Anti-Takeover Moves : Investors Relinquish Key Rights

On April 15, the stockholders of Chase Manhattan Corp. elected a board of 24 directors. Then they gave them the company.

After approving rules that make it almost impossible to replace a director for any reason, the bank company’s stockholders gave the board virtually unassailable authority to accept or reject any takeover bid.

The stockholders nearly eliminated their own power to overrule the board. From now on, overriding a board decision or repealing any of the April 15 rules will require a vote of 75% of all shares.

That is a greater margin than Congress needs to override a presidential veto. The changes themselves passed only by majorities as slim as 52.4%.

Like Chase’s stockholders, investors in about 40 other companies have voted this year to relinquish some of their most important rights. Stockholders in another 387 major corporations did the same thing in 1985.

Such extensive restrictions on shareholder rights--aggressively sought by corporate executives fearful of hostile takeovers--have set in motion perhaps the biggest shift in control of American business since the Great Depression, evoking the atmosphere of the 1920s when huge corporations were dominated by the owners of minuscule portions of their stock. The change could have major ramifications for the U.S. economy and for the political environment in which American business operates.

Critics say the latest crop of restrictions, often known as “shark repellents” for their anti-takeover design, allow even ineffective executives to fend off responsible challenges from those who advocate changes in corporate direction or management. Over time, that could make American industry less efficient.

Could Lose Legitimacy

Concentrating power in the hands of executives with limited stock holdings also could destroy the corporation’s best insulator from government interference--the perception that it is the public, through ownership of shares, that is really at the heart of the economic system.

“This might be one way business would lose its legitimacy as the private controller of the means of production,” said former Securities and Exchange Commissioner Bevis Longstreth, now a corporate lawyer in Manhattan. “And that could lead to more government intervention.”

The shift in power from stockholders to management arises out of a historic fissure between executives and the corporations’ nominal owners. Executives fear the power of institutional investors, who now own more than half the stock of companies listed on the New York Stock Exchange, to determine the fate of their firms and the future of their careers.

Institutions--insurance companies, mutual funds, banks and pension funds--do not demonstrate the same corporate loyalty that managements are accustomed to receiving from individual shareholders. Institutions trade stock more vigorously--they account for 75% of all transactions on the New York Stock Exchange--and are much more likely to react to short-term fluctuations in company earnings.

Executives hold institutional investors largely responsible for the wave of hostile takeovers, contending that they sell firms to the highest bidder solely for the sake of a quick profit and without regard to long-term company prospects and the impact on employees and communities.

“We better start looking at ways of protecting the American economic system from its shareholders,” said Andrew Sigler, chairman of Champion International Corp. and head of a task force on merger issues for the Conference Board, a management lobbying group. Three-fourths of Champion’s stock is owned by institutions.

Professional investors, who believe that share ownership should carry the right to a voice in corporate governance, regard such views with scorn.

‘Bohemian Grove’

“I call it management by Bohemian Grove,” said Robert Kirby, chairman of the Los Angeles investment management firm Capital Group, referring to the exclusive corporate retreat outside San Francisco. “Their argument is that shareholders aren’t investors in these companies, just guys who trade securities.”

Whatever the arguments, the trend is unmistakable: Ownership of a share of common stock no longer gives investors a predictable say in the affairs of a corporation.

At hundreds of companies--one being Federated Department Stores, owner of Bloomingdale’s, Bullock’s and Ralphs Grocery--shareholders no longer have the right to replace a majority of the board at a single election.

At such companies as Gannett, publisher of hundreds of newspapers, and Procter & Gamble, the consumer-goods concern, shareholders have lost the traditional privilege of calling their own shareholders’ meeting.

Many companies no longer allow each share an equal vote in corporate affairs.

At Potlatch Corp., a San Francisco natural resources company, long-term holders get four votes per share while those who have owned their stock for less than four years get one. At Dow Jones & Co., publisher of the Wall Street Journal, a proposal passed but under court challenge would give the controlling Bancroft family about 20% more voting power than that to which their actual share ownership entitles them. At Figgie International, founder Harry E. Figgie Jr., who directly owns about 10% of the shares, could potentially control nearly 80% of all votes.

Shareholder restrictions are in force at many of America’s biggest and most powerful corporations, including Mobil, Coca-Cola and Gulf & Western. Shareholders of Times Mirror Co., publisher of The Times, this year enacted some of the more restrictive rules, requiring on some votes majorities of 80%.

Even corporate raiders are sensitive to their usefulness. T. Boone Pickens, whose hostile takeover campaigns against big oil companies under the banner of “shareholders’ rights” made him shark No. 1 in the eyes of many oil executives, installed his own shark repellents at Mesa Petroleum, the Amarillo, Tex., company he chairs. Mesa’s rules, which date back as far as 1982, include staggered board terms and 75% majority-vote requirements for hostile takeovers.

Outsiders Disenfranchised

Since the effect of these proposals is to magnify the relative power of inside stockholders or of executives who themselves own little stock, they disenfranchise outside stockholders.

“A dominant minority amending bylaws to prevent anyone else from having any influence is well beyond the tolerable limits of what a public company ought to be doing,” says Robert A. G. Monks, formerly the government’s chief pension-fund regulator and now an independent activist on stockholder rights.

Associated as they may be with the takeover vogue, most stockholder restrictions are now so hard to repeal and deeply embedded in corporate bylaws that they will live on long after the merger wave--and today’s frightened executives--are gone.

Some bear little relevance to genuine takeover threats. At April’s meeting, Chase Manhattan Chairman Willard C. Butcher acknowledged that no bid for Chase, hostile or friendly, is currently in view. The bank, a spokesman says, knows of no one even accumulating any significant stock. In fact, the law requires the Federal Reserve Board to approve in advance the purchase of even 25% of a bank company by an outsider. No hostile takeover bid for a major federally chartered bank has ever succeeded.

Because shifts in corporate governance move not by a seamless evolution but in fits and starts, hundreds of companies have managed to implement stockholder restrictions before the emergence of any effective counterforce. Only lately have companies found them harder to pass, as sophisticated institutional investors became wise to their negative impact on stock prices and on stockholders’ authority over corporate affairs.

Large shareholders have begun to band together in efforts to give each other moral support in disputes with managements. The Council of Institutional Investors, an alliance of public pension funds, was founded by California State Treasurer Jesse Unruh last year after Phillips Petroleum Co. contemplated some harsh defensive moves against corporate raider Pickens. In March, the council proposed a “shareholder bill of rights” in opposition to many restrictive defensive maneuvers.

Inattentive to Rights

But most shareholders, even sophisticated money managers, are so inattentive to their rights as corporate owners that companies have been able to implement restrictions without significant challenge.

“It’s been really surprising that proposals that entrench management have passed despite institutional ownership,” said Kirby of Capital Group.

Some pass because institutional managers are often more concerned about their business relationships with companies in which they hold shares than about retaining rights whose direct financial significance appears remote. An insurance company might covet insurance business from a major corporation; an investment manager might be seeking a contract to manage the company’s billion-dollar pension fund; a bank might seek a lending relationship.

“Institutions are voting for these proposals either on a completely uninformed basis or to preserve their commercial relationships with clients,” said James E. Heard, director of the corporate governance service of the Investors Responsibility Research Center, a Washington research group.

Others can be imposed without a stockholder vote. This category includes the “poison pill,” in which a company is authorized to issue new stock after an unwanted suitor acquires a menacing holding. If the buyer tries to complete the merger, the stock floods the market and makes the acquisition unpalatably expensive. The bottom line is an almost insurmountable barrier to a hostile bid, and one that generally requires no advance approval from existing holders.

There is considerable evidence that shark repellents tend to diminish the average market value of stock. Recent SEC surveys indicate that stock prices drop by an average 3% or more--a “non-trivial effect,” in the words of SEC chief economist Gregg Jarrell--after a company adopts rules that discourage takeovers.

The SEC also found that such provisions tend to pass most easily in companies where insider ownership is high and institutional ownership relatively low.

“That explains how something harmful to the shareholders gets passed,” says Jarrell. “Even though the insiders’ stock will suffer a loss of value, they’ll get tenure out of this.”

Also Affects Individuals

Although institutions dominate stock trading, the contraction of shareholder rights does not affect only the faceless, computer-driven money machines of Wall Street caricature. For the assets of almost every institution are an agglomeration of the capital of millions of individuals.

Pension funds control more than $1.5 trillion in capital, a figure expected to rise to $3 trillion by 1990. That is the retirement capital of 64.5 million workers and 8.7 million retirees. Stock mutual funds, which grew by $26 billion, or 33%, in 1985, are the stock investments of 22 million Americans.

Nevertheless, the institutionalization of American capital has radically changed the rules of stock market investing.

Where individuals are customarily satisfied to express discontent with managements by simply selling their stock, institutions cannot do that. They often own too many shares in a given company to unload them all easily or without provoking a costly drop in price. Unhappy institutions prefer to react to consistently poor managerial performance by supporting dissidents in proxy contests or endorsing hostile takeovers.

As individuals, investors face obstacles in time and cost when exercising their theoretical rights to have a say in corporate affairs. Institutions often hold the resources to overcome those barriers.

Institutional managers contend that dilution of shareholder rights simply reflects executives’ uneasiness over their willingness and ability to question corporate decisions.

“Managements are now saying, ‘We didn’t understand that you shareholders were going to fire us,’ ” said Dean LeBaron, head of Batterymarch Financial Services and one of the most vocal institutional investors in the country.

But others contend that the practices of professional investors are so inimical to the traditional idea of the corporation as an economic organism with roots in a community, commitments to employees and a role in the country’s social structure--rather than as merely a collection of assets--that some change in the relationship between executives and stockholders is inevitable.

“There are no such things as shareholders today,” said Harold M. Williams, a former SEC chairman and now, as head of the Getty Trust, one of the nation’s most influential large investors and a director of Times Mirror. “Many own stock but don’t exercise any of the functions of traditional shareholders.”

Some Exit Quickly

Referring to market arbitragers, commonly called arbs, who hold shares in the course of takeover battles only long enough to sell them to a bidder, Williams asks: “Is an arb a shareholder in any traditional or meaningful sense? Who’s left to discharge the responsibilities of ownership by thinking and caring about the corporation as an institution? No one is.”

Champion International’s Sigler says institutional stock trading techniques leave these investors scant room for concern about the corporation’s survival as an entity.

“Of our top 50 owners at Champion, one guy will be our largest stockholder one month and be off the list the next,” he said. “How can I ask the shareholders what they want? I can’t find them.”

It isn’t surprising that the small individual investor has been elevated to a folk hero by executives under assault in today’s institutional environment. The truth, however, is that America’s cherished principle of shareholder democracy--the notion that as nominal owners of companies the shareholders should have some definite authority--has never been much more than a reassuring abstraction in the business world.

Tolerated by Businesses

“As long as shareholder democracy is a myth, the business community seems to tolerate it,” said Longstreth. “But as soon as it’s got the bite of reality, the business community tries to eliminate it.”

A chief executive addressing shareholders at an annual meeting refers to the enterprise he runs as “your corporation,” but few individual investors harbor the illusion that they have any genuine voice in their company’s affairs.

“My vote doesn’t mean anything,” said Fred Wilson, 63, a retired engineer for Rohm & Haas Co. who has accumulated a stock portfolio worth about $1 million in today’s market. “From a practical standpoint, there’s no way the individual can participate in running the company.”

Shareholder democracy became the pre-eminent model for corporate structure in the 1930s, when politicians and business reformers focused blame for the 1929 stock market crash and the Great Depression on the oligarchy of bankers who appeared to wield a stranglehold on the nation’s corporate wealth.

It was an era in which the investment house of Dillon Read & Co. could control the large corporation of Dodge Bros. with the ownership of only 1.7% of the company’s equity. Utilities magnate Samuel Insull, through a typical “pyramiding” arrangement, owned a majority of a company that owned a majority of another and so on, until he controlled a corporation at the bottom of the structure with a direct ownership of two hundredths of 1% of its stock. Such arrangements were outlawed.

Still, the individual had scarcely any access to the executive suite or the board room.

‘Little People’

In 1931, Adolf A. Berle, a leading corporate critic, observed of the 5 million Americans then holding common stock: “An overwhelming majority of these are ‘little people’ . . . who know little or nothing about corporate activities, whose advice is not sought in running the corporation and probably would be worth little if it were given.”

The level of corporate accountability to stockholders scarcely rose in the next five decades.

“In the 1950s, management might own no stock, but shares were so broadly distributed that no one could hold management to account,” said Harold Williams. “Anyone who could accumulate 10%, 15% of a company was very unwelcome, because that destabilized the status quo.”

Executives’ mistrust of stockholders is natural. The average executive has more at stake in his company than does almost any stockholder, no matter how devoted.

Says Harold Simmons, whose controversial raids on corporate assets as a major stockholder of many companies makes managements quail: “When a guy’s running the corporation, he’s worked his way to the top, spent his 20 or 30 years getting where he is, and there are many things on his mind, and maximization of stockholder value is just not on the top of his list.”

‘Get Rid of You’

Recounting the negative reaction his 9% stake in one mid-size corporation evoked from its chairman, Simmons remarks: “He said, ‘Look, Harold, I don’t want a big stockholder. My concerns are my employees, my management staff, my customers, my suppliers, my community, my government, and then my stockholders. You’re making my stockholders my major concern and I don’t like that. I want to get rid of you any way I can.’ ”

To be sure, some businessmen argue that management accountability has never been greater than today. SEC regulations mandate extensive public disclosure of corporate finances, an influence non-existent in the days of J. P. Morgan and Samuel Insull. Banks and other corporate lenders ideally keep closer track of their debtors’ affairs than ever before.

“You might take away one monitoring device,” said former SEC Commissioner A. A. Sommer, now a corporate lawyer in Washington, “but there are many others in its place.”

Still, even Sommer acknowledges that corporate managements exercise a daunting degree of power over their corporations, institutional stockholders notwithstanding.

“In 95% to 99% of all cases,” he said, “management is basically self-perpetuating. Even when the chief executive is retiring, he generally picks his own successor, not the board. The board will go along with the CEO unless he’s really off the wall.”

Discounts Offered

Nevertheless, laboring under the impression that their hold on their companies is slipping, many executives have begun to consider ways to lure individual investors back into holding stock, on the assumption that this will lend stability to their shareholder roster. Some offer individuals discounts on company products or offer them the opportunity to buy additional shares without commissions.

Many more have installed programs to place shares in the hands of employees, on the reasoning that workers are inclined to side with management, particularly in the face of a hostile takeover bid that might cost them their jobs.

But investor-relations experts say reaching individual investors is a costly process and probably not a rewarding one.

Accordingly, corporations will probably continue to fight institutions by trying to accumulate voting control in management hands.

“Any anti-takeover provision should have as its main goal requiring the raider to deal with the board,” said Dorman L. Commons, who was chairman of Natomas Co. until 1984, when Diamond Shamrock staged a takeover raid on the San Francisco company.

There was no other conceivable defense to the Natomas shareholders’ inclination to jump at Diamond’s offer, which was 50% higher than the stock’s market price.

“My opinion was the company was gone,” said Commons. “The number of shareholders who had been with the company for a long time and had any feeling about it was really quite small.”