I plan to cover three topics today:

• First, I'd like to give you a brief background on CalPERS – our purpose, our structure, and some of the factors that influence our organizational behavior.
• Second, I'll discuss CalPERS' Corporate Governance Program – first how it developed within the United States, and then how it has expanded internationally.
• Last, I'd like to leave you with a few issues to ponder concerning the future of corporate governance globally, as we approach the 21^st century.

First, what is CalPERS (besides a huge gorilla with a lot of money)? CalPERS is the largest retirement system in the United States that is dedicated exclusively to public employees. Our assets are currently valued at approximately $108 billion USDollars.

But most importantly, CalPERS provides for the retirement of over 1 million California public employees and their families. This is the most important factor to remember – the driver behind all of our decisions. It is the critical fact that we internally cannot forget, despite the glamour and sophistication of the investment world. Our business is to ensure the livelihoods of these 1 million people, when they leave the active workforce.

Although CalPERS has $108 billion, this is not one cent, or one dollar (or one Pound or one Deutschemark) too much. These assets are tied directly to the liabilities that we face – that is, the benefits that we are obligated to pay to our participants. We face a tremendous obligation in the next century, as the largest segment of the US population (that is, those born in the decade immediately after the second World War) prepare to retire. CalPERS' assets are invested with the goal of ensuring that there will be sufficient money available now, and into the future, without experiencing unnecessary or unexpected risk. Most of our equity assets are invested using a passive indexing strategy. 24% of the fund is targeted for international investments (with 20% targeted for equities, and 4% for fixed income). Right now, we are currently slightly below these targets, with 21% (or about $23 billion USDollars) invested outside of the United States.

CalPERS is administered by a 13-member board of trustees. Under the constitution of our state, these trustees have a primary obligation to act solely in the best interests of our 1 million participants. This is similar, I know, to the responsibilities of trustees in many other countries, including the UK. Our trustees have a fairly unique secondary duty, however, that is also imposed by our state constitution: to minimize the costs of the retirement system that are ultimately borne by our taxpayers.

CalPERS seeks to accomplish both this primary duty to our participants, and the secondary duty to taxpayers, with a three-part strategy:

• To offer innovative programs, that meet the needs of a changing population;
• To achieve excellence, both in service to our participants and in financial performance; and
• To exercise leadership – that is, to use our size and dominance in some markets to influence our own future.

Corporate Governance is one, but only one, of our programs that fulfills all three of these strategies: It is clearly innovative; its very purpose is to produce added returns for our investment program; and it provides us with the power to influence government and private sector decisions that affect our organization and participants.

CalPERS defines "corporate governance" to be the "relationship among various participants in determining the direction and performance of corporations". The primary participants are: shareholders; company management (led by the chief executive officer); and the board of directors. We recognize that, on its face, this may sound like an overly "American" definition because it does not expressly mention other stakeholder groups (the community, company employees, customers). In CalPERS' view, companies that are operated with long-term shareholder returns as the primary goal will, ultimately, also reward other stakeholders. Companies that are driven by short-term goals don't reward anyone in the long-term. We believe that companies that elevate these other stakeholders to the same level as shareholders are really simply diffusing accountability. When a company is accountable to any one of a diverse group of interests, the company is really not accountable to anyone. A CEO can always find some interest, at least on a short-term basis, that is benefited by any single action. Again, if in the long-term shareholders win, everyone else wins too. So, we believe that our definition of Corporate Governance is really not wholly different from the concepts embraced by others within Europe.

Turning now to our US program: We began our governance activities in the early 1980s, as a direct response to the takeover frenzy of the time. During these early years, we focused only on issues (such as poison pills and golden handshakes) that we believed placed company management interests out of alignment with shareholder interests.

In the early 1990s we refocused. Instead of talking with any company that happened to have one of these offensive anti-takeover devices – regardless of the economic performance of that company – we chose to only talk to companies with long term performance significantly below their industry peers. We asked ourselves, and the companies, whether this long-term poor relative performance was caused in some way by the company's governance structure. When we go into a corporate board room, we do not tell the directors what facilities they should close, or what products they should redesign, or what other changes they should make to the business strategy. We simply do not have the expertise for this. Moreover, those decisions are what we – as the company's owners – have hired the directors to make. Instead, our meetings are designed to hold our directors accountable. We say to them, "We hired you to perform, now what are you doing to correct the problems?"

Corporate governance is simply an enhancement technique that we use to improve the returns of our largely passive portfolio. Because of our size, we cannot simply sell the stocks of companies that are poorly performing, without negatively impacting the market as a whole. This would also be contrary to our indexing strategy, and, even more importantly, deprive us of the "upside" when the companies begin to improve. CalPERS' Board strongly believes that using a passive strategy to select stocks does not mean that we have to be a passive owner. We believe that we have a duty to our participants to put just as much effort into being an owner as in deciding to become one.

Our US program has had several successes over the past decade: IBM, General Motors, American Express, Sears, Avon and, most recently, Kmart. But, CalPERS does not claim that the turn-around at these companies was due solely (or even principally) to CalPERS. In all of the successful turn-around companies, there are internal forces who are working to effect necessary change. CalPERS, and other active investors, are simply the catalysts for change; our attention on the company management acts to empower these internal change agents, who ultimately have the power to produce results. It is simple logic that people who are under observation perform better; through CalPERS' observation, we hope to bring out this better performance.

How do we know that the CalPERS program been successful in the US? A study was published in the Journal of Applied Corporate Finance in 1994 (and was updated in 1996) that analyzed "the CalPERS Effect" on corporations who received our attention. This study looked at the stock performance of the 62 companies that we have targeted between 1987 and 1995. During the five years immediately before CalPERS' first contact, these companies underperformed the Standard & Poors' 500 Index by an average of 85%. But, starting with CalPERS' first contact, this performance significantly improved, so that for the subsequent five-year period, the companies outperformed this same index by an average 33%. We estimate that the improvement of these 62 companies has resulted in approximately $150 million USDollars, per year, in added returns. At a cost of less than $500,000, the program is clearly justified.

But, we also believe that the impact of the Corporate Governance movement within the US goes beyond the stock price of these 62 companies. In the US, no company – and no CEO of a company – wants to appear on our highly publicized "poor performer" list. As a result, boards and management are voluntarily and proactively taking steps to improve their own accountability. Simply put, the American corporate culture has changed; good governance is now something that is valued.

Why did our Board decide to extend our governance activities abroad? Both internal and external factors contributed to this decision. First, internally, our Board decided in 1995 to increase our asset allocation to international equities. Second, our Board recognized that its constitutional obligation to maximize returns extends just as much to our international investments as it does domestically. If we can add $150 million per year to our US portfolio, why shouldn't we seek similar gains for our international assets?

Externally, we are all aware of the dramatic changes in the capital markets that have occurred worldwide during the past 5-10 years. There has been a move away from traditional forms of financing, and a collapse of many of the barriers to globalization. Companies all over the world are now competing against each other for new capital. Add to this the changing role of the institutional investor. In many countries, including the US, corporate ownership is becoming increasingly concentrated in institutions. In all countries, institutions are achieving greater influence as the source of future capital, on a global basis. In the US alone, pension funds have grown from $2 trillion in 1986, to over $5 trillion a mere decade later. US institutional investments in foreign equity tripled between 1990 and 1994, rising from $100 billion to $300 billion in four years and continuing to rise dramatically. Clearly, CalPERS is not the only institution to exercise its rights as an owner. Throughout the world, institutions are awakening to the opportunities presented by governance activism.

These internal and external forces merged so that, in March of 1996 and after a year-long study, CalPERS' Board formally adopted its International Corporate Governance Program. As the first step in implementing this program, in December of 1996 our Board adopted a set of Global Governance Principles. The Principles focus on 6 basic concepts that we think are fundamental to free and fair markets throughout the world. Moreover, the Principles reflect the core of what we believe the corporate/shareholder relationship should be. Specifically, the 6 Global Principles are:

• Accountability
• Transparency
• Equity
• Voting Method Improvements
• Codes of Best Practices
• Long-Term Vision

Let me briefly discuss each. First, "accountability," in CalPERS' view, require a duty to shareholders. In particular, the board of directors has a special responsibility to develop the company's strategic vision, ensuring that the production of long-term shareholder value is a predominant factor. In doing so, the board and management should be open and accessible to inquiry by shareholders about the condition and performance of the company, and should disclose how key decisions are made, including those that affect:

• executive compensation
• strategic planning
• nomination of directors
• appointment and succession of management.

Lastly, accountability requires proper oversight of management and an executive compensation structure that is tied to long-term performance.

The second principle, "transparency," can be achieved through three key market elements: openness, accounting standards, and compliance reporting. Efficient markets depend upon investor confidence in the accuracy and openness of information provided to the investing public. Also, an internationally-recognized minimum accounting standard is necessary to ensure that investors can effectively analyze and compare company data. Lastly, where specific markets have adopted codes of best practices (as in the UK), companies within those markets should disclose whether or not they comply with them.

The third principle, "equity", simply refers to our strong belief that all shareholders – including minority and foreign investors – are entitled to equitable treatment. If global investing means anything, it must mean this. Equity also includes our general philosophical dedication to the principle that every share of stock held should be entitled to one vote.

The forth principle involves voting methods. CalPERS believes that proxy materials should be written in a manner designed to provide shareholders with the information necessary to make informed voting decisions. Similarly, proxy materials should be distributed in a manner designed to encourage shareholder participation. All shareholder votes, whether cast in person or by proxy, should be formally counted; vote outcomes should be formally announced. Lastly, proxy methods should take advantage of available technologies to make the process easier, more efficient and less expensive.

The fifth principle encourages all markets to develop for themselves a code of best practices, by which corporate directors and executives can regulate themselves, and can clearly define their relationship with and responsibilities to shareholders. Once a code of best practices is developed by market participants, companies should report to shareholders their compliance with that code.

Finally, CalPERS believes that corporate directors and management should have a long-term strategic vision which at its core emphasizes sustained shareholder value. In turn, despite differing investment strategies and tactics, shareholders should encourage corporate management to resist short-term behavior by supporting and rewarding long-term superior returns.

These are CalPERS Global Governance Principles. They represent the foundation for the next step in our program: to develop governance principles that are specific to certain markets. Our Board chose four specific markets, which represent our largest foreign holdings: the UK, France, Germany and Japan. We are presenting to our Board next week a draft set of market-specific principles for the UK and France; Germany and Japan will come later in the year. With the understanding that these principles are not yet final, I can give you a brief preview of what we have proposed. In each of these sets of principles, you will note that they are based on the existing governance activities of investors in those countries.

First, the UK principles will call for the existing codes of best practices (that is, Cadbury and Greenbury) to be the minimum benchmarks; we hope that these codes are strengthened by future reviewing committees (including Hampel), and not weakened. We also suggest that future reviewing committees include a non-UK investor who has demonstrated a commitment to good governance principles.

We believe that the structure of boards – worldwide – should be built upon the twin concepts of independence from management and accountability to shareholders. In the UK, this should include:

• independent chairmen;
• a majority of independent directors (even beyond Cadbury's recommended minimum of three);
• key committees consisting entirely of independent directors;
• appropriate training for directors, focusing on their enhanced monitoring responsibilities; and
• enough time to truly perform their duties, which means a limitation on the total number of boards on which directors sit.

CalPERS will also be proposing several points designed to strengthen the director-shareholder relationship in the UK, including:

• the regular election of all directors (even executive directors);
• the elimination of classified director terms;
• the incorporation of confidential voting
• improved access by shareholders to the proxy; and
• greater focus on pay-for-performance criteria.

CalPERS' proposed French Principles will embrace the Vienot Committee's acknowledgment that Boards represent all shareholders, including minority shareholders. We believe that French corporate boards should use the Vienot Report recommendations as a minimum benchmark of their duties and obligations. As in the UK, we will encourage a continued review of French corporate governance best practices, but suggest that future reviewing committees include a non-French investor with a commitment to good governance.

In France, we believe that the twin concepts of independence and accountability translate into:

• a majority of independent directors;
• key committees comprised entirely of independent directors;
• greater disclosure of the director nomination process, and other board governance issues; and
• greater focus on director duties, through limits on the number of total boards on which directors may sit.

As in the UK, we also believe the French director-shareholder relationship can be strengthened through:

• modifying the existing staggered board structure, focusing first on reducing the length of terms to no more than 3 years;
• greater disclosure of pay-for-performance criteria, similar to the 1995 working group's recommendation on stock options);
• one share/one vote;
• an end to cross shareholdings;
• limitation on the length of auditor terms (starting, at least at first, with no more than 3 years);
• improved access for shareholders to the proxy; and
• elimination of takeover defenses.

What is the future of corporate governance? CalPERS believes that the focus will be on quality directors – people with integrity and diligence; people who are independent, both in terms of their relationships with management, and in terms of their spirit.

Much like portfolio diversification, boards too will become more diverse. They will need to include people with international experience. The right skill mix will become an essential component of board composition.

Being a director is becoming a harder job. Directors have more responsibility, and potentially more liability, than in any time in the past, and this will continue to increase. As a result, we need to expect that some of our current directors will chose to withdraw. We will need to find qualified replacements, and perhaps even consider the feasibility of smaller boards. We will need to squarely face the issue of director liability – how much is appropriate to instill accountability, while not too much to discourage qualified participation.

CalPERS hopes that our international program will stimulate further debate and discussion about proper governance practices. We recognize that we cannot change corporate governance in Europe, but we can use our voice to support European investors and officials who can. By working with investors within Europe, we hope to influence all companies to focus on maximizing shareholder value.

Thank you.