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Going With The Institutions

Does it pay to sail in the wake of institutional investors Or will too many hands on the wheel steer the wrong investment course

With high-yield debt higher than 20 percent, the junk bond market lies in ashes. The avaricious dreams of dozens of takeover artists are empty memories. If you’re one of America‘s CEOs, you may be breathing a lot easier. But don’t relax too much; another storm is brewing, and this time the winds are swirling around a complex question: Who should control corporate America?

This time, CEOs have to deal with a once compliant and very silent fraternity: the institutional investors who have become America‘s most powerful shareholders. (See related articles on TIAA-CREF’s Clifton Wharton, p. 40, and Blackstone Group’s Peter G. Peterson, p. 18.) At the end of 1989, these investors-mainly public and private pension funds, mutual fund companies and insurers owned 44 percent of all the stock in the U.S., according to the latest estimate from the Securities Industry Association.

Their huge equity stake naturally has made institutional investors keen observers of the companies whose shares they own. Many complain, however, that it’s also turned them into whales so ponderous that they can’t change course easily, even in the clear and open waters of a bull market. It’s hard to unload a few hundred thousand shares of any single stock without roiling the market and suffering a nasty loss. “It’s become much more difficult to do the traditional thing that you used to do when you weren’t happy with a company: Vote with your feet,” says Roland M. Machold, who, as chief of the New Jersey Division of Investment, supervises more than $30 billion in holdings.

To some extent, institutional money managers have wedded their long-term fate-stretching from three to five years-to the fortunes of their largest holdings. As a result, many have become pliant no more. As Stephen B. Timbers, chief investment officer of the Kemper family of mutual funds, has put it on several occasions: “Why should anyone accept illiquidity without influence?”

For decades, institutional investors could be counted on to rubber-stamp all but the most outrageous proposal put forth by corporate management and directors. They cast their proxy ballots (if they bothered to vote at all) for whatever the directors suggested. It was very chummy. Enter the Japanese and Michael Milken. Exit chumminess. By turning up the competitive heat, Japan Inc. created huge headaches that made U.S. companies vulnerable to hostile takeovers bankrolled in the ’80s by Milken’s junk bond operation at Drexel Burnham Lambert.

The takeover boom spawned a defensiveness in corporate boardrooms that, in turn, led to widespread adoption of plans aimed at thwarting raiders. Not by happenstance, some of these plans-there now are an estimated 900 at corporations throughout the land-called for kingly sums to go to key managers ousted as a result of an unwanted takeover or merger. A number of corporate managers also scurried to state legislatures and to Capitol Hill in search of laws and allies that would make unfriendly takeovers tough to pull off.

While these events were unfolding, the value of the assets in institutional portfolios was ballooning, fed by a bull market in stocks and an accompanying rush by Americans into mutual funds. Members of the Washington, D.C.-based Council of Institutional Investors, an organization numbering more than 60, now own $1.5 trillion worth of U.S. stocks. Meanwhile, the Labor Department, which supervises investment practices of pension funds under the Employee Retirement Income Security Act (ERISA), began encouraging institutions to take active roles in corporate governance through proxy votes. All this imparted more clout and courage to institutional money managers, who viewed many of the anti-takeover schemes as nothing less than naked attempts by management to entrench itself.

Machold maintains that the proliferation of “poison pill” plans is symptomatic of a deeper problem: “There’s been a breakdown in the compact between shareholders and management. All investors-small ones and institutions-have suffered a loss of ownership and value as a result of a kind of erosion of corporate efficiency. A couple of years ago, Congress gave the savings and loan industry a free hand; you know what happened there. Now, in some ways, not only Congress but state legislatures are giving corporate managers a free hand. You see it in the high-level explosion of compensation, perks and so forth. These people are not accountable to anybody. And it’s not just unimportant companies. Look at GM’s decision to give [former Chairman] Roger Smith his $1 million-a-year pension boost just before he retired. Their rather naive explanation was that this kind of thing was needed to retain good managers. It made me laugh.”


Overall, 1990 already has been a banner year for institutional activism, with almost 100 shareholder proposals-triple 1988’s tally-put up for vote and about a dozen winning a plurality of votes, something that would have been unthinkable 20 years ago. For institutional investors, proxy contests have become the battlefield of choice. They can only become more so if the SEC changes proxy rules to make it easier to challenge management. The new activism is spreading; witness the following recent examples:

  • Institutional investors mounted a major campaign against a Pennsylvania bill that makes it very difficult for companies to be taken over without their consent. The measure passed, but, at last count, almost 90 Keystone State corporations-including H.J. Heinz, Westinghouse Electric and PNC Financial-had opted out of coverage. Their decisions were made easier by the prodding of investors such as the $58 billion California Public Employees’ Retirement System. Calpers’ chief, Dale M. Hanson, sent unusually blunt letters to companies in which it holds shares.
  • Pension funds from Massachusetts, New York City and California got top leaders of Exxon to discuss steps the oil company is taking to improve its environmental controls and halt the huge expenditures the company incurred as a result of the Exxon Valdez disaster in Alaska and smaller accidents elsewhere.
  • In the aftermath of its successful effort to fight off the unwanted advances of NL Industries’ leader Harold Simmons, Lockheed agreed to name to its board three directors approved by a group of pension funds. The funds had backed Simmons in a proxy battle.
  • The Wisconsin Investment Board waged-and won   a fight to have Champion International allow shareholders to vote on the company’s poison pill plan. The pension fund’s proposal had been strongly opposed by management.


At the same time, there are those who question the wisdom of increased interference in corporate affairs by big shareholders. Successfully investing in a company’s stock is quite a different thing from successfully running a company, as Carl Icahn appears to have discovered at TWA. Says a top executive at one Fortune 500 company, who has jousted with large investors on several occasions, “They think they know more about running a business than the people who have done it for 20 years. The truth is, they don’t.”

Nell Minow, general counsel of Institutional Shareholder Services, a Washington firm that provides analysis and advice on proxy questions and corporate issues to pension funds and other large shareholders, doesn’t deny that certain investors would like nothing better than to intervene directly in daily corporate affairs. “I had a client call me up and tell me,” she says, ” ‘I don’t like the way the company is running its operation. I think they should close down this plant, and I want to do a shareholder resolution on it.’ This client was an analyst who follows a certain industry, and he thought this would be a very clever way to send his message to the company. I explained to him that, even if I were to draft that for him, which I wouldn’t because I don’t think it’s appropriate, the SEC would knock it out immediately because they won’t allow shareholder initiatives dealing with what’s considered normal business.”

But what constitutes normal business isn’t engraved in stone. In a rather stunning development this year, the SEC ruled that shareholders could vote on whether their companies should stay in one line of business: tobacco. The agency decided that the health and moral concerns surrounding the product had lifted the issue out of the “normal business” category. Granted this was an unusual step, but it raised a huge question: Could other controversial issues now considered normal business-say, opening a plant overseas while closing one in the U.S.-eventually also be considered fair prey for shareholder votes?

In any case, shareholders already have one way to generate major changes in a company’s management: by electing directors sympathetic to their views. “Our big initiative this year involves directors,” says Minow, whose clients have over $1.3 trillion in investment assets. “We’ve developed a database on the directors of all S&P 500 companies. If I were to look up a director and find that he, say, paid greenmail to three different companies, I would recommend to the institutions that subscribe to our services to vote against him if he runs for a fourth company.”

Another kind of corporate commitment also argues against activism. By passively indexing their huge holdings so that they effectively mirror the market, institutions continue to provide corporations with a long-run opportunity. Tying investment performance to that of the overall market raises an almost utopian possibility of a U.S. that provides the kind of stable financial backing, geared to the long term, that Germany‘s banks and Japan‘s interlocking business network have provided in those nations for years.

But indexing, even with hedging, puts its adherents essentially at the mercy of the market. That’s a lot easier to justify when stock prices are rising, not falling. Just how many institutions will stick with it in a long bear market-like the one we may be headed for now-is a great unknown. So, too, is the ultimate effect of activism by institutional shareholders. But CEOs of publicly held companies will get a firsthand chance to ponder the answers.

A seasoned observer of business and Wall Street trends, Richard Rescigno is news editor of Barron’s.

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