At the end of July 1996 Richard Koppes left his job at CalPERS, the $100 billion California Public Employees Retirement System. CalPERS has been on the cutting edge of corporate governance since 1984 when Jesse Unruh, then California Treasurer, discovered the Bass brothers were “greenmailing” Texaco to the tune of $137 million. Unruh helped establish the Council of Institutional Investors (CII) to coordinate the fight for corporate governance reform. Soon afterward, Mr. Koppes joined CalPERS as general counsel.
A few of CalPERS’ accomplishments during Mr. Koppes’ tenure include:
In 1989 CalPERS wrote to the Securities and Exchange Commission urging proxy reform. After more than 1,700 letters of public comment the SEC proceeded with its historic Release No. 31,326 in 1992. After this limited deregulation, the United Shareholders Association estimated the cost of a target mailing to a corporation’s 1,000 largest shareholders was reduced from $1M to between $5,000 and $10,000.
CalPERS developed an annual list of targeted “underperformers.” Stephen Nesbitt, Michael Smith, and others have estimated that corporate governance activism from targeting underperformers has increased the value of CalPERS holdings considerably.
In May 1994, CalPERS wrote to the largest 200 domestic equity holdings in its portfolio requesting boards to perform an analysis of corporate governance issues. It later wrote to an additional 100 companies. CalPERS then issued its infamous “report card” leading many corporations to develop and implement corporate governance policy reforms to give shareholder greater voice. The American Society of Corporate Secretaries reports that 48% of 800 firms surveyed have or are seriously considering adopting corporate governance policies.
Many believe the ouster of board members and chief executives at some of the nation’s leading corporations, brought about through the efforts of CalPERS, CII, active limited partnerships, and others, combined with the reform measures listed above, may signal the eventual end of the separation of ownership and control within public corporations documented by Berle and Means in 1933. Significantly, the accomplishments have resulted from reduced government interference in the marketplace and increased acceptance by institutional investors of their fiduciary duties.
At the heart of many of these accomplishments has been CalPERS’ general counsel, Richard Koppes, a pioneer in the field of corporate governance for the last ten years. In 1994 the National Law Journal cited Mr. Koppes as one of America’s most influential lawyers. CalPERS gave him a $20,000 salary increase, added the title of deputy executive officer to his existing title of general counsel, and decided to extend their corporate governance program to worldwide markets…but those actions only held Koppes for one final year.
Upon leaving CalPERS, Mr. Koppes joined the faculty of Stanford University Law School, the international law firm of Jones, Day Reavis & Pogue, and he affiliated with American Partners Capital Group Inc. Mr. Koppes’ expertise should be in great demand as business executives around the world try to better understand their investors.
Job transitions are often a good time to reflect on past accomplishments and to speculate on future possibilities. In that spirit, I recently enjoyed an evening of conversation with Mr. Koppes at the Rio City Cafe, overlooking the Sacramento River. We began by discussing his current positions.
At Stanford Law School Mr. Koppes is associated with their Executive Education Program, building on three year’s of prior experience with their Director’s College, headed by Law and Economics professor Joseph A. Grundfest. The Director’s College is a 2 1/2 day intensive program designed to meet the needs of corporate directors, although general counsel and corporate secretaries can attend with their directors. The program offers a series of sessions attended by all participants. In addition, “breakout” sessions involve small groups in discussions on specific boardroom issues and allows them to work through practical problem-solving efforts. The upcoming March 1997 session will include a discussion between T.J. Rogers, of Cypress Semiconductor, and The Sisters of St. Francis of Philadelphia’s Doris Gormley on corporate responsibility. Koppes will teach a class on corporate governance in the fall of 1997. For more information on the Director’s College call (415) 723-5905). Another of Koppe’s goals is establishing a similar type of college for general counsel’s and fiduciaries.
Mr. Koppes is also working half time with the law firm of Jones, Day Reavis & Pogue, the 2nd largest U.S. law firm, with 20 offices around the world. As a member of the Corporate Counseling Practice Team, he counsels corporations on the issues of corporate governance, such as how to get along with shareholders and how to restructure boards. Koppes is also a member of the Institutional Investors Practice Team providing legal services to public pension funds and ERISA funds regarding real estate, alternative investments, tax, fiduciary counseling, health benefits, and other legal matters.
American Partners Capital Group Inc. is a limited partnership headed by former chief executive officer of CalPERS, Dale Hanson. They put together funds for institutional investors such as a Latin America Fund, a China Fund and a housing fund. Affiliation with American Partners Capital allows Koppes an opportunity to provide freelance counseling to corporations on building better relations with their shareholders. He provides his clients with a nonlegal monthly report on current issues using the expertise and contacts he has gained in the field. There is growing demand in this area since so many companies are largely owned by institutional investors.
That brought to mind Michael Useem’s observation in his recent book, Investor Capitalism, concerning who CEOs talk to. According to Useem’s description, many CEOs would rather talk to the analysts, not just because they might help push up the price of company stock, but because the analysts know the business and know that of their competitors. That’s an information trade which many CEOs recognize as mutually beneficial, whereas many don’t see the benefit of discussions with long-term shareholders on issues of corporate governance. I asked Koppes if he thought that was changing.
Koppes: Yes, companies are beginning to realize you can’t just talk to the buy side analysts. You have to talk to the owners who are interested in the long term strategic view of the company. Because so many funds hold the market, they want to know there is good governance in place in order to protect their immense holdings. If so, then they can relax a little. If there is good governance and a good board, the board will take care of the problems. CalPERS only has one person to handle their entire index fund. The index fund is mindless; it just buys, buys, buys.
From that standpoint why should the CEO listen to them? Indexed funds are going to keep their stock in the firm no matter what.
Because the shareholders hold the proxies and the CEOs might find themselves out of a job. What happens in these business cycles is that things that are up eventually come down. Dale Hanson said it well, “if you know your shareholders in the good times, they may stick with you in the bad times.” If you understand their strategic view, if you know where management is headed, when the bad times come, the long term holder will be there and may continue to vote with you. Otherwise, they’ll side with a Carl Ichan. So even though they might be locked into the company, they are not locked into the management.
McRitchie: DOL’s Interpretive Bulletin 94-2 and their earlier Avon Letter issued in 1988 signaled that prudent exercise of proxy voting is not optional. Trustees must monitor all activities of investment managers to whom discretion has been delegated. Their latest “Proxy Project Report,” released in February, indicates that, although behavior is improving, only 35% of plans which delegated voting authority could provide evidence that they performed substantive monitoring of how their investment managers voted. Do you have any idea why DOL has never taken an enforcement action in this area? Do you think that it will take DOL enforcement or private actions to get more fiduciaries to monitor?
Koppes: I don’t know. Maybe after the elections (he says with a chuckle). I think they should. I think they need to enforce. However, a growing number of corporate funds are becoming active. TRW’s Martin Coyle, co-chair of CII, spoke recently at CII and chided the corporate pension funds for not taking governance seriously. He chided the public funds for not being as active as CalPERS and others, and he challenged the unions for having agendas other than sound corporate governance. He was really right on track in issuing all those challenges. Look what happened to ADM (Archer Daniels Midland). The CalPERS proposal requiring that ADM’s board be composed of a majority of independent directors was defeated at the annual meeting, but received 42% of the votes. There were a lot of corporate funds that voted in favor of the resolution. I think that’s real progress. That’s a substantial record given the shareholder base of ADM. That’s practically a landslide! My view is that the glass is half full, not half empty. I think that change has come a long way. There is still a way to go but I don’t despair. I think things have really changed for the better.
McRitchie: I’m intrigued by your article, An Ounce of Prevention. There will always be inefficiencies in trading based on public information. I’m not sure if the Internet will improve market efficiencies, because information is more readily available, or hinder them, because so much is misinformation. There is also the real problem that as more of the market is traded on an index basis, the less efficient it becomes. But as I read your article, I believe you have something else in mind.
Koppes: No one calls for accountability when the market keeps going up. Maybe someday it won’t. What we’re saying is its okay for pension funds to be indexed but they better have some kind of active governance program because there needs to be some thought process or oversight by the fiduciaries. When beneficiaries start suing, funds with a governance program can say “we are taking actions to correct some of the problems.” Nobody cares when times are good. That’s why we call it an “ounce of prevention,” just a little bit of oversight may help. At least you can then present an argument in court. Its better than just saying we followed the market mindlessly.
McRitchie: John Coffee, of Columbia University has urged institutional investors to restrict portfolio diversification to a level consistent with their ability to monitor, suggesting that a large fund could satisfy diversification standards with a portfolio of 100 stocks. I spoke to Ron Luraschi at Longview Funds, administered by Amalgamated Bank. They seem to be trying to follow a corporate governance strategy similar to CalPERS, based on an S&am pP 500 portfolio of $1 billion. It seems to me that if they would reduce the size of their portfolio they might have a better chance of earning significant returns from their corporate governance program. They could focus on a few companies and, when they are successful, payoff would be greater. Has any pension fund adopted such a strategy for a substantial portion of its funds?
Koppes: Several funds have taken such a strategy with a portion of their funds. I don’t think its necessary from the standpoint of prudence for a fund, such as CalPERS, to own 1,500 companies. I think they could own substantially less. The question is, how much less? A hundred would be too few. When Dale Hansen was at CalPERS he would challenge the investment staff to look at 300-500. I think its an interesting question. Would CalPERS be better off if they owned 300-500 companies? First, even if they were still indexed, it would give them a chance to know the companies better. It would give them larger positions which would give them a stronger voice. Right now CalPERS has a voice because of who it is and its access to the media. Let’s face it, CalPERS only owns 0.7% or less of most companies. It would probably be better if they owned 3-5% of the companies; they could then benefit from being “relational” investors.
McRitchie: It seems DOL could put out additional guidance to clarify that prudence is measured by the portfolio as a whole, rather than by each investment.
Koppes: These kinds of changes in investment theory and practice take a while.
McRitchie: If there were more corporate governance funds, more relational funds, would that make any difference?
Koppes: Yes. I really think there should be more such funds. First of all the limited partners, the pension funds, would make more money. An index fund is only meeting the index. If you’re really going to answer the liability issues of what you’re going to do when the “baby boomers” retire, you’ve really got to do better than the index. I think one of the ways to do that is through relational investing. I was talking with Ralph Whitworth this morning. I called him just to see how they’re doing. (ed. Relational Investors LP, a fund created by Ralph Whitworth and David H. Batchelder, uses a strategy similar to CalPERS’ Focus List. Relational Investors focuses on underperformers relative to peers and the market. They plan to buy 3 to 10 percent stakes in mid-sized firms where there is a clear path toward reversing the performance. The fund will receive a total of $200 million from CalPERS.) They made their first investment for CalPERS and the company stock has come up even prior to further intervention. He says they might just cash in and go onto the next choice. The State of Wisconsin Investment Board put $20M in the LENS Fund. These funds just make good investment sense.
McRitchie: What about any impact outside the strict rise in price for the shareholder? When I was a lobbyist I saw the tremendous influence of corporations in the capitol building everyday; obviously that’s no secret. When those who run corporations aren’t accountable, we have problems which often lead to government intervention and increased costs. It seems to me that if corporations were more accountable, at least to their shareholders, they would be a little more benign and would need a little less regulation.
Koppes: I agree. Companies who are accountable to their shareholders will pay more attention to environmental laws because it makes economic sense…not just social or political sense. A well run company will please its shareholders, will have satisfied employees, will have good products and services. They will be good corporate citizens, obeying the laws and providing benefits to the community. Somehow we got into “stakeholders” being an ugly word but these interests are not mutually exclusive. George Fischer the CEO of Kodak is a good example. He’s a marvelous visionary who has doubled the price of Kodak’s stock, has increased the quality of products, and has rescued Kodak from decline. At the same time the morale of their employees, which was extremely low when he arrived four years ago, has never been higher. He didn’t go through a mindless downsizing. Yes, they had to tighten but they focused on the long-term. When Fisher spoke to the Council (CII) a few weeks ago they loved it. He talked about his three goals: employee morale, (they are the backbone of Kodak), making sure the consumer is happy with a good product, and increasing shareholder value. It should be as simple as ABC. Unfortunately, some companies got focused not on shareholders, customers or employees but on management needs; they got totally off focus. They need to know their ownership base better. They need to make sure they have a strong independent board, good governance procedures, and keep in mind what George Fischer said. Not just mindless downsizing and cost-cutting. They need a long-term plan rather than keeping their eyes on just the next quarter.
McRitchie: DOL had a focus on innovative workplaces for a while. I’ve read that several investor groups approached DOL interested in building funds around innovative workplaces practices. Studies have documented a link between employee ownership, corporate performance, and participation. There is also evidence that such companies pay less for workers’ compensation costs. What was the basis of CalPERS getting into innovative workplace practices?
Koppes: Well, I’d have to say that at least part of the basis was that several of the trustees have union backgrounds and they felt there was a connection. So the board commissioned a study by John Pound and Lilli Gordon to examine: Did good workplace practices produce a shareholder return? The answer was yes. That’s why CalPERS is interested …because it impacts the bottom line…not because CalPERS is a social do gooder.
McRitchie: So what do they do with that information?
Koppes: It was used with the targeted companies and in discussions with CII. Its really more of an educational opportunity. Companies then begin to look more at it and begin to think “oh, this might effect our shareholders…we better be concerned about it.” Eventually it comes back to have an impact that reinforces the creation of shareholder value.
McRitchie: What about the new lead plaintiff provision? Do you think many institutional investors are busy scanning the courts to take over cases?
Koppes: Institutions by and large are still pretty cautious, but some have gotten in… CalPERS, Colorado Public Employees Retirement Association, State of Wisconsin Investment Board, CalSTRS. There hasn’t been a real rush to the courthouse. Its just another arrow in the quiver of large institutional investors to use in a governance campaign. It cuts both ways. When I was at CalPERS we viewed these from both sides…some where they needed to be gone after, like W.R. Grace, and others, like Intel, where they were being abused.
McRitchie: I’m having breakfast with Robert Monks in a couple of days. I’m a little nervous about meeting a personal hero. I’ve been extremely impressed with the books that he and Nell Minow have authored. What can you tell me about him? He’s seems like a man with a million ideas.
Koppes: Bob’s a full time activist. He’s also a true intellectual, one of the most passionate people I’ve met and sort of a grandfather of the movement. Bob and I, for a number of years, would get together for dinner. By the end of the evening I would feel intellectually and emotionally drained. Bob is usually 5-10 years ahead of everyone else, as far as vision, and he doesn’t have a lot of patience with people who can’t see the next 5-10 years. In the pension fund community there are a lot of people who wallow in the present, are overwhelmed by present concerns. Bob doesn’t have a lot of patience for that.
McRitchie: One of the ideas he helped develop at one point was shareholder committees. What do you think of them?
Koppes: Shareholder committees came about as a frustration with insular boards. Now there’s not as much need because boards are more responsive. As long as there is a strong independent board that comes from an independent nominating committee, and they’re not just the CEO’s golfing buddies, and as long as there’s communication and an understanding of who your shareholders are, then I don’t think they are needed. Its only needed when there’s a disconnect between shareholders and the board.
McRitchie: And the concept of lead directors…is that the same?
Koppes: No, I think designating lead directors is a good idea. I frankly think there needs to be more attention placed on the independent director. There needs to be more attention to leadership from outside the company if you’re going to have a strong independent board. Whether you call that a “lead director” or something else doesn’t really matter …leadership among the independent directors is what’s important.
McRitchie: What about ownership shares vs trading shares?
Koppes: A company should ignore those who are betting. It needs to be managed for the long term.
McRitchie: Maybe there should be a substantial waiting period prior to being able to vote shares?
Koppes: That would really go against our culture. I think we should be able to beat bad takeovers on the basis of ideas, not artificial mechanisms. We need to get investors thinking long term.
McRitchie: Confidentiality in voting?
Koppes: I think we’re moving in that direction. All companies should have it.
McRitchie: I recently started posting a few reviews on the Corporate Governance site. I’ve reviewed recent books by Margaret Blair, Michael Useem, Monks and Minow and others. Looking back, what are a few books in the field that have been influential for you?
Koppes: Well, there’s Michael Jacobs’ Break the Wall Street Rule, Jay Lorsch’s Pawns or Potentates, and, of course, Barbarians at the Gate by Bryan Burrough and John Helyar.
McRitchie: I thought you’d be giving me a list of legal textbooks.
Koppes: More people are influenced by a good story. These books brought corporate governance out of the shadows of “agency theory” and into the public view. They had an impact because people related to them …probably even more so in the movie version of Barbarians.