Why Corporate Governance Today?

II. Adding Value To The Fund

CalPERS' focus is on the bottom line, and it has not wavered from that position since the first corporate governance campaign of a decade ago. But have its efforts really added value? According to studies by investment consultants and business academics, the answer to that question is a resounding "Yes."

In 1992, CalPERS asked Wilshire & Associates of Santa Monica, a leading investment consulting firm, to study the effect of corporate governance on the shareholder returns. The initial report indicated that a company's stock performance seemed to improve as a result of CalPERS' focus.

A more extensive study by Wilshire Senior Vice President Steven L. Nesbitt, published in January 1994, examined the performance of 42 companies targeted by CalPERS between 1987 and 1992.^[12]   It shows that the stock price of these companies trailed the Standard & Poor 500 Index by 66%, in the five year period before CalPERS acted -- but outperformed that index by 41%, in the following five years.

An update of this study was published on July 19, 1995. This update noted that the 1994 study was incomplete to the extent that five years had not passed for all 42 targeted companies from the time of CalPERS' first involvement. Companies which did not have five years of history since their targeted dated were included in the average only for the time available. With the passage of additional time, the update permitted a more precise re-measurement of the CalPERS Effect. That re-measurement finds that the excess return for the 42 companies increases from the 41.3% initially reported, to 52.5%. The updated report concludes that "this Effect is again statistically significant".^[13]

This issue was also studied by financial consultants with The Gordon Group, Inc.^[14]  The consultants sampled relative returns from a variety of shareholders along an "active investing spectrum" ranging from the outright purchase of a company (most active), to the ongoing monitoring of corporate management (least active).^[15]  CalPERS' corporate governance campaign would be at the least active end of this spectrum. The Gordon Group report strongly supports the cost-effectiveness of corporate governance: ^[16]  "The overall evidence . . . shows that over the past several decades active investment strategies have consistently led, on average, to significant value increases."

"We find that examples of this type of investment undertaken in the past few years have had a consistent and dramatically positive impact on share values. Our candid explanation for this finding is that these initiatives galvanize management improvements while posing very little danger of self-dealing or other problems, . . ." ^[17]

The Legacy of USA

The Wilshire and Gordon Group findings were recently corroborated in an independent paper by a team of business professors at the University of North Carolina. The professors systematically studied the marketplace effect of shareholder activism, conducted during the seven-year lifespan of the former United Shareholders Association (USA). ^[18]

USA was founded in August 1986 by T. Boone Pickens as a non-profit advocacy group for shareholder rights. It operated until 1993, when its own board of directors voted for dismantlement, on the grounds that the objectives of USA had been realized. As expressed in the independent paper, USA was a " . . . conduit through which small shareholders could unite and attempt to influence the governance of large U.S. corporations." ^[19]

USA placed special emphasis on the cost-effectiveness of shareholder proposals as a monitoring tool, when wielded by small individual shareholders in a unified manner. Its members were primarily small individual investors. The paper concludes that USA's corporate governance activities were ". . . successful in influencing corporate governance and in enhancing shareholder wealth." ^[20]

Exploring Relationships

Of course, the goal of improved performance is not unique to the corporate governance arena. It also has expression in standard investment strategies that seek the highest returns with the least risk (i.e., "buy high, sell low"). It may also fairly be said that the strategy of relational investing is but one manner of engaging in "corporate governance". ^[21]

With the relational investing strategy, the investor consciously commits to purchasing a large block of common or preferred stock in a single corporation, coupled with a commitment to active management over a long-term holding period.^[22] The philosophy of corporate governance and the strategy of relational investing, have elements in common. Both require active monitoring of performance, and both serve to extend the investment potential of an indexed fund. ^[23]

CalPERS is exploring the extent to which synergy could be created between these commonalities. In June 1995, the Board approved a funding commitment of $200 million to a relational investing partnership, marking its inauguration of a "corporate governance related investing" strategy.

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12 - Steven L. Nesbitt, Long-Term Rewards From Shareholder Activism: A Study of the "CalPERS Effect", J. of Applied Corp. Fin. (Winter 1994).

13 - Steven L. Nesbitt, The "CalPERS Effect": A Corporate Governance Update, July 19, 1995.

14 - Lilli Gordon & John Pound, Active Investing in the U.S. Equity Market: Past Performance and Future Prospects, paper presented to the Board (Jan. 11, 1993).

15 - The Gordon Group sampled the relative returns of some 50 publicly-traded companies, in which activist shareholders owned between 5% and 30% of the stock, for the time period from 1986 through 1992.

16 - Id. at 44.

17 Ibid.

18 - Deon Strickland, Kenneth W. Wiles and Marc Zenner, A Requiem for USA: Is small shareholder monitoring effective?, paper pub. by Kenan-Flagler Business School, Univ. of No. Carolina at Chapel Hill (May 1995).

19 - Id. at 1.

20 - Id. at 1-2.

21 - "CalPERS' active monitoring through on-going formal and informal contacts with independent Board members and the CEO is the beginning of one form of 'relationship investing,' rather than simply a form of trouble shooting for underperformers." See "Getting the Herd to Run," supra note 1, at 35.

22 - See "Duty to Monitor," supra note 14 at fn. 30; See Judith H. Dobrzynski, Relationship Investing, Business Week, March 15, 1993, cover story.

23 - See John Pound, Creating Relationships Between Institutional Investors and Corporations: A Proposal to Restore Balance in the American Corporate Governance Process, paper presented at the Columbia School of Law Relational Investing Conference (April 1993).

CalPERS, 8-1-95.
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CALIFORNIA PUBLIC EMPLOYEES' RETIREMENT SYSTEM
WHY CORPORATE GOVERNANCE TODAY?
A Policy Statement
August 14, 1995
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