Despite New Activism, Shareholders Seen as Too Passive

No longer interested in just the financial returns of investing in public companies, U.S. shareholders are awakening to the importance of the management of those companies. If not quite the start of a golden age of shareholder activism, recent efforts when it comes to executive compensation and the make-up of boards of directors show a move in the right direction. Those working with shareholders and tracking corporate management behavior agree that U.S. investors lag behind their European counterparts when it comes to taking management behavior into consideration when choosing where to invest. Changes, however, are in the air. “We are seeing the initial stages of pushback,” said Jack Zwingli, chief executive of Audit Integrity, a Los Angeles firm that ranks public companies on their governance performance. Passivity on the part of American investors is still strong, an attitude of not wanting to challenge management. The reasons for that behavior are plentiful, from the legal structure of companies, a short-term mentality by investors, and incentives that get in the way of thinking about corporate governance. Plus, it is hard work to drill down to how management is performing. “It can be expensive to carry out those strategies,” said Ralph Whitworth, a principal and co-founder of Relational Investors, an asset management and investment adviser firm based in San Diego. “It is a much more intensive investment process.” How much the current financial meltdown plays into shareholder activism remains up in the air. It is probably less the recession spurring activists than it is recent corporate scandals, said Zwingli, whose firm got off the ground in the fallout of the debacles involving Enron, Adelphia and other companies. Right environment Whitworth, however, takes a different look and said the current environment was ripe to create more shareholder activists. Beth Young, a senior research associate with The Corporate Library, a research firm based in Maine, is of the opinion that the recession has played some role, particularly in the new “say on pay” rules that go into effect next year. “There has been some idea that compensation was responsible for the recession; that incentives played in with the bad decisions,” Young said. In the area of contesting director positions by proxies, the amount of activity actually decreased in 2010, according to research done by Georgeson, a proxy solicitation firm. Between 2005 and 2009, proxy contests increased 150 percent. The 57 proxy contests in 2009 was the highest number recorded by Georgeson. In the 2010 proxy season, however, the number of contested slates put up by large shareholders decreased and the success rate dropped as well. Georgeson attributes the reduction to high-profile proxy contests – such as those involving Yahoo! and Motorola and investor Carl Icahn – falling short, and that market conditions are not right for hostile activity. Whatever activism is taking place is largely the domain of the institutional investors, and those single investors with deep pockets and influence. Relational Investors, for example, represents many big pension funds, including CalPERS and CalSTRS. The firm was a pioneer with a strategy of investing in order to bring improvements to corporate governance, executive and board compensation and board composition, areas critical to the value proposition of a public company, Whitworth said. When Occidental Petroleum announced sweeping changes in its executive pay, CEO succession, and the make-up of the board, Relational Investors and CalSTRS sounded its approval. The two own 1.24 percent of outstanding Occidental shares valued at more than $800 million. “If management and boards are accountable and follow best practices in the areas of compensation and risk management then they are more valuable, more attractive and have a higher stock price,” Whitworth said. While there is much talk about shareholder activism, it does raise the question of whether the interest remains when the economy is in a better state. During the bad times is when abuses get the spotlight and then the attention dims when things go well, said Zwingli, of Audit Integrity. As the market bounces back somewhat we hope the focus won’t be taken off corporate governance,” Zwingli said.