Chapter 7: SHAREHOLDER ACTIVISM: KEEPING CORPORATIONS ON THEIR ETHICAL TOES

CHAPTER 7

Shareholder Activism: Keeping Corporations on Their Ethical Toes

IT IS BETTER TO LIGHT A CANDLE THAN CURSE THE DARK. – ANCIENT CHINESE PROVERB

WHEN IT CAME TO HOLDING STOCK in one of the world’s major corporations, it used to be a case of love it or leave it. Shareholders of all stripes who didn’t like the deal corporate management set up, or objected to an investment in a country where human rights were routinely violated, or simply were offended by the way a company treated its employees, had a single option. They had to follow what some have called the first “Wall Street Rule”: when disenchanted with management, sell your holdings.

Developing Ethical and Financial Responsibility

Today, the relationship is very different. Investors from the United States to Europe (and even Japan) are attempting to make corporations more ethically and financially responsible through shareholder activism. This often confrontational attitude by shareholders in the governance of companies is a relatively recent development.

In the past, walking away often meant selling big chunks of a company’s stock, which could drive the share price down. Virtue had a price. Depending on the size of the investment, it may actually be more expensive to walk away from corporate stock than to work with company management to change corporate behavior. In some cases, even walking away wasn’t really an option. Large institutional investors (such as pension funds, trusts, mutual funds and endowments) all have only one thing in common: they manage assets on behalf of someone else. They also frequently hold indexed portfolios, which preclude the sale of a specific stock, regardless of its performance indicators or its underlying corporate ethics. The only route for change left was from within.

Public opinion has begun calling for boards of directors to exercise their powers in the interests of the many people who can be affected, rather than solely in the interests of shareholders and the bottom line. Shareholders now have much more information with which to challenge the board on both financial and ethical issues. The premise behind shareholder activism is that organizations can use their investment strength to bring about social justice through social change. Shareholder activism (or advocacy) describes the actions many socially aware investors take in their role as owners of corporations. These efforts include discussions with companies on issues of concern and submitting

and voting proxy resolutions. Socially responsible proxy resolutions are generally aimed at influencing corporate behavior toward adapting a more responsible level of corporate citizenship, steering management toward action that enhances the well-being of all the company’s stakeholders and, most importantly, improving financial performance over time.

Most institutional investors agree that regular engagement, or “turning up the heat from time to time,” is the best form of intervention. This may involve attending annual meetings and voting on the issue, or voicing their views to the press. Publishing corporate governance guidelines and making corporate management aware of these demands has also proven to be an effective weapon for shareholder activists.

The institutional activism movement has not lacked for skeptics. Business leaders and politicians have argued that large pension funds lack the expertise and ability to serve as effective monitors of corporate performance and lack the understanding of long-term corporate strategy. Their interference in the governance of companies can actually hurt performance or skew priorities. WARNING : Shareholders must be wary of having their financial power hijacked by organized stakeholder groups who are less concerned about the long-term financial welfare of a firm than the cause they represent. The cause (e.g., child labor, worker’s rights) may seem virtuous on the surface, but investors must look at the motivation for raising an issue before they throw their considerable financial weight behind it. Some stakeholder groups are actually anti-capitalist groups in “sheep’s clothing” and have their own ethical issues that need to be resolved.

The Roots of Activism

The roots of activism have taken hold in the changing nature of world investment patterns. As institutional investors amass a burgeoning percentage of corporate equity, so have they gained shareholder power.

The phenomena had its origins in the US. It became formalized during the hostile takeover period of the early 1980s when corporate management appeared to have lost touch with the concerns of common shareholders, instead focusing on purely managerial concerns—especially when it came to lining individuals’ pockets. Conflicts of interest became so common—and obvious—they were impossible to ignore. Corporate raiders (or corporate strategists, depending on your outlook) used junk bonds to take many public companies private, broke them apart and then resold the assets in pieces. Often, the result was socially devastating in the form of factory closings and lost jobs. NOTE : Many of the companies that were treated in this manner were, admittedly, unhealthy or burdened with overpriced union contracts. It was the methodology used, not the underlying problems, that incensed activists.

Institutional Dissent

Prior to the 1980s, shareholder activism was confined to a smattering of individuals with political axes to grind and a distrust of corporate power. Publicity

was their main goal; they also hoped that the public spotlight would create outrage among the general public and other shareholders who would then pressure management or legislators to change corporate policy. Other goals included efforts to create a more self-conscious business community and to simply to make life miserable for management.

Churches

Religious groups have been longstanding members of the shareholder activism movement. They grounded their activism in a religious commitment to social justice and they often used selective investment screens to avoid “sin” companies; many still do not invest in entertainment companies, such as casinos or those producing military technology, tobacco or alcohol products. A clear win for religious groups in the early 1980s was the adoption of World Health Organization (WHO) guidelines on the sale of infant formula in developing countries by global commodity companies.

Shareholder Activists: Whiners or Winners?

Shareholder activism is not just about confrontation and challenge. In fact, it is more a process of negotiation and compromise. Though the world media has focused on the filing of proxy resolutions aimed at changing corporate behavior, such resolutions are really a last resort. Shareholder activists usually file resolutions only after they have failed to reach an agreement on contentious issues through negotiation with management.

Shareholder actions usually begin with an attempt to engage management in a dialogue on a specific issue. A proxy resolution is the “stick” that makes palatable the “carrot” of discussion. Even after a resolution is filed, compromise may occur and the resolution may be withdrawn. If it does go to a vote, it is rare for a shareholder resolution to pass. While on the surface it may look like a defeat for activists, it has served the purpose of rousing public interest, and sometimes, publicly embarrassing corporate management and inflicting damage to the corporate reputation—the latter is something that may eventually hurt the longterm bottom line, so these activists may back off. The reality is that once on the table, the issues raised by shareholder resolutions rarely go away on their own. Consequently, management tends to resist even simple revisions fearing that such action is the “thin edge of the wedge” of a much greater level of interference.

Investors of the World Unite!

On issues of intervention, many institutional investors take different approaches domestically and internationally. In their home countries, they may tend to hold larger percentages of company stock and have more intimate relationships with company management, allowing them more direct intervention. When they invest abroad, they may have smaller stakes in companies and only a superficial understanding of the local market, forcing a more indirect approach.

A striking development is the extent of communication among institutions around the world. Institutional investors abroad are able to give support to local investors and learn about key issues in their particular markets. When possible, they also try to forge alliances with local investors to share knowledge and expertise, creating a world of global investors with similar concerns.

This trend became clearly evident in the mid 1990s when TIAA-CREF—a US pension fund and the largest private pension plan in the world, with more than US$260 billion under management, extended its corporate governance initiatives to Europe.

While most of these initiatives involve private meetings, one European corporate governance initiative was widely publicized, and that involved a French company called Eramet.

The French government, which in addition to CREF was a major stockholder in the company, intended to give one of the company’s nickel mines away to resolve an outside dispute. TIAA-CREF objected on the grounds that the mine belonged to the shareholders in common; it argued that the government should buy the mine first from Eramet before giving it away. TIAA-CREF introduced a resolution that won enthusiastic support from Société Générale (a leading French bank soon to face its own ethical problems in 2008), and other investors. The resolution not only led to changes in Eramet’s management, it also raised the issue of corporate governance among business leaders in Europe.

As Global Capital Moves, So Do Investors

As investor activism spreads, more and more Europeans buy shares and European companies must be more respectful of the rights of minority investors. One example: A Paris court blocked Schneider Electric’s proposed US$7.1 billion takeover of Legrand, a rival maker of electrical equipment, following a suit by minority shareholders in Legrand, who argued that the terms of the deal discriminated against their class of holdings.

The message to French companies was clear: they can no longer treat their investors, especially minority shareholders, with disdain. Rather, they must fairly weigh the interests of all their owners when considering mergers. It is a message that companies across continental Europe are increasingly having to heed.

Shareholder activism has even come to Japan—a country where the questioning of authority and open protest in business are rare. The MAC Japan Active Shareholder Fund was launched as the country’s first mutual fund dedicated to better corporate governance through shareholder activism. NOTE : Japan has also had another tradition of “shareholder” activism in which members of criminal gangs (yakuza) bought company shares and then threatened to disrupt corporate meetings. They blackmailed management to avoid the disruption. Many global corporations find little difference in the methods (if not motivation) of the yakuza and those of shareholder/stakeholder activists in getting their way. The violence that often accompanies anti-globalization rallies does not help to discredit the comparison.

Executive Pay On Display

There is one area of corporate policy where shareholder activism can claim global success. It is in the area of public disclosure of senior executive pay. Shareholders had reason to be upset. In the US, for example, CEO compensation increased by 212 percent in the 1990s, as opposed to factory workers who saw their earnings increase by only 54 percent. In Japan, by contrast, the average CEO makes 17 times what the average worker makes—versus 85 times for CEOs of major American corporations. Europe is not far behind the US when it comes to executive pay excess. The typical European CEO now earns about 75 percent of the average US CEO.

Due to shareholder protests and demands, many governments throughout the world have forced disclosure of management pay rates, bonuses and retirement packages. In the early 1990s, not a single large French, German or Japanese company chose to disclose remuneration details for individual top executives. That is beginning to change. In Britain, the government is closer to requiring companies to put an annual resolution to shareholders to approve the report of the board remuneration committee. In France, the government drafted statute changes that would require release of details of the remuneration awarded the top two officers in a company. In Germany, the Socialist party (which strongly promoted full disclosure of individual pay while in the opposition through most of the 1990s) is considering legislation requiring release of such figures. In Japan, one company announced that it had formed an advisory panel of outsiders to provide recommendations on executive pay; another small firm—People Co—became the first listed corporation in Japan to disclose pay details for individual directors and top executives.

NOTE : General Electric was forced to review and reduce the retirement package of its legendary former CEO, Jack Welch after the exorbitance of the benefits came to light. Other CEOs scurried to either renegotiate or protect their own “golden handshake” retirements.

A New Trend: Mandated Ethics

In the US, shareholder activism is already heading to a new frontier: activists are pressuring the US government to restrict foreign access to the US stock and bond markets. If successful, the move would have a major impact on global businesses, especially for those dealing in nations seen as having a less-thanexemplary record on social responsibility.

Their target is the growing practice by foreign firms with questionable ties to rogue nations of raising money on Wall Street. Though the US has banned trade and other financial dealings with some nations, its capital markets have always been accessible to any foreign company that meets its investment standards. Now, this may all change, making a company’s ethical practices just as important as its financial potential.

The number of foreign firms registered with the US Securities and Exchange Commission tripled in the 1990s to more than 1,200.

The issue came to the fore when a subsidiary of the China National Petroleum Company (CNPC) sought to sell shares on the New York Stock Exchange.

CNPC has a major oil project in Sudan, an African country whose regime is accused of waging a religious war in which millions have been killed. The US has banned trade, loans or aid to Sudan because of the government’s support of terrorism and poor human rights record.

But the anti-investment campaign goes well beyond Sudan. Legislation has been introduced in the US Congress to screen any foreign-based company that wants to sell shares in the US for questionable activities or ownership ties. The US government has resisted pressure from human rights groups, citing its concern that restricting access would raise doubts about the US commitment to free markets and open flow of capital.

But the effort has triggered a debate over the appropriate role of financial markets in a global economy and whether society can afford to turn a blind eye to the social or political consequences of unrestricted flows of money. US officials and financiers argue that tampering with capital markets could backfire. Companies can take their business to dozens of other stock exchanges, from London’s and Tokyo’s to Hong Kong’s. And foreign governments could retaliate, banning US firms from their markets. Piety, it seems, has a price.