Has ‘Greed’ Supplanted ‘Shareholder Value?’

Two weeks ago the state’s giant CalPERS pension fund announced its annual “hit list,” 10 American companies whose stocks have been such dogs that the fund intends to bully them into action “to enhance performance for the benefit . . . of all shareholders.”

It was an ironic scene-setter for last week’s political free-for-all: A motley crew of major Democratic and Republican figures who agree on little else attacked the “greedy corporation” that focuses excessively on making money and boosting its stock price--at workers’ expense.

Even allowing for the inevitability of strange bedfellows in politics, hearing Labor Secretary Robert Reich, Sen. Edward M. Kennedy (D-Mass.), and Republican presidential hopefuls Sen. Bob Dole and Patrick Buchanan all lash out at corporate greed sent a chill down Wall Street.

Because if corporate America is avaricious, what does that make powerful institutional shareholders like the $95-billion-asset California Public Employees’ Retirement System--which for the last 10 years has been actively pressuring laggard companies to take whatever steps necessary to boost “shareholder value”?

Indeed, institutional shareholder activism has been a key force behind the restructuring wave that has swept American business since the mid-1980s, leading to dramatic upheaval at such corporate icons as IBM, Eastman Kodak and Sears, Roebuck.

CalPERS brags that its interventionist policies have turned underperforming companies into stock market stars: Of 53 CalPERS targets studied by Wilshire Associates last year, the average company’s stock rose 54% more than the blue-chip Standard & Poor’s 500 stock index in the five years after CalPERS got involved.

In fact, CalPERS says that it and other institutional activists have been so successful in pushing the nation’s largest companies to focus on stock performance that the fund is “moving down the corporate food chain,” in its words, targeting smaller, non-blue-chip companies.

But if shareholder value has been well-served by institutional demands in recent years, there also has been a high cost. To enhance earnings and boost stock prices, many companies targeted by shareholder activists have hacked tens of thousands of jobs and have kept wage increases for remaining workers to a minimum--exactly the behavior now assailed by Reich and Buchanan both.

The human cost of restructurings hasn’t gone unnoticed among big investors, of course. Some high-profile public pension funds, which have routinely used their clout to effect social change, say they are increasingly focusing corporate evaluation efforts on how companies treat workers, not just on the bottom-line results.

Yet the political debate already seems to be framed, and it is a devilish one for pension funds whose first responsibility is to their beneficiaries: How much profit is enough? And how can shareholders know for certain that the corporate managers they are continually hounding for performance aren’t producing better results by “hollowing out” their companies, sacrificing human talent and long-term investment just to raise earnings in the short term?

As the spectacular 1990s stock bull market has powered ahead over the last 13 months, in no small part fueled by corporate earnings that have been far stronger than most analysts thought possible, some big investors admit they have been nagged by worries over how those profits have been achieved.

“I think this is something we all have to come to grips with,” says Jon Lukomnik, New York City’s deputy controller for pensions, who oversees $60 billion in assets. Referring to still-widespread corporate cost-cutting, he says, “You can shrink your way to profitability [in the short run] but not to greatness” in the long run.

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Yet judging whether an individual company gives the correct weightings to short-term and long-term shareholder concerns is no simple task, if what is “correct” can even be defined.

The stock market, Lukomnik notes, is quick to reward good short-term surprises, while steps taken for a company’s long-term health often aren’t immediately quantifiable by the market.

For their part, public pension funds such as New York City’s and CalPERS, whose size gives them enormous influence on Wall Street, insist they are only interested in a company’s long-term performance.

Typically, major pension funds are buy-and-hold investors that, by virtue of their size, end up owning nearly every major U.S. stock. That is what drives institutional activism: The funds can’t vote with their feet by selling stocks they don’t like. So they believe that their only option with laggard stocks is to pressure the companies’ managers to do better.

But the funds say the decision to bring pressure is never made lightly. CalPERS, for example, says its annual corporate hit list comprises only the worst stocks in its 1,500-stock portfolio and that performance is judged over a five-year period.

Moreover, CalPERS says it goes public with target companies’ names only when the companies’ managers seem unwilling to engage CalPERS in meaningful discussions about their problems.

“Some of these companies want to spend all of their time arguing with us about the numbers, when they are well known to be underperformers by everyone,” says Kayla Gillan, CalPERS assistant general counsel in Sacramento.

The public pension funds also insist that they are not interested in micromanaging troubled companies. Rather than tell a company’s managers how to run the business, the changes sought by the funds generally involve fixing what they view as corporate governance abuses--too many “inside” directors on a corporate board, for example, or a lack of linkage between directors’ compensation and the performance of the business.

“We have found a high correlation between certain governance practices and underperformance by a company’s stock,” says William D. Crist, president of CalPERS’ Board of Administration.

Yet as politicians condemn the perceived corporate slavishness to earnings, a key issue is whether activists’ efforts--no matter how generic and well-meaning--end up encouraging potentially destructive behavior on the part of company managers, all in the name of short-term gain.

Massachusetts Institute of Technology economist Lester Thurow fears the return of “19th century survival-of-the-fittest capitalism, wherein it is possible to do anything up to the letter of the law to make money for shareholders.”

John Nash, head of the Corporate Directors Assn. in Washington, says the current national debate about pay levels--the idea that many workers have received shockingly little as corporate profits have boomed in the 1990s--should be striking a chord with more company directors.

“If that wealth isn’t shared with workers, there isn’t going to be any consumer purchasing power,” Nash says. The day will soon follow, he says, “when there won’t be any corporate earnings.”

Many activist pension funds say they understand that all too well. As a defense, they cite how they opposed investor Kirk Kerkorian’s demand last year that Chrysler Corp. distribute most of its $7.5-billion cash hoard to shareholders.

Chrysler said the cash was needed as a “rainy day” fund and for future investment in the company. Kerkorian took his case to the pension funds, but garnered relatively little support. On Feb. 8 he gave up his fight.

“Kirk courted us very heavily on the assumption that he could swing the investment community,” says Bill Patterson, director of the Teamsters union’s office of corporate affairs, which helps oversee $46 billion in union pension funds.

Instead, most of the major public funds took Chrysler’s side that its long-term prosperity was at stake.

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Still, many of the funds concede that Chrysler’s case was fairly cut-and-dried. Kerkorian, after all, looked like a black-hatted raider motivated by pure greed.

The challenge for the activist funds today, many of them admit, is to better measure the performance of companies in their portfolios not simply by earnings and share price gains, but by how well the company is positioned for long-term success.

For example, “it’s not in our interest for a company to show a [short-term] profit by eliminating research and development,” says CalPERS’ Crist.

He says CalPERS already includes in its regular corporate evaluation process a “screen” that addresses workplace issues at individual companies. “We ask, ‘What value do they place on their work force, on labor’s involvement in the company?’ ” Crist says.

But many pension executives say the idea of using a wide range of long-term performance variables in deciding which companies are leaders and which are laggards--and which to target for public attack--is still a relatively new one, and threatens to force the funds into micro-managing roles.

“Generally, if the stock has done well, we don’t look it,” one pension official concedes. As the debate intensifies over alleged corporate greed and its impact on society, however, the same activist shareholders who fought South African apartheid and other social ills may find themselves under growing political pressure to abandon their ignorance-is-bliss attitude toward their corporate winners.

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Is There a Better System?

Attacks on “corporate greed” haven’t just become fashionable in America; they are also the new wave in Britain, according to the Feb. 10 issue of the Economist, the London-based business magazine. Fueled in part by continuing corporate cutbacks in the name of higher profit, “All over the English-speaking world, and even tentatively in Germany, people are beginning to ask an elementary question. Who do companies belong to, and in whose interest should they be run?” the magazine says.

The idea that companies should be beholden to more than just their shareholders is an old one. “Stakeholder capitalism” has long been practiced in much of continental Europe and Japan. As the Economist describes stakeholder capitalism, “Firms often accept broader obligations that balance the interests of shareholders against those of other ‘stakeholders,’ notably employees, but including also suppliers, customers and the wider ‘community.’ ”

But the magazine notes that stakeholder capitalism in Germany and Japan in particular has come under severe strain in recent years. Japan’s famed kereitsu system of interlocking business relationships arguably helped worsen the country’s long recession and kept many companies from dealing with competitive issues much earlier. In Germany, the notion of lifetime employment has ended as many companies have belatedly come to recognize how high labor costs have weakened their stature internationally.

In both Germany and Japan, it could be argued that paying too little attention to shareholders--and perhaps too much to other stakeholders--has left the countries’ corporations in worse shape for the longer term, especially in the competitive race with the United States.