Shareholder Power

In 1932, a classic book called The Modern Corporation and Private Property spelled out the view that underlies most of the corporate governance activism in the United States today. Written by two academics named Adolf Berle and Gardiner Means, the book explained how the birth of the modern publicly owned company in prior decades had brought about a fundamental split between ownership and control.

Before, most large companies had been owned by trusts or families controlled by people like Carnegie, Frick, and Rockefeller. They either ran their companies themselves or hired—and fired—managers to work under their direction. There was no question that the owners were in charge.

Berle and Means pointed out that when ownership passed to millions of anonymous stockholders who bought and sold on a daily basis, the corporation was transformed into a self-perpetuating institution controlled not by the owners, but by the executives. This, they asserted, posed a fundamental governance dilemma: How do investors ensure that executives are working in the best interests of the owners, rather than in their own interests—while at the same time assuring that the company will be managed in the most profitable fashion possible?

This basic issue still animates almost every governance debate we have today, from proxy access and broker voting to director independence and “say on pay.” Activist investors, led primarily by a handful of large pension funds, have been demanding more accountability—i.e., more control—over both corporate managers and directors, on the theory that too many management decisions are made without the best interests of the owners in mind. Executives and board members, backed by powerful voices such as Martin Lipton of Wachtell Lipton, counter that the activists’ remedies go too far and leave companies open to shareholder micromanagement or abuse that could undercut profitability.

Both sides agree with a central premise underlying Berle and Means’ view, that a board’s role is to ensure that the company is run in the best long-term interests of shareholders, says Weil Gotshal & Manges partner Ira Millstein, a pivotal figure in corporate governance who last year helped found a center on the subject at Yale University (See “An Architect of Governance,” page 26). But much of the agreement ends there. “The whole issue under debate all these years has been clarifying the powers of management, the board, and shareholders,” says Richard Koppes, a long-time leader among the activists who served from 1986 to 1996 as deputy executive officer and general counsel at the California Public Employees’ Retirement System (CalPERS). He now is of counsel to Jones Day and advises companies on governance issues.

A California Giant

Although Berle and Means’ concerns have welled up periodically over the decades, today’s shareholder activism really got underway in the early 1980s. It was a time when corporate takeovers were raging and companies were fending off raiders such as T. Boone Pickens and Bass Brothers, a Fort Worth, Texas-based investment firm run by the Bass family. They issued poison pills and paid greenmail, tacking on golden parachutes for top executives in case these defenses failed. Such actions gave rise to charges that entrenched management was putting its own interests ahead of those of stockholders.

One of the strongest responses came from CalPERS, whose status as the country’s largest pension fund made it a major institutional investor. At first, it tried lawsuits, but quickly realized that this wasn’t a cost-effective way to deal with hundreds of companies that had adopted what it considered offensive practices, remembers Robert Carlson, who was CalPERS’ president at the time and remains on its board today.

A better alternative was to try to convince management to act on behalf of long-term investors. That approach would work better if CalPERS could join forces with other pension funds and institutional investors with similar goals. But Carlson and his colleagues quickly found that the Securities and Exchange Commission prohibited such collaborations. So they spent the better part of two years lobbying to get the SEC to change its rule.

They got a big boost when California State Treasurer Jesse Unruh joined the CalPERS board in 1982. A fiery Democratic politician who had dominated the state assembly as its Speaker in the 1960s, Unruh railed against the greenmail that companies such as Texaco were paying out. Once the SEC finally cleared the way, he recruited public pension fund leaders from New York and New Jersey to found the Council of Institutional Investors (CII) in 1985. Today the CII, along with CalPERS, its largest member, is probably the most powerful voice for shareholder activism in the United States. It represents 130 public, labor, and corporate pension funds with collective assets of more than $3 trillion.