Institutional Investors Turn Activist (1991)
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Holmes Report
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Institutional Investors Turn Activist (1991)

Individual investors, who had been challenging corporations on their involvement in South Africa and their social programs, joined with institutions which believed manage­ment was not responsive to its employers.

Paul Holmes

 

Earlier this year, the worst night­mare of many investor relations professionals came true. The subject of CEO pay suddenly became front-page news, and item one on the agenda of many investors. Critics pointed to the contrast between soaring CEO paychecks and crumbling corporate performance.

They noted that American execu­tives earned much more than their Japanese counterparts, particularly in comparison to the salary of the ordi­nary worker. And those critics were not only on the Ralph Nader wing of American corporate politics; they included some of the most pow­erful institutions in the country.

For the first time, the factions within the sharehold­er activism movement had found a cause that united them. Individual investors, or the ethical investment funds they controlled, who had been challenging corporations on their involvement in South Africa and their social programs, joined with institutions which believed manage­ment was not responsive to its employers.

"There are three different kinds of activists out there," says Howard Kalt, principal of San Francisco IR firm Kalt Rosen. "The first is institutional, and is concerned primarily with issues of corporate governance. The second is individual, and is performance and compensation oriented, emphasizing issues such as corporate pay. The third is what I would call third parry, inter­ested in socio-economic issues such as South Africa or the environment.

"All three have to be taken seri­ously."

The third group was actually the first to make its presence felt, having awakened in the '60s and grown by the end of the '80s to such an extent that more than $450 billion of funds are now under ethical management by local governments, insurance companies, colleges and religious institutions, as well as social screen­ing funds operated by Merrill Lynch, Dean Witter and others.

There is an increasing body of lit­erature on ethical investing, includ­ing the Council on Economic Priori­ties' The Better World Investment Guide, which explains the thinking behind ethical investing: "Corpora­tions are more than institutions for making money. They are institutions for making an economy work more productively, safely, and spiritedly."

While few of the motions placed on shareholder ballots have achieved more than 5 or 10% of the vote, and while none achieved a majority they had a sobering effect on management.

"If you get three per cent on a particular issue you can place it on the agenda next year, and go on making sure it's on the agenda for ever," says Ken Lightcap, managing director of Manning Selvage & Lee, New York. "These issues attract more publicity than some­times they deserve, and most man­agements would prefer not to have 20% of their shareholders unhappy.

"For that reason, many manage­ments sought to compromise with activist groups, to avoid issues ever going to the ballot, so the success they achieved was out of all propor­tion to the votes they got."

The same has been true of more recent issues brought to a vote by institutional investors. The most common issues are secret ballots (the allegation being that some share­holders, particularly employee investors, might be intimidated from voting against management); the recision of poison pill defenses; and the annual election of directors.

To a large extent, the takeover boom of the '80s brought these issues to the fore. Management, concerned about its own survival if a company was acquired, introduced measures designed to make the company less attractive. Shareholders, being the beneficiaries of takeover battles, reacted against these measures.

One firm, New York's Investor Access, has surveyed opinion on such issues. It believes secret ballots will be adopted by most companies (several have done so voluntarily in recent years) and that poison pill defenses will be rescinded by the majority.

Investor Access president Michael Seely advises companies fac­ing governance issues: "Corporate management and institutional investors are natural allies," he says. "To harmonize this relationship, they must express a holistic vision of the company, one ordered by values that clear the potential conflict on issues as wide-ranging as the secret ballot, South Africa and the Valdez Principals."

The solution, Seely believes, is something he calls "value-based gov­ernance." Corporations should be run more democratically, secret ballots and the right to vote out incumbent directors and replace them with out­siders should be granted, companies should establish shareholder value committees to review performance, and managers should link compensa­tion to shareholders' return.

"What is needed to spark this pre­destined affinity are accountability and communications," he says. "To ensure both you need a mediator, the independent board."

Others, however, remain con­cerned that if the activism movement goes too far the right—and ability—of management to manage, and particularly to focus on long-term growth, could be threatened.

"There's a very thin line between the rights of shareholders, who own the company, after all, and the rights of management, which has been appointed by the board to run the company and should be able to get on with that task," says Howard Kalt.

A recent Business Roundtable paper suggests that the American democratic process would be too slow and unwieldy for corporations. "Excessive corporate governance by referendum... can also chill innovation and risk taking. Corporate governance by referendum instead of by the board of directors has all the same draw­backs as federal government by refer­endum rather than by Congress."

Clearly, no one is suggesting that managements do what some have done in the past: hold their meetings in out-of-the-way locations (one company even went so far as to book all the flights into the town where it was holding its annual meeting) or providing faulty microphones.

But Kalt has another concern. He believes that in controversial proxy fights, companies are at a serious dis­advantage because of the regulatory environment in which they operate, and that many activists have taken advantage of the situation.

"Companies are restricted as to what they can say, not only in official documents but in the media, where proxy contests are increasingly being fought," Kalt contends. "Individual shareholders are able to make all sorts of wild allegations about mismanage­ment which the media repeats with­out any apparent consideration of the credibility of the source."

Most IR professionals agree that many shareholder grievances are jus­tified, and that the corporate IR department has a role in identifying those grievances before they are placed on the ballot, and forecast which will attract the most widespread support. If it can do this, management can sit down with share­holders and hammer out solutions that do not involve the company's dirty linen being aired in public.

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