Some of the nation's biggest stockholders have joined forces to create a powerful new council that already is influencing the management of corporate America.
Armed with a staggering $100 billion of assets under their control, about 20 trustees of state, municipal and union pension funds have formed the Council of Institutional Investors. The purpose of the council is to use the combined power of its members' stock holdings to prevent corporate executives from making "self-serving or bad business decisions," and to educate its members about corporate affairs.
"The emergence of the Council of Institutional Investors is a dramatic and potentially far-reaching indication that the leviathan of institutional stock owners is now beginning to emerge as a market force," said Harrison J. Goldin, comptroller of New York City and co-chairman of the council's executive committee. " . . . We think this is going to be a very important development in American finance whose implications remain to be seen."
Institutions, including pension funds, college endowments and mutual funds, dominate trading on the New York Stock Exchange, accounting for an estimated 70 percent of daily volume and about 45 percent of total public stock ownership. Institutions hold a majority of the stock of some of the nation's best known corporations, including CBS Inc. (62 percent) International Business Machines Corp. (51 percent) and General Foods (56 percent).
The growth of institutional stock holdings is a direct result of the growth of pension fund assets in the last decade. Since 1975, local, state and corporate pension fund assets have increased from about $400 billion to more than $1.3 trillion, according to the Employe Benefits Research Institute, which estimates that about half of that $1.3 trillion is invested in stocks.
While the amount of stock held by institutions was growing rapidly in the last decade, the institutions' influence was not: Most institutional investors were passive shareowners who almost always supported management. In the unusual instances where institutions disagreed vehemently with management, they generally solved the conflict by selling their stock.
That is no longer the case. While the leaders of the council emphasized in interviews that they do not want to be considered anti-management, they made it clear that they will be active supporters of shareholder rights. Gone are the days, they said, when management automatically can count on institutional support for all of its decisions, especially adoption of antitakeover policies.
The cataclysmic event of 1984 that led to the recent formation of the council was the decision by the directors of several major public companies, most notably Texaco Inc. and Walt Disney Productions, to pay millions of dollars of "greenmail." The shareholders were not consulted.
Greenmail, also known as corporate blackmail, occurs when a company buys back its stock from an unwanted shareholder (who is threatening a takeover) at a premium over the stock market price, benefitting that single stockholder at the expense of the other shareholders. Top corporate executives, many of whom own very little stock in the companies they manage, offer the payment if the unwanted suitor will not attempt a takeover in the future. Once completed, the deal usually causes the stock price to drop precipitously and leaves many stockholders believing that corporate management is more interested in preserving its jobs than in maximizing the price of its stock.
"Like a lot of institutional investors, we have been very concerned about the erosion of shareholder rights in the last couple of years," said Roland Machold, who manages $13.5 billion for the New Jersey Division of Investment and is a member of the council. "I think corporations are responsible to shareholders. Some of the moves to limit shareholders rights by perpetuating boards of directors or paying extraordinary salaries are really instrusions on shareholders' rights."
Machold added that now "companies might have to worry more. For many years, they have never faced any challenge on their proxy votes because individuals have a tendency to go along with them, and many institutions had a policy that if they did not like management's recommendations, they would sell the stock. That attitude has changed. We are not passing the buck anymore. What is happening is healthy for corporate democracy."
But not everyone agrees that formation of the council and the growing power of institutions in corporate battles for control is a healthy phenomenon. Some investment bankers privately complain that some members of the council may be using it to further their political careers. Others express concern about the incredible amount of power elected and appointed public officials will have in corporate affairs, particularly in deciding the outcome of takeover battles, even though they are managing public pension funds and not their own money.
The continuing growth of pension fund assets invested in stocks raises further questions about concentration of power. It may leave some individual shareholders, who do not share the council's direct access to top corporate executives and merger experts, in an inferior position to the council members.
Another concern: The domination of trading by institutions has led to greater volatility in stock prices, at least in the short run. These wide swings in stock prices occur as institutional investors, acting with what some have called a "herd mentality," move in and out of investments daily. The use of "program trading" by some institutions adds to this volatility, as some professional money managers automatically move in or out of stocks based on technical market data, rather than new financial information about individual companies.
Top executives of several corporations have said they believe institutional managers, who generally are bound by their fiduciary duty to accept the highest offer for the stock in their portfolios, force management to make short-run decisions intended to keep the stock price high rather than enhancing the company's long-run interests.
Council members disagree, pointing out that they have the power to exercise discretion in accepting or rejecting takeover bids if they believe management is talented enough to produce a higher value for their stock in the next few years. Council members also point out that they do not act as a monolithic block in voting their shares.
The influence of the council in takeover battles was demonstrated during the fight for control of Phillips Petroleum earlier this year. The principal players -- including Mesa Petroleum Co. Chairman T. Boone Pickens Jr. and Phillips Petroleum Co. Chairman William C. Douce -- met with the council in Goldin's office in New York to make their pitches and answer questions.
And institutional investors are important factors in the current fight for control of Unocal Corp., about 40 percent of which is owned by institutions. One member of the council interviewed by The Washington Post seemed to be enjoying his power in that takeover battle last week when he commented that a director of Unocal was on his other phone, obviously calling to ask for his support in that fight. "He can wait," the council member said. "The proxy vote is not until Monday."
Corporate pension fund managers have to deal with a range of conflicting pressures. On one hand, they ordinarily would vote against antitakeover provisions to corporate bylaws in order to maximimize the return on investment they manage. On the other, they may want to pacify top corporate management by supporting these management-entrenchment devices.
By supporting management, they may improve their chances of being retained to oversee investment of corporate pension funds, according to Dean LeBaron, president of Batterymarch Financial Management, one of the nation's biggest private money managers. LeBaron said that the current clash between management and shareholders is caused in many cases by the difference between the stock market price and the underlying value of a corporation's assets.
Because many stocks sell at a price lower than the value of a corporation's assets, this creates a conflict between stockholders, who are interested in maximizing the value of their shares even if it means selling the company to realize the value, and managers, who may own little stock and are interested in preserving the company so they can hold onto their jobs.
"Traditionally, institutions have not utilized the power they had, and the kind of votes that are passing on antitakeover amendments today do not suggest exercise of power now among the institutions," LeBaron said, noting that Batterymarch generally has voted against antitakeover provisions. "Institutions are poor corporate citizens by past tradition, and the council is trying to change that . . .
"For many institutional investors there are conflicts of interest. Why vote against an antitakeover measure and management if it will be passed anyway because you then reduce the likelihood that management would hire you to manage its pension fund ? Another conflict is that you might lose access to management which you need for information."
California Treasurer Jesse Unruh, who is co-chairman of the council along with Goldin and Wisconsin State Investment Board trustee John Konrad, said he believes the mere existence of the council will make corporate management at least pay serious attention to institutional investors.
"If we called a meeting for tomorrow and asked [Unocal Chairman] Fred Hartley and [Unocal hostile suitor] Pickens to appear, it would happen," Unruh said. "That hasn't happened in the past."
The Washington Suburban Sanitary Commission Pension Fund had a basic reason for joining the council, according to accountant Linda Herman. "The reason we joined was to be more knowledgeable about investments and legislation," Herman said. "We got involved to have access to information," she said.
The council has said that it opposes adoption of legislation proposed by several members of Congress that would restrict takeover activity. Such legislation certainly would not enhance the value of pension fund assets invested in stocks, because it would decrease the chance for takeover bids at a premium to prevailing stock market prices.
"The Council of Institutional Investors dramatizes the developing consensus among large investors that market forces may offer adequate opportunity to remedy many of the excesses that may not be in the best interest of shareholders," Goldin said. "Moreover, we would not want the blunt instrument of legislation needlessly to throw the baby out with the bathwater.
"For example, I do not oppose attempted takeover activity per se, nor, assuredly, the sale of corporate assets in whole or in part." Should Pickens or other well-known corporate raiders propose an open auction for securities in his pension fund, Goldin "would not want to restrain them," he said.
" . . . And lest some be concerned that, with the raiders and the arbs [arbitrageurs] and the sharks on one side and institutional investors on the other, the small investor will be squeezed between, I remind you that I and other trustees like me are, in fact, representatives not of some impersonal, nameless and faceless economic force, but of the millions of ordinary Americans who depend on us to secure their economic interest [by managing their pension funds]. As we do, we, by the same token, act for the millions of individual investors whose cause is identical to the beneficiaries whose futures are entrusted to our care."