arbitration procedure.  A Complaint for Declaratory and Injunctive Relief (Complaint) by Les Greenberg with the United States Securities and Exchange Commission (USDC Case No. CV 06-7878-GHK(CTx) alleges that the SICA is dominated by the securities industry and operates in violation of the Federal Advisory Committee Act.  This relationship keeps the public investor mandatory arbitration process tilted in favor of the securities industry.

Greenberg’s Petition for Rulemaking (SEC File No. 4-502), which is the underlying catalyst for the lawsuit, proposes to:

  1. Permit arbitration panel members, should they elect to do so, to conduct legal research, or, in the alternative, forbid Self-Regulatory Organizations (SROs), e.g., NASD, sponsored arbitration forums from restricting arbitrators from conducting legal research;
  2. Abolish the requirement that a securities industry arbitrator be assigned to each three person panel hearing customer disputes or, in the alternative, require that information presented to a panel of arbitrators by a securities industry arbitrator be revealed to the parties during open hearing;
  3. Require SROs to conduct continuing evaluations of ability of every arbitrator on their panels to perform his/her duties, including, but not limited to mandatory peer evaluations;
  4. Require SROs to train arbitrators in applicable law; and,
  5. Require SROs to reveal in pre-dispute arbitration agreements whether their arbitrators are required to follow the law in their decision-making process, the training of their arbitrators in the law, and their process, if any, to evaluate their arbitrators on a continuing basis.

2007 Proxy Season

Majority vote and executive compensation proposals will be the most frequently filed shareholder proposals for the 2007 proxy season, based on early indications. ISS’ Governance Research Service is currently tracking over 400 governance-related resolutions already filed for the 2007 annual meeting season, including 107 majority vote proposals and 135 proposals related to executive compensation practices. (Early Snapshot on Shareholder Proposals for the 2007 Proxy Season, ISS Governance Blog, 12/15/06)

CalSTRS Takes New Leadership Role

CalSTRS became the first major US public pension fund to join the Enhanced Analytics Initiative. EAI is an international group of pension funds and managers aimed at encouraging investment research that considers the effect on corporate performance of long-term factors not used in traditional fundamental analysis, such as climate change, corporate governance, employment standards and executive pay. Members typically allocate at least 5% of commissions to brokerage firms that do research in these areas. (CalSTRS joins research group, Pensions&Investments, 12/12/06)

Scandals Continued In 2006

Keith Regan of E-Commerce Times concludes that “Investors, customers and the general public seem to have grown somewhat immune to corporate scandals of varying degrees, even tolerating apparent criminal behavior from vendors as long as it doesn’t interrupt their own businesses. Whether this year’s batch of scandals engender new laws or regulations remains to be seen.”

James Hoopes, the Murata Professor of Business Ethics at Babson College, says “the arrogance, self-righteousness and unexamined values that underlay Enron and the 2001-2002 wave of corporate scandals continues largely unabated and at unacceptably high levels. Public cynicism will continue at high and justifiable levels until business leaders begin to know themselves.”

Regan concludes, “as both options scandals and the HP debacle demonstrate, boards still are not as independent of the daily operation of a business as the law wants them to be.” (2006 in Review, Part 3: Corporate Governance Returns – With a Vengeance, E-Commerce Times, 12/14/06) Of course, the simple solution is proxy access, giving investors the power to finally elect their own representatives to the board.

SEC Action

The SEC approved optional electronic delivery of proxy statements and annual reports by 2008 proxy season. Investors can opt for paper. The issued guidance to firms making the internal-controls provision (Section 404) in Sarbanes-Oxley less onerous. Raised minimum threshold for individual investors in hedge funds to $2.5 million in investment assets, from $1 million of net worth. Will revisit its mutual-fund governance rule. Proposed easier way for foreign companies to withdraw from U.S. reporting rules. (see S.E.C. Eases Regulations on Business, NYTimes, 12/14/06) The agency said it plans to make the e-proxy model mandatory by January 2008, though some members expressed concern about doing that. Blog provides excellent coverage at The SEC’s Big Day, 12/14/06. While at Blog see Our “What is a Perk” Survey Results. How about Larry Ellison’s $1.8 million for home security?

Morgan Stanley’s Smart Move

Morgan Stanley has hired Kenneth A. Bertsch from Moody’s to oversee the way it votes the shares it holds. As the WSJ reports, the hiring comes “as Morgan Stanley’s $448 billion investment arm has been flexing its shareholder muscle at New York Times Co. As 7.6% owner of the Times’s common shares, a London money manager with Morgan Stanley Investment Management has been pushing the newspaper to eliminate its dual share structure and to separate the chairman and publisher positions.”

As director of corporate governance at money-management firm TIAA-CREF from 1999 to 2002, Bertsch supported a move to have companies record stock options as an expense and requiring an investor vote on new stock issuance.

At Moody’s, he conducted research showing ties between executive compensation and credit risk and also the link between bonus and option awards to be “predictive of both default and large rating downgrades.

Reportedly, Morgan Stanley has been among those most likely to support management proposals on compensation and least likely to support shareholder proposals to limit pay. (Morgan Stanley Buffs Activist Profile, 12/13/06) It seems reasonable to assume Morgan Stanley wouldn’t have hired Bertsch unless they had already decided to take a more active role in proxy voting on behalf of client investors.

Harvard Downloads Available

The Program on Corporate Governance is pleased to announce two new discussion papers — a study of option backdating and corporate governance and a study comparing executive pay in Japan and the US.

Lucky CEOs by Lucian Bebchuk, Yaniv Grinstein, and Urs Peyer studies the relation between corporate governance and opportunistic option grant manipulation, focusing on how grant date prices rank within the price distribution of the grant month. Investigating the incidence of “lucky grants” — defined as grants given at the lowest price of the month – they estimate that about 1150 lucky grants resulted from manipulation and that 12% of firms provided one or more lucky grant due to manipulation during the period 1996-2005.

Executive Compensation in Japan: Estimating Levels and Determinants from Tax Records by Minoru Nakazato, J. Mark Ramseyer, and Eric B. Rasmusen compiles data on total executive incomes from income tax data and financial records to obtain some indication of which executives have substantial investment income. They find that Japanese executives earn far less than U.S. executives – holding firm size constant, about one-third the pay of their U.S. peers. Using tobit regression analysis, they further confirm that executive pay in Japan depends on firm size, with an elasticity of .24, but not on accounting profitability or stock returns. Corporate governance variables such as board composition have little or no effect on executive compensation, except that firms with large lead shareholders do appear to pay less.

CSR Position Opening

Director of Corporate Social Responsibility (CSR) operates a program of corporate ownership responsibilities, assets under management, that represent the social concern of the members of thePension Boards and participants of the United Church Foundation. The Director, CSR is responsible for a wide range of activities conducted with the Corporate Social Responsibility Ministry. Major Responsibilities:

  • Review and report on resolutions proposed for corporate vote.
  • In coordination with the Corporate Social Responsibility Committee of each organization, implement the voting of shares at corporate meetings.
  • Represent the Pension Boards and United Church Foundation within external professional organizations.
  • Monitor adherence to social screening policy through utilization for PortolioScreener database
  • Prepare communications materials regarding departmental activities.
  • Enhance public image of department’s activities through visits to seminaries, denominational conferences and congregations.
  • Prepare and administer departmental budget.

The ideal candidate should have:

  • Masters Degree or commensurate experience.
  • Significant understanding of the ownership structures, types of financial operations and decision-making processes of corporations.
  • Ability to analyze emerging issues.
  • Understanding of employee benefits and experience in employee benefit communications a plus.

Contact Information: Candidates and sources, please communicate with Bob Sellery or Katie Wilson, Robert Sellery Associates, Ltd., 1050 Connecticut Avenue, N.W., 10th Floor, Washington, D.C. 20036. Tel: 202.331.0090; Fax: 202.772.3101. All inquiries will be kept in strict confidence.

Global Warming

ExxonMobil is still funding European organizations that seek to cast doubt on the scientific consensus on global warming and undermine support for legislation to curb emission of greenhouse gases. Some estimates suggest $19m (£9.7m) since 1998. (Exxon spends millions to cast doubt on warming, 12/07/06, The Independent)

Meanwhile, groups owning 1.7 million shares of TXU stock, led by five New York City and state pension funds, filed two resolutions to be put before TXU Corp. shareholders that would challenge the company’s plans to build 11 coal-fired generating plants. One resolution asks “how TXU is responding to rising regulatory pressure to significantly reduce carbon dioxide emissions from power plants.” The second resolution asks for an accounting on “how enhanced energy efficiency programs in Texas could impact the company’s ability to sell the 9,000 megawatts of extra power that the new plants would generate.” The resolutions were put together by Ceres. (Groups plan TXU dissent, 12/8/06, Star-Telegram)

James E. Rogers, chief executive of Duke Energy, a coal-burning utility in the Midwest and the Southeast, has emerged as an unexpected advocate of federal regulation that would for the first time impose a cost for emitting carbon dioxide. (The Cost of an Overheated Planet, 12/12/06, NYTimes)

And from Gristmill is “How to Talk to a Climate Skeptic,” a series by Coby Beck containing responses to the most common skeptical arguments on global warming.

Chicago Group Calls for End to DB Plan

A Chicago business group of elite business leaders has sounded major alarm bells about the state’s ability to fund retirement and health coverage costs for state workers, claiming that taxpayers will have to pay more than $100 billion in unfunded pension liabilities and nearly $50 billion in unfunded health coverage expenses. According to the group, the shortfall stems from long-term inattention to the costs of the state’s pension and health benefits, which are uncommonly generous compared with those in private industry.

The Civic Committee of the Commercial Club used the occasion to call on lawmakers to reform the state’s public worker retirement funding system and to raise taxes by $5 billion a year to help pay the bills, according to a report from Crain’s Chicago Business. Where the report breaks new ground is in estimating the potential liability of paying promised health benefits to more than 100,000 retired state workers, downstate teachers and future retirees. Those costs now are funded out of the regular annual state budget, but the report warns that costs are exploding and concludes that the total unfunded liability to taxpayers is about $48 billion.  (Surviving Illinois’ debt sentence, 12/7/06; It’s time to ask why state is $106 billion in red; 12/11/06, Chicago Sun-Times and Chicago Group Sounds Pension, Health Funding Alarm, 12/7/06, Expect more attacks on public pension plans nationwide as accounting rules kick in requiring disclosure of healthcare obligations.

Proxy Access

In preparation for the upcoming SEC meeting of December 13th, we recently suggested reviewing the excellent program put on by last month, Shareholder Access and By-Law Amendments: What to Expect Now. However, the SEC’s meeting notice for December 13th does not include proxy access. That’s the second postponement since the courts decision. Originally, the topic was scheduled for mid-October, then December 13, now January. Grant & Eisenhofer, the firm that represented AFSCME, issued a press release that included the following:

We would like to thank and congratulate all of our clients and friends for the efforts that many of you have made to lobby both Congress and the SEC to avoid promulgating new rules that would have the effect of reversing the landmark decision on proxy access in AFSCME v. AIG, and would have a devastating effect on shareholders’ rights.  The fight is not over, however.  Just last week Commissioner Campos was quoted in the press as saying that the Commission was still “struggling” with the issue of proxy access, and Commissioner Nazareth noted her belief that it is important for the SEC to reach a long term solution on shareholders’ access to corporate proxy statements.  Indeed, corporations are still attempting to undermine shareholders’ rights on the proxy access issue.  For example, Hewlett Packard Company recently sought permission from the SEC’s Division of Corporation Finance to exclude a proxy access proposal from that corporation’s 2007 proxy statement, arguing that the Second Circuit’s decision in AFSCME v. AIG was wrong.

We urge you to keep communicating with the SEC and your federal legislators to protect the important right of shareholders to adopt bylaws to install proxy access rules at the companies they own, which was recognized by the Second Circuit in AFSCME v. AIG.  And we congratulate you on your efforts to date.  Obviously, your efforts have been working.

SEC Chairman Christopher Cox issued the following statement: “The agenda for the Dec. 13 meeting is already overloaded with several major items, including new Sarbanes-Oxley Section 404 guidance, foreign issuer deregistration, Gramm-Leach-Bliley Act rules, Internet proxy delivery and hedge fund rules, each of which requires detailed public staff explanation and commission discussion. As it is, this is slated to be one of the longest commission open meetings in quite a while.” “The SEC response to the 2nd Circuit (appeals court) decision on Rule 14a-8 is entitled to thorough consideration and public discussion on its own merits, and for that reason is now scheduled for consideration at the next open meeting in January.” (SEC pulls shareholder nomination item from agenda, Pensions & Investments, 12/7/06) (see also Sec Tables Consideration Of Proxy Access, 12/08/06, The Harvard Law School Corporate Governance Blog)

And this from Broc Romanek’s Blog: “Until it proposes new rules, the SEC has said that the 2nd Circuit court’s AFSCME decision will stand, giving shareholders more power to nominate directors. The SEC is being aggressively lobbied by both sides in the debate. In fact, the Business Roundtable threatened yesterday to sue the SEC if it acted, following the US Chamber of Commerce’s lead who last month warned the SEC that it may not have the authority to act. I wish I had a bookie that handled bets for this sort of thing, because it was easy money that the SEC would postpone this proposal given the magnitude and controversial nature of what it is considering….” (Third Time’s a Charm?, 12/7/06)

“Cox is clearly looking to get a consensus or at least a 4-1 vote on proxy access, and he hasn’t got it now,” ISS Executive Vice President Patrick McGurn noted. “This means that the shareholder proposal at H-P and maybe a dozen other companies that are likely to get such resolutions have a better chance of making it into the proxy.” Hewlett-Packard asked the SEC for permission to exclude the access proposal filed by AFSCME and state pension funds from Connecticut, New York, and North Carolina, arguing the AIG decision of the New York-based Second Circuit is not binding on agency staff and Hewlett-Packard, because HP is based in California, outside the court’s jurisdiction. Richard Ferlauto, director of pension and benefit policy at AFSCME, said the latest SEC delay means agency staff “most likely” will not issue a “no action” letter. “If the company still attempts to omit the proposal, we will seek to enforce our rights in court,” Ferlauto told Governance Weekly. (SEC Delays Proxy Access Again, 12/08/06)

For a discussion of a couple of items that will be taken up on the 13th, see If You Love a Company, Set It Free? (, 12/8/06)

I’m sure the subject will be a major topic of discussion at Directors Forum 2007 next month in San Diego (January 21-23). List of speakersRegistration Information. Sign up here. Please be sure to mention Corpgov.Net when you register. I hope to see you there.

CEO Pay Top Issue for 2007

Directorship magazine warns boards will be replaced by angry shareholders if they mismanage the CEO pay issue. “CEO compensation continues to be the one issue that unites the fractious tribes,” the magazine said in an editorial. “Labor and religious groups, the proxy advisory and governance groups, the credit rating agencies and major pension funds and hedge funds may have conflicting agendas, but they can unite on CEO comp.”

Here are the primary forces at work, according to the magazine:

  • Democratic victories in the House and Senate mean that politicians like Rep. Barney Frank, head of the House Banking Committee, are going to push for shareholder approval of CEO compensation.
  • Companies are going to have to disclose a lump sum figure for how much a CEO gets paid in their proxies, as per new requirements from the Securities and Exchange Commission. This will have a “shock and awe” effect.
  • Institutional Shareholder Services, the major proxy advisory firm, predicts a record number of shareholder resolutions seeking majority voting in support of directors. And more resolutions are going to seek an end to staggered boards. That means an entire board can be voted out at once.
  • At a critical meeting on December 13, the SEC may give ground to the American Federation of State, County, and Municipal Employees (AFSCME), which wants the SEC to allow shareholders to nominate directors and to require companies to include those nominations in proxies.
  • The New York Stock Exchange has moved forward with its plan to specify that broker-dealers holding shares in “Street name” will not be able to vote with management unless the actual owner of the shares, meaning investors, specifically direct them to do that. This will have an impact on voting percentages.

“If you add up all these forces, the reality may be that a board can now be voted out or dramatically transformed if it mismanages CEO pay,” says Editor in Chief William J. Holstein. “If companies allow coalitions of shareholder activists to form with major institutional investors and private equity funds, the result could be a huge wave of battles for control of companies.” (Directorship Magazine Predicts the 2007 Proxy Season Will Be a “Perfect Storm”)

Wealth Gap

The World Institute for Development Economics Research of the United Nations University reports that in 2000, the top 1% of the world’s population — some 37 million adults with a net worth of at least $515,000 — accounted for about 40% of the world’s total net worth. The bottom half of the population owned merely 1% percent of the globe’s wealth. Median net worth was under $2,200. Fast growth and wealth accumulation in China and India since 2000 may have closed the average gap between rich world and poor to some degree.

According to the report, in 2000 the United States accounted for 4.7 percent of the world’s population but 32.6 percent of the world’s wealth. Nearly 4 out of every 10 people in the wealthiest 1 percent of the global population were American.

The average American had a net worth of $144,000. The average person in Luxembourg had $183,000; Japanese $180,000; Swiss $171,000; and Chinese $2,600. Among Americans, wealth is distributed about as unequally as it is around the globe. A recent study found that in 2004 the top 1% of Americans earned a higher share of the nation’s income than at any time since the 1920s. (Study Finds Wealth Inequality Is Widening Worldwide, NYTimes, 12/6/06) Narrowing the gap may be one of the best ways to fight terrorism.

Relationship Investing

Mutual Series managers look for companies that are way out of favor — trading 30 percent or more below their worth. The funds also invest in distressed debt — bonds of companies having problems meeting their obligations, some of them under bankruptcy-court protection. In addition, the funds bet on companies involved in mergers and acquisitions. And unlike at many rival fund companies, Mutual Series managers will take on the role of shareholder activist if a company’s management is seen as hampering a stock’s potential. (When fund managers play musical chairs, Pittsburgh Post Gazette, 12/04/06)

The C$103 billion (US$91 billion) Canada Pension Plan Investment Board will become more of an activist, investing up to C$5 billion in companies considered undervalued and deemed to have turnaround potential. The pension fund will purchase a 10% interest in a typically undervalued business and then team up with that company’s directors to devise ways of bolstering performance. The relationship portfolio will comprise up to six companies and, if successful, may be expanded to the international marketplace. (Canadian plan adopts activist investing role, Pensions & Investments, 11/27/06)

CorpGov Bits

Directors Forum 2007 uniquely features panels balanced to bring together Institutional Investors, Directors & Officers and Regulatory Organizations. Shareholder Panelists from TIAA-CREF, CalPERS, CalSTRS, Council of Institutional Investors, AFL-CIO and AFSCME and others. Directors & Management panelists from companies in-the news such as Pfizer, Coca-Cola, HomeDepot, EMC, Krispy Kreme, Ameriprise Financial, Time Warner, General Mills, Target, HealthSouth, AstraZeneca PLC, McDonald’s. Government and Regulatory Organizations Panelists From the SEC, the ISS, NYSE, NASDAQ, Glass Lewis, GovernanceMetrics, PCAOB and ICGN. Keynote speakers include Paul S. Atkins, Raymond S. Troubh, Robert E. Denham, and Ann Yerger. Early Registration Deadline Ends December 4th!

European investors are realizing that it makes sense to participate in U.S. securities class-action cases by serving as lead plaintiffs, or by filing claims for their share of billions of dollars in settlements. (Europeans Take a More Active Role in U.S. Cases, ISS Corporate Governance Blog, 12/4/06)

CFO magazine article steps through recent attempts to link pay to performance. (Pay Daze, 12/01/06)

A summary of August A. Busch III six-year consulting agreement upon retirement as chairman of the Anheuser-Busch Companies, filed with the Securities and Exchange Commission, says the company “will also provide draught beer services and packaged products to your residence as you may request.” . …At a media conference last week sponsored by Reuters, America’s highest-paid executive, Barry Diller, chief executive of IAC/InteractiveCorp, suggested that compensation consultants be “flushed into the East River.”(Keep the Gold Watch, Give a Bottomless Keg, NYTimes, 12/03/06)

Investors, led by the Teachers’ Retirement System of Louisiana, amended their complaint against Cablevision’s directors and executives to include legal claims against Lyons Benenson, a New York-based consulting firm. According to lawyers for the investors, the case may be the first time that a compensation consultant has been sued over a company’s option practices. More than 180 U.S. firms have disclosed internal or regulatory probes into their option practices, according to Bloomberg News. (Investors Sue Cablevision’s Pay Consultant, ISS Governance Weekly, 12/01/06)

Critics accuse Wal-Mart of destroying neighborhoods, exploiting its workers and discriminating against female employees. But when American consumers were asked to name a U.S. company that was socially responsible, they named Wal-Mart above all others. (The Best Corporate Citizens,, 11/28/06) Ouch!

Some securities lawyers are concerned that portfolio-monitoring services offered to institutional investors by plaintiff’s lawyers are disguised attempts to stir up more lawsuits. (Attorneys question portfolio-monitoring services, Investment News, 12/04/06)

Footnoted sees a recent filing by MSC Industrial (MSM) as evidence that “no matter how much things seem to change — and how many executives whine about Sarbanes-Oxley — the more things stay the same.” (The more things change…,12/ 4/06)

The corporate seat of power is not only getting hotter, but is increasingly equipped with an ejector button that directors are ever quicker to press. In fact, turnover in the corner office is heading toward a record high this year. According to the outplacement firm Challenger, Gray & Christmas, as of the end of October, 1,234 chiefs had left their jobs, compared with 1,110 by that time last year and a full-year total of just 663 in 2004. (Signing Up A New Chief In The Age Of Prenups, NYTimes, 11/25/06)

Colorado Directors Keep Posts

Robert McCormick, the vice president of proxy research and operations at advisory service Glass Lewis, says that 0.12% of directors up for election in 2005 failed to get a majority. That was down from 0.18% in 2004. Colorado directors were even more successful this year, with none of the 505 up for re-election failing to get a majority, according to a Rocky Mountain News analysis.

The News reviewed the most recent voting results for 98 of the 111 Colorado-headquartered public companies it tracks. Only 13 director nominees had more than 20% of votes withheld, meaning they failed to get 80% of the vote. Another 22 had 10-20%, meaning they fell short of 90%. In all, 423, or 84%, had fewer than 5% of their votes withheld, meaning they got 95% or more of the votes cast.

See Directors find elections tough to lose, Rocky Mountain News, 12/2/06, for the full article, which includes a board of directors scorecard for several Colorado companies.

AVI BioPharma Shareholder Advocacy Trust

One of the long unresolved issues in corporate governance has been how dispersed shareowners can ban together to take action to enact needed changes in the CEO, board or corporate governance of individual companies. Many large institutional investors belong organizations, such as the Council of Institutional Investors or the International Corporate Governance Network, which at least can facilitate such discussions. They can also afford to subscribe to proxy monitoring services, such as those provided by ISS and Glass Lewis, which advise them on firm specific issues. However, individual investors, especially those who have invested in small cap stocks, have more limited sources of information and few dedicated advocates.
For years I have endorsed the efforts of the Corporate Monitoring Project, especially their proposals to allow shareowners to choose a proxy advisory firm to be hired by the company, since this would eliminate the problematic free-rider issue, allowing all shareowners to benefit from independent professional analysis of the issues at nominal joint expense.

Now comes an interesting monitoring innovation with potential, the “advocacy trust.” The AVI BioPharma Shareholder Advocacy Trust was conceived and created by Richard Macary, a New York based independent analyst, corporate consultant, and venture capitalist, who believes AVI needs a change in senior management to capitalize on its paradigm-shifting technology.

The Trust is set up as a “statutory business trust” under the laws of the State of Delaware. The managing trustee for the Trust is The Shareholder Advocate, LLC, a Delaware Limited Liability Company majority owned and operated by Richard Macary, and the Resident Trustee is Christiana Bank & Trust Company. The trust agreement gives the “Managing Trustee” certain fiduciary powers and authority to take actions and expend money to advance the goals of the Trust.

According to its website, the advocacy trust “offers individual shareholders a vehicle and forum for voicing their concerns and obtaining greater influence on the direction of the Company. By supporting and contributing to the AVI Shareholder Advocacy Trust, shareholders like you will have the opportunity to speak with a combined voice that the management and board cannot easily ignore, and the Trust will have the power and resources to take appropriate actions if management and the Board are not responsive.”

Of course, the Trust “will have the power and resources to take appropriate actions” only if it wins adequate support from shareowners. The Trust doesn’t own any stock itself. It is a not a “for profit” vehicle, which depends on voluntary contributions from shareowners. “Any funds not used by the Trust to achieve its objectives will be returned to the Trust contributors on a pro rata basis.”

Macary further elaborates in an e-mail. “In a way, it’s similar to contributing to a campaign or political action committee where you agree with their platform or want to see a specific candidate elected, so you contribute. Your only upside in that scenario is that if your candidate wins, you believe it will be good for you or your position, be it lower taxes, a cleaner environment, less regulation, etc. The money gets spent by these groups to further their goals.”

The Trust is also set up to compensate the managing trustee, Macary, who conducts and coordinates research and advocacy efforts. “The trustee is very much like a general contractor in that he, she or they will essentially hire and direct all of the professional and advisors needed to execute upon the trust’s goals. This would include legal representation, proxy firms, governance advisors, accountant (forensic if needed), industry consultants, executive recruiting firms, etc.” AVI Shareholder Advocacy Trust, set a cap on the compensation to no more than $5,000 per month based on up to 10% of the contributed trust assets.

At AVI, Macary found that some of the larger investors are not activists or they simply don’t want to expend their limited time and resources to get into a proxy fight over what for them is likely a relatively small holding. While they are unhappy, they are also not motivated to do the amount of work needed to pressure the board and/or launch a proxy contest. However, they are willing to support someone else with a commodity that they have more of than their time, which is money.

I hope so. Since the advocacy trust model is dependent on voluntary contributions, Macary must present carefully laid out plans that shareowners believe require their financial support to succeed. If the Trust fails to convince shareowners of the viability of its plans, it won’t attract necessary contributions. On the other hand, if it appears the efforts of the Trust will inevitably lead to victory, contributions may dry up as shareowners presume others will make the necessary contributions.

So far, Macary appears to be straddling that fine line. The Trust has certainly gotten good press, especially in Portland Oregon, where AVI is based. (New group targets AVI, Portland Business Journal, 10/27/06; The shareholders are revolting, Portland Business Journal, 10/27/06) It may be a good fit for micro or small cap companies where management has been an obvious and significant impediment to shareholder value and where individuals hold most of the shares. However, there needs to be a motivated shareowner base with at least one larger investor whose participation can motivate others.

The legal structure and sophisticated use of electronic forms of communication certainly appear to be a step up from efforts by other groups of relatively small shareholders. However, Macary’s efforts might be even more likely to lead to success if he were also to embrace Mark Latham’s corporate monitoring proposal (see Publications), which eliminates the ‘free-rider” issue, ensures all shareowners receive analysis that might be done by the Trust or at their direction, and it would provide a mechanism whereby all shareowners who benefit from the increase in value that may result from such efforts also help foot the bill.

Directors Harder to Recruit

An executive from Korn Ferry estimated that 10 years ago it took roughly 90 days to fill a directorship; today it can take up to 180 days. Of the 391 new directors hired by S&P 500 companies so far in 2006, only 29% are active CEOs, a 38% decline from 2001. Meanwhile, the number of CFOs and other high-ranking execs among the new director hires jumped 67% over the same time period, and this year accounted for 15% of all new slots, according to executive search firm Spencer Stuart. (Board seats are begging for warm bodiesFinancial Week, 11/27/06)

Blue Option

According to the Blue Investment Management’s research, an index of 76 “blue” S&P 500 companies that meet specific ethical criteria — think socially responsible stocks with a liberal political bent — would have beaten an index of 380 “red” stocks and the S&P benchmark by more than 120% and 105% respectively, over the five years ended June 30. (Talk about voting with your purseFinancial Week, 11/27/06)

Nazareth’s Vote Key: AFSCME Forges Ahead

Annette L. Nazareth’s vote may be key at the SEC’s meeting on 12/13/06 on whether shareholder nominations for directors must be included in corporate proxies starting in 2007, according to an article published in Directorship (A Key Player in the SEC’s Critical Vote, 11/29/06). SEC Chairman Chris Cox places a high priority on consensus and does not want a divisive 3-2 vote along party lines. The article indicates “it’s possible that Cox will once again delay the meeting because of the sensitivity of the issue, but probably only for a month, until January. So it still appears that directors going into the 2007 proxy season will be contending with new rules for electing boards.”

Roel Campos, one of two Democrats on the commission, told MarketWach (SEC ‘struggling’ on proxy-access issue – Campos, 12/1/06) he is pushing SEC Chairman Christopher Cox and other commissioners to provide “real shareholder access” to corporate proxy ballots, which would make it easier and cheaper for them to express dissatisfaction with corporate managers and boards. He said others on the SEC “just don’t want any shareholder access at all,” making compromise difficult. If a majority of the five-member commission can’t agree on a response,

Campos said he thinks it ought to let the appellate court ruling in the AFSCME case stand. In that event, he said U.S. companies could not count on the SEC staff to support their efforts to block consideration of shareholder proxy-voting proposals, which would ensure that the issue is put to shareholders at some companies. SEC Commissioner Annette Nazareth, the second Democrat on the commission, told reporters that a do-nothing approach wouldn’t be ideal. Still, she said, it would not be disastrous and might keep pressure on the commission to reach a long-term solution on shareholders’ access to corporate proxy ballots.

Letting the AFSCME case stand, without modification, would allow shareholders to tailor iniatiatives to the specific circumstances of each company, a much better approach in my opinion than the complicated and burdensome SEC proposal that was shelved because of objections from incumbent CEOs who were concerned about losing power over their boards.

The November issue of Directorship carries an interview with Richard Ferlauto at AFSCME. Of course, their lawsuit over the ability to place nominees on the proxy at AIG led to reopening this most fundamental shareowner rights issue. Now they have filed a “books and records” demand under Delaware law, requesting internal documents from Home Depot on backdating of the stock options issue, board level discussions on the CEO’s compensation and the decision- making processes. (The Voice of a Powerful Union) Ferlauto and AFSCME continue to break new ground.

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Ending The Wall Street Walk: Why Corporate Governance Now?

What would you do if the company in which you’ve invested your hard earned dollars throws it away on fat retirement benefits to outside members of its board of directors? One individual investor, Richard Ayers, conducted a proxy battle this year with Nevada Power Company over the issue. Although he won more than 30% of the vote, individual investors and “ethical” funds face a Sisyphisian task in bringing change to today’s corporations.

The reality is that if you don’t like the way the management handles your business, you have traditionally had two choices: hold your nose or sell out. The message is usually the same whether it is being dispensed by Barron’s, Merrill Lynch or the manager of a so-called “socially responsible” investment fund. It’s called the “Wall Street Walk.”

But dumping stocks is an easy short term solution that only compounds the short term investment horizon that plagues Wall Street. In many cases, this conventional wisdom may not only be wrong for the investor, the cumulative effect of such acts may also profoundly impact the quality of our products and environment, the treatment of employees, our balance of payments, and the well being of society-at-large. The real issue is often not last quarter’s balance sheet but the strategic direction of a company and the integrity of its management.

Corporate Governance

Corporate governance, the nuts-and-bolts of how a public company fulfills its responsibilities to investors and other stakeholders, is oddly frequently overlooked in debates over corporate social responsibility. Despite its still relatively low profile, it’s where much of the real action is going on when it comes to positively changing corporate behavior.

In 1932, Lewis Gilbert owned 10 shares in New York’s Consolidated Gas Company and found that his questions were ignored at the annual meeting. Lewis and his brother pushed for reform. Finally, in 1942, the Securities and Exchange Commission adopted a requirement that companies put shareholder resolutions to a vote under specified circumstances. In 1967 organizer Saul Alinsky, a Rochester based community organization, and several national churches turned to shareholder activism to target Kodak’s poor record of minority hiring.

More recently, the social investment community has focused on high profile, public campaigns aimed at divestment of corporations involved in perceived social injustices such as involvement in apartheid South Africa, Dow Chemical, GM, or companies that operate in Burma. Although such shareholder actions have certainly had an impact, most won only a small fraction of votes. Progress has been made largely because targeted corporations wanted to minimize adverse publicity.

Corporate governance actions spearheaded by huge, multi-billion dollar pension funds such as CalPERS, the California Public Employees’ Retirement System, and other large funds, changes the balance when such social concerns are seen as affecting share value. Their entry provides the foundation for the beginnings of a much larger degree of meaningful self regulation of businesses by owners.

Robber Baron Accountability

At the turn of the century, corporations were dominated by “captains of industry.” Carnegie, du Pont, Mellon, Morgan, Rockefeller, and others owned large blocks of stock and exercised direct control over their investments. “Agency costs” were not much of a problem because ownership and control were embodied in the same individuals. Corporations were accountable to their owners.

By 1932, however, Adolph Berle and Gardiner Means documented a significant shift in their book The Modern Corporation and Private Property. Ownership had become so dispersed that control had shifted from owners to managers. Owners essentially traded their ability to monitor management for increased diversification and liquidity. Being an active shareholder no longer paid because, despite potential gains to shareholders as a group, it was no longer rational for any one shareholder to act. Why shoulder the entire expense of corporate activism for only a small portion of the gains while other shareholders get a “free ride?”

Mark Roe, a professor of law at Columbia University, recently reexamined the historical evidence and concludes that our corporate system based on strong managers and weak owners is not the inevitable result of large scale production as Berle and Means assumed. Instead, it is the unintended consequence of political decisions which reflect the public’s dislike of concentrated financial power. The framework of corporate democracy, much of which developed in reaction to the stock market crash of 1929, restored public confidence by subordinating finance to commerce and providing legitimacy for the otherwise uncontrollable growth of power in the hands of a few private individuals.

The New Deal’s Glass-Steagall Act separated investment and commercial banking. Similar laws limited control of stock by insurance companies and mutual funds. Together, they insured that financial institutions could not easily control industry, but they also restricted collective action. Although these reforms may have saved us from the real evils of concentrated wealth and power in the finance sector, they had the unintended result of ensuring that management of America’s corporations would soon be accountable to no one. The framework of corporate governance set up in the aftermath of the 1929 crash has the appearance of being democratic (one share, one vote) but lacks basic mechanisms to carry out more than an illusion.

Since the 1930s, corporate governance consisted primarily of attorneys engaged in theoretical debates about reducing “agency costs” – essentially inefficiencies which arise when the “principles” (stockholders) hire an “agent” (chief executive officer, CEO) whose interests differ from their own. Stockholders want their shares to increase in value and pay higher dividends; the CEO wants status, a high salary, bonuses and perks. The Holy Grail for those in the field of corporate governance has been to develop a variety of rewards and punishments to better align the CEO’s interests with those of the shareholders. Instead of actively participating in corporate governance issues, shareholders became passive. With few options left to them, dissatisfied owners were told by the system to love it or leave. That strategy became known as the “Wall Street Walk” or the “Wall Street Rule.”

The Politics of Corporate Governing

This rather dry history has been overtaken by a series of high-profile, hot button debates swirling around the role of the corporation in society. Issues of corporate governance — junk bonds, corporate takeovers, downsizing, executive pay, the rise of pension funds– are discussed daily in the press. So what has changed and how can it lead to more effective and responsible, corporate leadership?

In the 1960s, empire building by CEOs led to a kind of merger madness, as conglomerates gobbled up unrelated companies. When many of these conglomerates lagged in price in the 1970s, it heightened the realization that CEOs needed oversight. Accountability, of a sort, came in the 1980s when corporate raiders using “junk bonds” took many companies private, disassembled them and sold them back to the public in parts. The results to employees and communities were often devastating in the form of plant shutdowns and lost jobs. While workers and communities struggled with massive layoffs, CEOs invented golden parachute severance packages and designed poison pills which made takeovers less attractive through stock dilution mechanisms which hit new shareholders.

By the late 1980s, a backlash set in. The “junk bond” market imploded, and an irate public and corporate boards began to demand a more active role in corporate governance. They recognized that their intervention could soften the impact of corporate restructuring on workers, communities, operations, and profits.

These developments led to the modern field of corporate governance which examines the legal, cultural and institutional arrangements that determine the direction and performance of corporations. Practitioners include: (1) the shareholders, who usually hold one vote per share of common stock owned, (2) the board members, whom shareholders elect, and (3) the management of the firm, which is usually headed by a CEO appointed by the board. Other participants include advisors, creditors, employees, customers, suppliers, government and its citizens. Each party can influence the firm’s direction.

Pension Fund Power

Between 1955 and 1980, the institutional investor share of outstanding stock rose from 23% to 33%. In 1990, it had risen to 53% and now stands at more than 60%. Pension funds, as a subset, experienced even more rapid relative growth. Their share of the market rose from 0.8% in 1950 to 9.4% (1970), to 18.5% (1980), to 28% (1990) and stands above 30% today. This shift has set the stage for the rise of a subtler form of corporate governance which has yet to be fully realized. Instead of waiting for corporate raiders to impose dramatic changes through hostile takeovers, pension funds have the opportunity to become long term “relational” investors, working with boards and CEOs to make needed adjustments earlier and less painfully. Corporate governance would then move from revolutions and palace coups to the smoother transitions characteristic of democratic governments.

While legal impediments largely preclude mutual funds, insurance companies, and banks from holding large blocks of stocks, fewer such prohibitions apply to pension funds. Most pension funds are free to hold blocks of stock large enough to make monitoring of management feasible, from a cost-benefit standpoint. In addition, the Department of Labor, which governs most pension funds under the Employment Retirement Securities Act (ERISA), has clarified that voting rights are plan assets. It is, therefore, the duty of pension fiduciaries (trustees) to ensure such assets are voted solely in the interest of plan participants and beneficiaries. Unlike individual investors who can just throw their proxies away, pension funds are legally required to follow the issues of corporate politics and to vote.

Ideally, pension funds, who have predictable payouts, should be taking a long term investment time horizon and should be urging the firms they invest in the to do the same. The growth of pension funds dramatically increases the capacity of the financial community to identify and redress agency costs, since they bring the possibility of sophisticated monitoring by professional analysts. Unlike other institutional investors, pension funds have nothing to sell their portfolio companies and no intrinsic interest in acquiring operating control.

CalPERS: Leading the Pack

The California Public Employees’ Retirement System involvement with corporate governance issues can be traced back to a morning in 1984. Jesse Unruh, then treasurer of California and a CalPERS board member, read that Texaco had repurchased almost 10% of its own stock from the Bass brothers at a $137 million premium. Essentially, Texaco’s management paid “greenmail” to avoid loss of their jobs in a takeover. CalPERS was also a large shareholder but, of course, was not given the same option of selling its stock back to the company at a premium. Unruh quickly organized a powerful shareholder’s rights movement with the creation of the Council of Institutional Investors (CII — composed mostly of pension funds) to fight for equal and fair treatment of shareholders, shareholder approval of certain corporate decisions, and needed regulatory reforms.

CalPERS has $100 billion in assets, serves 1 million members and is administered by a 13 member board. Six are elected by various membership groups; the others are either appointed by elected officials or serve by virtue of their elected office. In contrast to the short time frame of most institutional investors, CalPERS takes along-term perspective. Their average holding period ranges from 6 to 10 years.

CalPERS equity strategy consists of making long-term investments so it can be in a position to influence corporate governance. Many pension fund managers, subject to the “star” system on Wall Street, actively manage their funds with hopes of beating the market. But recent studies have shown that active management is not cost effective. After factoring in fees and turnover expenses, “indexing” – owning a representative share of a particular market – is the best strategy for most pension funds (as well as for most individuals through low-cost index funds such as those offered by Vanguard).

CalPERS targets poor corporate performers in its portfolio and pushes for reforms. These range from firm specific advise, such as arguing a few years ago that Sears and Westinghouse should divest poorly performing divisions and redefine their strategic core businesses, to more general advice. For example, CalPERS believes most firms need to expand employee training and shared managerial authority with lower level employees. Although CalPERS must often bear the full cost of monitoring, and other shareholders get a “free ride,” the sheer size of its investments makes such monitoring worthwhile.

A 1995 study by Steven Nesbitt, Senior Vice President of the consulting firm of Wilshire Associates which was under contract with CalPERS, examined the performance of 42 companies targeted by CalPERS. It found the stock price of these companies trailed the S&P 500 Index by 66% in the five year period before CalPERS acted to achieve reforms. The same firms outperformed the Index by 52.5% in the following five years. A similar independent study by Michael P. Smith (with Economic Analysis Corporation, Los Angeles) concludes that corporate governance activism has increased the value of CalPERS’ holdings in 34 firms over the 1987-93 period by $19 million at a monitoring cost of $3.5 million.

Unfulfilled Promise

CalPERS’ investment strategy is hardly typical. Most institutional stock owners are adopting shorter and shorter time horizons, evaluating companies on a 1-3 year time frame, rather than the longer term outlook of CalPERS. The average holding period has declined from more than 7 years in 1960 to about 2 years today. The result has been an increase in transaction costs. In 1987, for example, $25 billion was spent on stock trading in the U.S. That is an amount equal to one-sixth of corporate profits or 40% of dividends that year. Money managers have shifted the emphasis of capital from long-term investments to making a quick buck.

Although CalPERS has been active in corporate governance, most pension funds are not. While some progress is being made, the Department of Labor reports that only 35% of plans which delegated voting authority could provide evidence that they performed substantive monitoring of how their investment managers carried out proxy voting. But its no wonder plans don’t monitor; the Department has never taken an enforcement action against a fund for their failure to properly monitor voting decisions.

Most pension funds exist in a culture of “blame avoidance” built around the legal concept of “prudence.” Although portfolio theorists generally agree that 99% of the risk management value of diversification can be achieved with a portfolio of only 100 stocks, pension plans continue to over diversify. While the aggregate holdings of institutional investors now stand at more than 60%, the holdings of individual institutional investors in individual companies rarely exceeds 2% and tends to be in the 0.1% to 1% range. Since the holdings of most pension funds are not nearly as large as those of CalPERS, they would derive similar benefits from active corporate governance only if they consolidated their holdings into larger blocks to make monitoring cost effective.

If more pension funds would follow CalPERS’ lead, accountability might finally make its way into the boardroom. That would be a healthy development for investors, companies, employees and the environment. For example, it is widely accepted that employees in “knowledge” industries, such as computer software, hold the key to additional wealth generating capacity in their training, skills and information networks. Margaret Blair, of Vanderbilt University, points to evidence that this is true not only in Silicon Valley but for most industries in the United States. Blair calculates that tangibles, such as property, plant and equipment, accounted for 62% of the total value of mining and manufacturing firms in 1982 but only for 38% in 1991. The value of intellectual property has risen dramatically as workers have become more educated.

More democratic and flexible workplaces make fuller use of employee capacities and yield tangible economic benefits. Yet managers faced with a potential loss of status and power have been slow to change. A 1986 study by the National Center for Employee Ownership found firms with significant employee ownership and participation in decision making grew 8 to 11% faster than their counterparts. A year later the General Accounting Office found that such firms experienced a 52% higher annual productivity growth rate. Findings, such as these, led CalPERS to advocate employee training and shared managerial authority. Similar findings linking “social responsibility” to the bottom line have led TIAA-CREF (a cooperative pension fund for educators) to push for more women and minorities on boards.

Corporations have a profound effect on the quality of our environment and our lives. If they were governed and operated more democratically the influence they have on other social institutions such as government, education and even the family could be expected to change in a positive direction.

Ending Corporate Demockery

What measures can be taken to bring about more genuine democratic corporate governance? Perhaps the most important are in the area of corporate elections. Corporate board elections are about as democratic as old-style communist regimes: they talk the talk but don’t walk the walk. A 1991 study found that over 80% of board candidates were filled by CEO recommendations. Until 1992, when the SEC revised its proxy rules under pressure from CalPERS, CII, and others, shareholders could not even communicate with each other without going through elaborate and expensive filing procedures. Serious obstacles to communication remain. Filing is still required whenever a voting group owning 5% or more, in total, agree to vote together. In addition, most votes are only advisory and access to shareholder lists is limited.

Management controls the proxy machinery. Since proxies are normally voted well in advance of the annual meeting, they can find out how shareholders vote. Many money managers, who act as investment and voting agents for fiduciaries, have business relations with the management of firms holding elections. They are not required by law to maintain written records of how they voted on behalf of their clients, so they are likely to change their vote, if requested by management. In addition, unvoted proxies are often counted in favor of management.

To realize the potential of more democratic corporate governance we need to encourage monitoring and active participation in corporate governance by investors, especially pension funds. Among the many reforms needed, Congress and/or the Securities and Exchange Commission could:

  • Institute proxy reform measures, especially for confidentiality in collection, independence in tabulation and uniform treatment of votes and abstentions.
  • Change the definition of a “voting group” so that shareholders who are not seeking to control a corporation can freely communicate with each other.
  • Allow groups of investors holding at least 10% of outstanding shares access to proxy statements to nominate at least one independent director and to present other non-control related proposals to shareholders.
  • Require investment companies, banks and insurance companies to meet the same fiduciary standards for the voting of proxies as pension funds under ERISA.

Congress and/or the Department of Labor could:

  • Require ERISA trustees to keep records to demonstrate they have acted for the exclusive benefit of plan participants in their voting and governance actions.
  • Ensure pension funds are voted solely in the interest of plan participants and beneficiaries through enforcement efforts.
  • Clarify, through administrative guidance, that diversification standards under ERISA do not require investment in hundreds or thousands of stocks; prudence is to be evaluated on a portfolio-wide, rather than individual investment, basis.
  • Require trustees of employee stock ownership plans to vote unallocated shares in the same proportion as employees vote.

Further Reading: Blair, Margaret M., Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century, The Brookings Institution, 1995.

Denham, Robert and Michael Porter, Lifting All Boats: Increasing the Payoff From Private Investment in the US Economy, Report of the Capital Allocation Subcouncil to the Competitiveness Policy Council, Washington, DC, 1995.

Hawley, James P. and Andrew T. Williams, Corporate Governance in the United States: The Rise of Fiduciary Capitalism a Review of the Literature, Saint Mary’s College of California, Moraga, 1/31/96.

Monks, Robert A.G. and Nell Minow, Watching the Watchers; Corporate Governance for the 21st Century, Blackwell Publishers Inc., Cambridge, MA, 1996.

Roe, Mark J., Strong Managers, Weak Owners: The Political Roots of American Corporate Finance, Princeton University Press, Princeton, NJ, 1994.

U.S. Department of Labor, Pension Welfare Benefits Administration, “Proxy Project Report,” Washington, DC, 2/23/96.

Organizations of Interest Council of Institutional InvestorsNational Center for Employee OwnershipAmerican Association of Individual Investors

Thanks, to Jon Entine for several suggestions to the above article. For an example of Jon’s work see, The Messy Reality of Socially Responsible Business. An edited version of “Ending The Wall Street Walk: Why Corporate Governance Now?” appeared in the September/October 1996 edition of At Work, by Berrett-Koehler Publishers.

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