Institutions Asleep at the Wheel
Rebecca Byrne
10/15/02 - 07:15 AM EDT
This story is part of a special series by TheStreet.com investigating shareholders' reaction to corporate corruption on Wall Street. Click here to see a full listing of stories. Almost nobody on Wall Street escaped blame in the wake of the recent season of corruption. But how many have complained about the true guardians of investor wealth -- institutional shareholders?
These supposed advocates of shareholder rights control huge sums of other people's money but were no more effective at stopping the carnage on Wall Street than the smallest of individual holders.
"As long as the piper gets paid and it appears as if everything's OK, very few were asking the tough questions," said Bill Smith, a professor of management at Towson University. "That's a lesson for us all."
Where Were They?
While activism on the part of institutional holders was once viewed as a nuisance, in retrospect it's clear that pension funds and labor unions could have done more to prevent these past few years' debacle. Although some of their weapons, specifically nonbinding resolutions, lack teeth, these investors wield enormous power when it comes to pressuring companies to change their governance structure.
Jeff Gates, president of the Shared Capitalism Institute, argues that pension trustees like the California Public Employees Retirement System, or Calpers, failed to protect investors because they opted for a financial model that focuses on short-term gains with little regard for the longer-term benefits.
No one could have predicted the extent of the fraud that took place in recent years. But it's been reported that Calpers, which was an investor in
Enron, apparently knew about some of the dubious financial partnerships arranged by the company and yet failed to alert anyone. Moreover, Calpers, and others like it, were big investors in
WorldCom, despite some obvious corporate governance concerns prior to the firm's meltdown.
Among pension funds, Calpers has been one of the more outspoken critics of excessive executive pay and has publicly advocated greater independence by corporate boards and accounting firms. Because the fund gets its money directly from the state of California, it isn't beholden to corporations and doesn't rely on them for management fees.
History of Dissent
The fund has had its share of victories over the years. According to a study by Wilshire Associates, the performance of 69 companies targeted by Calpers between 1987 and 1997 improved dramatically, going from an underperformance rating of 88.7% to an outperformance rating of 23.3% five years later.
But Calpers and other pension funds have proven to be ineffective in key areas. For example, between 1982 and 2000, executive pay skyrocketed while boards of directors grew less independent than ever.
In 1982, CEOs in the 365 firms that account for the bulk of pension assets were making 42 times what their average worker was earning, according to Gates. But by 2000, the earnings gap had widened to 531 to 1.
In a soon-to-be-published article, Gates cites other examples of flagrant abuses that were never acknowledged by some of the major activists.
Advanced Micro Devices(AMD Quote), for example, spent $500,000 providing a chauffeured Mercedes to chairman W. Jerry Sanders despite his $134 million annual paycheck. At
Disney(DIS Quote), CEO Michael Eisner was awarded a three-year, $637 million pay package, which was 21,233 times the annual pay of Disney's typical worker, according to Gates.
"What's most instructive about Calpers is not how much they've done -- that's only relevant relative to how little others have done -- but how little they've done compared to what needs doing, and compared to what they could have done with the market power and visibility they possess," Gates said.
Other pundits agree that large institutions, including labor unions -- which have only recently become active players in the field of
corporate governance -- have been woefully inadequate in effecting real change.
"The potential for abuse was obvious 20 years ago," said James Mitarotonda, CEO of Barington Capital Group. "You'd think these people would be most upset."
Different Masters
The fact that mutual fund managers were nowhere to be found isn't surprising to anyone. Because their primary concern is generating fees from managing corporate pension plans, few portfolio managers are willing to rock the boat by complaining about corporate governance issues.
"There are huge conflicts of interest," noted Nel Minnow, director of corporate governance at the Corporate Library. "All too often, institutional investors have voted 'yes' because they want to maintain good relationships with the portfolio companies and get business from them."
"There were a number of indicators about some of the disasters and the shareholders should have been more sensitive to them and should have responded," Minnow said.
Big Heads
To be sure, Calpers, TIAA-CREF, the State of Wisconsin Investment Board and others may have started out with noble intentions. In the 1980s, these funds began to turn their attention to the corporate boardroom to take action against poison pill antitakeover plans and the practice of "greenmail," where directors paid a premium to corporate raiders to stop them from taking control of the company.
It was through activist lobbying that a 1992 SEC rule barring 10 or more shareholders from communicating was overturned. But the emphasis on short-term financial gains has long been apparent, according to some observers, who say the whole system has been geared towards instant gratification.
Larraine Segil, partner at the Lared Group and professor of executive education at Caltech, said some institutions and fund managers that once advocated good corporate governance have seen their agendas change over time.
"Those kinds of activists become quite important in their own right," she said. "And then it goes over the edge of representing their constituency to personal aggrandizement."
