Corporations determine far more than any other institution the air we breathe, the quality of the water we drink, even where we live. Yet they are not accountable to anyone.
Those words were on the 1991 cover of Power and Accountability: Restoring the Balances of Power Between Corporations and Society by Robert A.G. Monks and Nell Minow, long before 2010 when the United States Supreme Court ruled that the First Amendment prohibits government from placing limits on independent spending for political purposes by corporations in Citizens United v. Federal Election Commission. It was a great awakening. Many more began to realize how much power over our government we had ceded to corporations.
In 1987 Time magazine estimated that “of the 170 countries that exist today, more than 160 have written charters modeled directly or indirectly on the U.S. version.” More recently, David Law and Mila Versteeg compared constitutions world wide and found ours losing influence. “Nobody wants to copy Windows 3.1,” says Law. Our constitution fails to protect entitlements to food, education and health care and is considered by many to be “frozen in amber.” In contrast, the Canadian Charter is seen by those in developing countries as “more expansive and less absolute.”
Many are now engaged in a movements, such as “We the People,” to “end corporate rule” and “legalize democracy.” While I support those efforts, a multi-pronged approach aimed at “legalizing” democracy both within our governments and within our corporations is needed. While many have written a great deal about political democracy, fewer have drawn attention to the need for corporations to be more democratic. Since corporations have so much control over our governments, we can’t take control of our government without a higher degree of control over how our corporations are governed. It is a symbiotic relationship.
What would you do if the company in which you’ve invested your hard earned dollars frittered it away so that an investment of $20,000 is now worth $3,000? David Monier, a shareowner at Princeton National Bancorp, Inc (PNBC), decided he wasn’t going to sit by idly. He utilized model United State Proxy Exchange language and reports his proxy access proposal will be included on PNCB’s proxy. If adopted, it would allow:
- Any party of one or more shareowners that has held continuously, for two years, one percent of the Company’s securities eligible to vote for the election of directors, and/or
- Any party of shareowners of whom one hundred or more satisfy SEC Rule 14a-8(b) eligibility requirements ($2,000 worth of stock held for a year),
This is significant because shareowners don’t have access to place their nominees on corporate proxies. Their proxies are treated as management proxies. If shareowners want to nominate directors they must hire a soliciting firm and mail out their own proxies. Since costs can be in the millions, only hedge funds can generally afford to do it and they are often looking to break up the company and sell off the parts. Monier will also be nominating Steve Bonucci from the floor of the annual meeting, so there is a real opportunity for change. Let’s hope CalPERS, PERA and other institutional investors at PNBC support this move initiated by a retail shareowner.
Some proposals, like Monier’s, are driven by shareowners who believe their companies retain substantial value but that value is jeopardized by poor corporate governance… often poor oversight by corporate boards. Others, especially after Citizens United, are concerned their corporations are donating to bad political causes or should just get out of politics. Many have turned to the Center for Political Accountability for assistance in filing proposals seeking disclosure of corporate spending. Still other investors are concerned with social or environmental issues like hydraulic fracturing. They are requesting greater disclosure of measures the company has taken to manage and mitigate the potential community and environmental impacts. Like political campaigns, those attempting to democratize corporations from the inside also face a Sisyphisian task.
The reality is that if you don’t like the way management handles your business, you have traditionally had two choices: hold your nose or sell out. The message is usually the same whether dispensed by Barron’s, Merrill Lynch or the manager of many “socially responsible” investment funds. Selling out is taking the “Wall Street Walk.”
Dumping stocks compounds the short term investment horizon plaguing Wall Street. The average stock is now held for 22 seconds, according to some. Although such high speed trading guarantees “liquidity” (buyers and sellers are always there), it has moved us from an ownership to a casino economy. The Wall Street Walk is often wrong for the investor, the quality of our products and environment, the treatment of employees, our balance of payments, and society-at-large. The real issue is often not last quarter’s balance sheet but the comapny’s strategic direction and the integrity of its management.
Corporate governance, the nuts-and-bolts of how a public company fulfills its responsibilities to investors and other stakeholders, is 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 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 or proposals to a vote under specified circumstances. In 1967 organizer Saul Alinsky and several national churches turned to shareholder activism to target Kodak’s poor record of minority hiring.
Later, the social investment community focused on high profile, public campaigns aimed at divestment of corporations involved in perceived social injustices such as involvement in apartheid South Africa, Union Carbide’s Bhopal or GM’s Corvair. Although such shareholder actions certainly had an impact, most won only a small fraction of votes. Progress resulted 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, began to change the balance when such social concerns were also seen as affecting share value. Their entry provided 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 minimal 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, 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” has 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. Shareowners 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 shareowners. Instead of actively participating in corporate governance issues, shareowners 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 — corporate takeovers, downsizing, executive pay, the rise and fall of pension funds, the corrupting influence of corporate money in politics– 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 shareowners.
By the late 1980s, a backlash set in. The “junk bond” market imploded. 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 primarily include: (1) the shareowners, who usually hold one vote per share of common stock owned, (2) the board members, whom shareowners “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 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 and conflicts of interest 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 mutual funds or insurance companies, pension funds, especially public 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 $230 billion in assets, serves 1.6 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 studies have shown that active management is often 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).
Until recently, CalPERS targeted poor corporate performers in its portfolio and pushed for reforms. Those ranged from firm specific advice, such as arguing 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 concluded 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.
In 2010, CalPERS adopted a new strategy for engaging underperforming public stock companies through confidential company engagements rather than by posting a public “name-and-shame” Focus List. However, some Focus List company engagements will continue to become public information – primarily through proxy actions and shareowner solicitations.
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, and now, according to some, 22 seconds. 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 once reported 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 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, CalPERS, CalSTRS and others 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 Demockary
What measures can be taken to bring about more genuine democratic corporate governance? Perhaps the most important are in the area of corporate elections. Filing shareowner proposals on individual issues can have some impact, but it is like trying to run state government through propositions. Corporations would be much more responsive to shareowners and to the general public if they could be held accountable by those who “elect” their directors, shareowners.
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 remain. Most companies still use “plurality” voting standards for directors. That is, if the election is uncontested (as most are), the director needs only the vote of one share to remain in office. (Most Fortune 500 companies use a “majority” standard that requires directors failing to get a majority of the vote to tender their resignation, which may or may not be accepted.)
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. Until 2003, mutual funds were not even required by law to maintain written records of how they voted on behalf of their clients, so they were likely to change their vote, if requested by management. In addition, unvoted proxies were often counted in favor of management via broker voting. Even today, when most retail shareowners vote one item but leave other items on the proxy blank, those blank votes are voted automatically with management.
Ninety-five percent of shareowners who receive their proxy electronically hit the delete button or let them expire. To realize the potential of more democratic corporate governance we need to encourage monitoring and active participation in corporate governance by investors. Here are some steps you can take as an individual shareowner or an investor in mutual funds:
- Keep informed on the issues through news sources such as the CorporaterReformcoalition.org, CorpGov.net, Accountability-Central.com, and SocialFunds.com.
- Ask mutual and pension funds to announce their votes in advance. They are less likely to change their vote under pressure from corporate management when they do. If you like the way they vote, copy them when voting your own shares; if you don’t, lobby them to switch.
- Use the power of social media. Facebook is a great place to exchange “likes,” notes on what we did last weekend, and photos. The United States Proxy Exchange (USPX) uses similar tools to help retail investors influence corporations. USPX developed guidelines for “say on pay” voting, model shareowner proposals for proxy access and other guidance to help members make corporations more democratic. For $50 a year, you get your own blog, linked to a network of veteran volunteers who can help you file proposals and defend them against no-action requests.
- Sharegate.com, will soon be online with additional tools.
- Research mutual fund voting on Proxy Democracy. Invest in funds that vote they way you would.
- Don’t toss your proxy. Visit ProxyDemocracy.org and MoxyVote.com to see how respected institutional investors are voting. Find the “brand” that fits your philosophy and copy their voting patterns on MoxyVote.com‘s voting platform.
- Launch a corporate campaign. Find tools at theShareholderActivist.com.
- Upgrade the power of the press. Help your community (student government, city government, corporation) launch a contest to award the best coverage of elections and ongoing governance issues using VoterMedia.org.