Why Corporate Governance Today?

IV. A Shift In Focus

As CalPERS enters its second decade of shareholder activism, it will continue to seek governance reforms in the four broad subject areas outlined above. But its focus is shifting, in response to the new direction taken by some of the largest and most publicly-visible companies in America.

The early 1990s were a period of sweeping and highly-visible change in boardrooms across America. The list of companies at which directors ousted their CEOs reads like a directory of industry giants: American Express, Chrysler, General Motors, IBM, Kodak and Westinghouse. This activity took place in a relatively short time period, and was hailed as a boardroom revolution. It was widely attributed to shareholder activism, with emphasis on CalPERS' role as a catalyst.^[29]

A case in point is GM, whose board of directors fired the CEO and restructured management, when faced with a downgrading of corporation's credit rating. The company's stock rose that very day, in contrast with an overall drop in the market of 60 points. Encouraged by this positive reaction, which was hailed as a "governance dividend,"^[30] the GM board of directors went on to adopt a set of formal corporate governance guidelines. Due in part to CalPERS' promotion, it has since become a model for other directors to follow.^[31]

Given this turnaround, some financial analysts wonder if the corporate governance movement is outmoded. Is there value left to be gained, through shareholder activism? CalPERS believes there is, but that refinements can now be made based on its decade of experience. This paper next outlines the areas in which changes may take place, in future corporate governance campaigns.

Moving the Herd

Corporate governance has been demonstrated as an effective device to prod big companies into taking necessary steps toward improved performance. CalPERS believes that the same tactics can be effective with small companies as well.

Institutional investors have been criticized for a tendency to "follow the herd" in trading large volumes of stock, by the passive use of an index. In the words of Columbia University Law School professor John C. Coffee, Jr., this results in "chilling" the investment managers who might otherwise attempt to outperform the index by active trading.^[32]

CalPERS has attempted to break this cycle. As a result of its focused activities at selected companies, the System has also gained the attention of other companies, as to common issues in a peer group and concepts of corporate governance in a general sense. Taking advantage of this phenomenon, CalPERS seeks to "move the herd" rather than follow it, while still retaining the risk-reward reliability of an indexed portfolio.^[33]

As more companies in the indexed herd are prodded to change, the corporate governance movement may become a stampede. But if shareholders slow their demands now, because many of the big companies are self-motivated to improve performance, the herd will surely straggle.

Personal Accountability of Directors

In the past, CalPERS encouraged the independent directors as a group, to act as catalysts on the board and to heighten their oversight of management. In future campaigns, CalPERS may call directors to account for their individual performance. It may urge directors to devote more time to fewer boards, avoiding the problem of "multiple directorships." Or, it may encourage boards to restructure for optimum size, diversity, and independence.

Boards of directors may be receptive to these ideas now, more than ever before, according to a survey of Chief Executive Officers (CEOs), conducted by the National Association of Corporate Directors (NACD).^[34] A candidate's time and commitment ranked high in priority. The size of a board was also critical to most CEOs. In general, they indicated a preference for smaller boards, presumably to heighten the effectiveness of its leadership.^[35] Director independence was another priority, with almost one-third of the CEOs stating they plan to increase the number of independent directors on their boards. In the interest of board diversity, the NACD found there is strong support for qualified women and minority directors and a variety of professional backgrounds.

Hopefully, this trend will also boost director independence.^[36] The importance of director independence has been underscored by SEC Chairman Arthur Levitt, in warning against multiple directorships:

"I don't care how talented you are, you can't be a good watchdog if you're only on patrol three times a year."^[37]

This concept has also been recognized by the judiciary. As expressed by E. Norman Veasey, Chief Justice of Delaware, in a mid-1994 speech before the American Bar Association on the "new dynamics" of corporate governance:

"The principle of judicial independence, and consequently the independence of corporate counselors and corporate directors, is what makes corporate governance work.

"The defining tension in corporate governance today is between deference to directors' decisions and the scope of judicial review. The essence of the business judgment rule is that the directors' business decisions will be respected if they are made by directors who are disinterested, independent, and who act with the requisite due care, and if the decision can be attributed to any rational business purpose."^[38]

Tracking DOL Oversight

In 1988, when the Department of Labor (DOL) issued its so-called Avon Letter, it put pension plans trustees^[39] on notice that voting rights must be diligently exercised as an aspect of fiduciary duty. There were no new directives on proxy voting until shortly after Olena Berg was appointed administrator of pension and welfare at the DOL, in mid-1993.

In July 1994, the DOL updated its Avon Letter in a bulletin that consolidates the voting requirements of ERISA fiduciaries. The DOL now advocates a corporate activist role for pension plan trustees, to include " . . . activities intended to monitor or influence corporate management."^[40]

A few months before this bulletin was published, Ms. Berg cautioned funds to "act as owners" and indicated that active investment strategies may be an aspect of fiduciary duty.^[41] A few months afterward, she announced plans to issue a third directive on proxy voting and other issues of corporate governance.^[42] Clearly, the DOL is entering a new phase of vigorous oversight on these issues.

As a governmental plan, CalPERS is not regulated by DOL. However, in interpreting issues of fiduciary duty, courts have traditionally referred to DOL publications for guidance. Clearly, the impact of ERISA on institutional investment practices is widespread. CalPERS finds it good policy to consider the DOL's heightened interests and renewed warnings that corporate governance is an aspect of fiduciary duty.

The Governance Balance

CalPERS will continue to screen its indexed portfolio to identify companies that have performance problems, along with a potential for improvement. As an aspect of fiduciary duty, CalPERS has always balanced the cost of corporate governance, against the practical possibilities of improved performance at targeted companies.

Given the current corporate climate of receptivity to principles of governance, CalPERS will increase its communications with directors and managers -- by special projects such as the GM Guidelines survey, and participation in conferences sponsored by business organizations such as the NACD and the U.S. Business Roundtable.

As before, CalPERS will continue to foster a shareholder's ability to select directors, and to enable their effective oversight of management. The System will promote governance changes that align the interests of shareholders, with those of the directors and managers.

The Board's commitment to corporate governance merges its rights as a long-term shareholder with the duties of a fiduciary. Its bottom line has been, and will continue to be, improved performance. From this perspective, corporate governance is not a novel concept.

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29 - David George Ball, Revolution in the Board Room?, St. John's Law R. (March 1994); Richard M. Clurman, Who's in Charge? (Whittle, 1993); Dan Coardiz, Corporate Hangmen, Financial World, March 30, 1993, at 24; Steve Lohr, Pulling Down the Corporate Clubhouse, The N.Y. Times, April 12, 1992 at 3.1.

30 - See Barbara Ettorre, Evolution Inside the Boardrooms, Management Review (Oct. 1993) at 10.

31 - In 1994, CalPERS circulated the "GM Guidelines" to 300 companies listed in the Standard & Poor 500 Index, challenging their directors to take similar action. CalPERS then "graded" the responses based on the quality of their process (e.g., companies that had developed a comprehensive list of guidelines with involvement by the board of directors and the chairman, were awarded an A+. Of the more than 200 responses, some 50% merited an A or A+. (See "CalPERS Issues Governance 'Report Cards'," IRRC Corp. Gov. Bulletin (Apr.-June 1995) at 7-10.)

32 - John C. Coffee, Jr., Liquidity Versus Control: The Institutional Investor as Corporate Monitor, 91 Colum. L. Rev. 1277, 1329 (Oct. 1991).

33 - A 1994 study of CalPERS by three business professors termed this reputational success or ". . . the acquiring and maintaining legitimacy as a shareholder activist in order to pursue on-going influence with targeted firms, and to achieve additional influence with non-targeted firms." See "Getting the Herd to Run," supra note 1, at 29.

34 - The 1995 Corporate Governance Survey, paper published by the NACD (March 1995), at p. 10. In this paper, the NACD reports the results of its survey of some 6,000 CEOs in this country and 1,000 abroad.

35 - But this may mean "rightsizing" instead of downsizing, depending on the needs of a given corporation. Id. at 4.

36 - Given the diversity of professional backgrounds that they are willing to consider for their boards, CEOs are finding it relatively easy to identify and recruit outsiders." Id. at 11-13.

37 - Id. at 4.

38 - Justice Veasey's remarks strongly suggest that Delaware judiciary, which is a bellwether for securities law, would look to the independence of a company's directors in its analysis of the facts surrounding a shareholder action for breach of fiduciary duty.

39 - DOL Op. Ltr. to Helmuth Fandl, Avon Products, Inc. (Feb. 29, 1988).

40 - DOL Interp. Bulletin 94-1 (July 1994).

41 - See Corporate Governance, BNA's Corp. Couns. Wkly., Mar. 7 1994, at 3.

42 - See IRRC Corp. Gov. Bulletin, Jan-Mar. 1995, at 1.

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