Rogue Missives - Monday, December 16, 1996

Rogue Missives

ROGUE ARCHIVES

Monday, December 16, 1996

Accountability Rules
"What managers forget is that they are employees. And what directors forget is that they're fiduciaries."

So says Robert Goch, corporate governance director for the Investor's Rights Association of America (IRAA), an organization that has quickly become a mainstay of the proxy battles that are setting new standards for corporate governance.

Formed three years ago in Great Neck, New York, by members of the now defunct United Shareholders of America, the IRAA is a small but active group of individual investors who have taken up the call to investor activism. And the organization has already had significant success sponsoring shareholder proposals designed to remind corporate boards and managers exactly who the real owners are.

"These resolutions are a way of getting both management and boards to recognize that they serve the shareholder," Goch said. "It's like, 'Hey, we're here! Wake up! We're paying your salaries.'"

Two weeks ago, the IRAA released a list of 27 underperforming companies it will target during the 1997 proxy season. The group is still looking at other companies, as well, and may end up putting a total of 45 companies on its action list. Each company has lagged behind either the S&P 500 index or its industry peers over the past five years.

"These companies have been underperforming significantly," Goch said. "Of the 30 companies, I'd say that over half have had negative non-inflation adjusted returns over the last five years. That's to say that a dollar invested in 1991 would give a shareholder less than a dollar today in non-adjusted dollars, despite the S&P averaging about 15.6% a year over this period. Those are nominal negative returns."

The hit list includes Bausch & Lomb, Calgon Carbon, Drug Emporium, Goulds Pumps, Marsh Supermarkets, Occidental Petroleum, Safety-Kleen, Syms, TCBY Enterprises, Topps, and Tyco, among others. Over this period, Drug Emporium has dropped, on average, 11% a year. TCBY, the yogurt maker, has seen its shares slide by 7% a year. Topps, the popular maker of trading cards, has attracted all the enthusiasm of a washed-up second baseman, down 15% a year.

Even the winners have turned in only lukewarm price appreciation, with Bausch & Lomb up 3% on an annual basis and Occidental Petroleum up 7%, both significantly underperforming the raging S&P index.

The IRAA is sponsoring so-called "sell-or-merge" resolutions that would require these companies to "take immediate action to engage the services of an investment banker to explore all alternatives to enhance shareholder value," according to the group's recent news release.

"The resolution is called a sell-or-merge, but it's really to explore any type of restructuring of the company," Goch said. "[I]f not [a merger or sale], an internal restructuring. That is to say, fixing some governance measures which we think lead to lack of accountability to the shareholders. I mean, we're talking about companies that have significantly underperformed a peer group."

The IRAA was formed by Bill Steiner, the former chairman of the New York chapter of United Shareholders of America's, an investor advocacy group that started in 1986 but folded in February of 1994. USA was the brainchild of T. Boone Pickens, the chairman of Mesa Petroleum who became a national figure in the mid-80s when he made a series of spectacular but failed efforts to take over Phillips Petroleum Co. and Unocal Corp.

In putting up $1 million to get USA started, Pickens said he wanted the group to become the "most effective grass-roots citizens lobby in Washington." And the group did eventually claim 65,000 members. But what it seemed designed to do, mainly, was get rid of the anti-takeover measures that had thwarted Pickens' ambitions.

As THE WASHINGTON POST reported at the time, Pickens argued that the "decline of big business in this country is the fault of a selfish, entrenched, myopic management." The newspaper noted that he was "seeking support for a nationwide campaign to force top managers to be more accountable to shareholders. Run his way, companies would be leaner, smaller and more profitable, jettisoning operations that cannot keep up competitively. 'I think I can make a difference in the competitiveness of this country,' he said."

"We will call attention to specific examples of management entrenchment and shareholder ripoffs," Pickens said in launching the USA. "In other words, we will be kicking butts and taking names. We're going to phase out the good ol' boys."

The USA found natural allies in large public pension funds which were also becoming more active at the time. Indeed, the efforts of corporate executives in the mid 1980s to set up "poison pills" and other obstacles to hostile takeovers contributed a great deal to turning the often arcane issues of corporate governance into the grounds for a shareholder revolt. That's because poorly performing management was often protected by governance structures that made it hard for shareholders to exert power.

USA played an active role in pushing for change at the large companies that had proved simply too large to experience the hostile takeover boom of the 1980s as a legitimate threat. For example, USA president Ralph Whitworth pushed for a transformation at IBM, even calling for the company to be split into parts shortly after Louis V. Gerstner, Jr. took over as CEO at IBM in July 1993.

Whitworth also played a vocal role in sparking the ouster of Kay Whitmore, the CEO who had allowed Eastman Kodak to become a bloated conglomerate, slow to adjust to changes in the marketplace. When in April of 1993 turnaround specialist Christopher J. Steffens left his post as Kodak's chief financial officer after only 12 weeks on the job, Whitworth said simply, "The wrong guy left." He called on the board to take action. And they eventually did.

The IRAA in many ways has continued on the path blazed by Pickens' USA. But the group has only recently begun tying governance issues directly to performance. In the past two years, the IRAA has focused almost completely on specific governance issues. These include the elimination of staggered boards; the elimination of outside directors' retirement plans; the use of stock rather than cash to compensate outside directors; the establishment of confidential voting; the removal of "poison pills"; the elimination of "golden parachutes"; and the promotion of independent boards not controlled by management.

Last year, for example, the group filed about 120 resolutions with 80 different companies, focusing on the exorbitant pension benefits that companies sometimes pay outside directors. The previous year, the organization focused on doing away with "classified" or staggered boards where the entire slate of directors is not up for re-election each year.

Classified boards tend to entrench management by making it difficult for large shareholders or outsiders to seize control of the company. And the threat of a takeover -- or the "market for corporate control" in the lingo of corporate governance -- is often considered the ultimate check on management performance.

The IRAA has also tackled a number of other now familiar governance issues. One of the more popular proposals has been to require companies to pay directors at least half of their compensation in stock, a strategy meant to align the board members with other shareholders. The group has also sponsored resolutions to get rid of "golden parachutes," those contract clauses that give top executives very sweet deals in the case of a merger or buy-out. Golden parachutes effectively eliminate any disincentive for executives to wreck a company, since they know rewards will be coming even if they lose their jobs.

Director compensation and pensions have also proved to be popular issues because they can often involve egregious examples of the misappropriation of shareholder assets. In one well-publicized case, for example, investors discovered in 1995 that WR Grace was paying five of its outside directors $200,000 to $600,000 a year in consulting fees, plus additional fees paid to these directors' consulting firms. Strong outside directors are the key to a board's independence, and that independence is surely in doubt when the directors are making a fortune from "consulting work" performed for the company's current management.

The IRAA has been successful in large part because the group has been able to muster support from large institutional investors, such as public pension funds and union pension funds. Institutional Shareholder Services, a proxy advisory service for institutional investors, is increasingly advising clients to vote with the IRAA, in part because many institutional investors now have written bylaws indicating that their funds support the issues. For example, CALPERS, California's large public pension fund, has stated its emphatic support for doing away with staggered election of board members. Whenever a shareholder resolution on the issue makes it onto a proxy statement for a company the fund is invested in, CALPERS will vote for it.

Of course, it's still remarkably difficult to pass shareholder resolutions. The IRAA has seen a few go through with majority support. But even gaining 30% to 45% of the proxies for a measure opposed by management can prove quite embarrassing to a company and lead to major changes. And to the extent that the IRAA has gained such wide support, companies have proved increasingly willing to negotiate settlements before the resolutions make it to a vote.

Goch said the IRAA was "extremely successful" this past year in getting companies to take action on governance issues. He said the organization has negotiated with companies such as American Express, Anheiser-Busch, Digitial Equipment, Goodrich, Johnson & Johnson, McGraw-Hill, NYNEX, Time-Warner, Sun Oil, and Woolworth, and that these companies have agreed to withdraw their pension plans for outside directors as a result.

But in the realm of shareholder activism, it has become increasingly clear that governance issues are in most cases simply a proxy for concerns about performance. And indeed, Goch said that the group is now combining both issues. About two-thirds of the companies on the IRAA's "sell-or-merge" hit list will also receive governance-related resolutions from the organization.

"We're looking for long-term performance," he said. "If you look at the companies we've targeted this year, we don't look at companies that have had a bad quarter or a bad year. We're looking at long-term dogs. And what we want are long-term performance objectives.

"We don't think the boards are good. And where we see that there are structural deficiencies in corporate governance, we're going forward and filing other resolutions with these very companies. They've been underperforming for so long that we really want to put the fire under the board there and say, 'Look. Do something!'"

Goch said that of the 27 companies on the IRAA's list so far, he expects at least four and perhaps as many as six to be taken over in the next year. Tyco Toys, for one, has already received a premium offer from Mattel. And Johnson & Johnson is rumored to be interested in Bausch & Lomb. Still, he doesn't necessarily expect the various boards to put these companies up for sale even if the resolutions pass. The point is simply to provide a wake-up call to get the business in order. "If you can't clean up your own house, give someone else a chance," he said.

Of course, there are grounds for skepticism. By the traditional laws of Wall Street, markets are seen to be working most efficiently when investors vote with their feet. Some would argue that shareholders faced with an underperforming company or an unresponsive board would do best simply to sell out and find another investment. Large institutional holders may be able to argue that such a course is not always practicable, but small investors don't have the same excuse.

At the same time, it's possible to argue that the 500 or so individual investors of the IRAA are simply paying $25 a year in membership dues to participate in an investment strategy based on coercion. Pick out a litter of real dogs and then try to force a quick fix that stops the propagation of further losses and leads to a fast pay-off from a company being bought out.

Yet Goch said the IRAA is really just aiming to provide a way for individuals already invested in these companies to be taken seriously. And there's no particular reason why "relationship investing" over the long haul can't work just as well for individuals as for large pension funds.

On the other hand, the organization's success so far owes a great deal to how closely the IRAA's shareholder proposals mirror the performance-related concerns of the institutional investors who have driven shareholder activism over the last decade. While there is nothing particularly wrong with building coalitions, the area that remains largely underrepresented is that of a "stakeholder" activism that would aim to judge corporate "performance" within a broader context of the impact companies have on employees, customers, and the communities in which they do business.

"We are strictly a shareholder advocacy group," Goch explained. "We're familiar with the conflicts of interest that can take place among the various constituents of corporations, from suppliers to bondholders to other lenders, to customers and communities. But *our* emphasis is on enhancing shareholder value."

Whether these larger issues are truly incompatible with efforts to "enhance shareholder value" remains an open question. Nevertheless, the IRAA's remarkable success so far suggests that individual investors can indeed play ball with the big boys when it comes to the proxy game. And that success should perhaps inspire other individual investors to imagine themselves as potential owner-activists.

-- Louis Corrigan (RgeSeymour)

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ROGUE ARCHIVES

Monday, December 16, 1996
Accountability Rules "What managers forget is that they are employees. And what directors forget is that they're fiduciaries." So says Robert Goch, corporate governance director for the Investor's Rights Association of America (IRAA), an organization that has quickly become a mainstay of the proxy battles that are setting new standards for corporate governance. Formed three years ago in Great Neck, New York, by members of the now defunct United Shareholders of America, the IRAA is a small but active group of individual investors who have taken up the call to investor activism. And the organization has already had significant success sponsoring shareholder proposals designed to remind corporate boards and managers exactly who the real owners are. "These resolutions are a way of getting both management and boards to recognize that they serve the shareholder," Goch said. "It's like, 'Hey, we're here! Wake up! We're paying your salaries.'" Two weeks ago, the IRAA released a list of 27 underperforming companies it will target during the 1997 proxy season. The group is still looking at other companies, as well, and may end up putting a total of 45 companies on its action list. Each company has lagged behind either the S&P 500 index or its industry peers over the past five years. "These companies have been underperforming significantly," Goch said. "Of the 30 companies, I'd say that over half have had negative non-inflation adjusted returns over the last five years. That's to say that a dollar invested in 1991 would give a shareholder less than a dollar today in non-adjusted dollars, despite the S&P averaging about 15.6% a year over this period. Those are nominal negative returns." The hit list includes Bausch & Lomb, Calgon Carbon, Drug Emporium, Goulds Pumps, Marsh Supermarkets, Occidental Petroleum, Safety-Kleen, Syms, TCBY Enterprises, Topps, and Tyco, among others. Over this period, Drug Emporium has dropped, on average, 11% a year. TCBY, the yogurt maker, has seen its shares slide by 7% a year. Topps, the popular maker of trading cards, has attracted all the enthusiasm of a washed-up second baseman, down 15% a year. Even the winners have turned in only lukewarm price appreciation, with Bausch & Lomb up 3% on an annual basis and Occidental Petroleum up 7%, both significantly underperforming the raging S&P index. The IRAA is sponsoring so-called "sell-or-merge" resolutions that would require these companies to "take immediate action to engage the services of an investment banker to explore all alternatives to enhance shareholder value," according to the group's recent news release. "The resolution is called a sell-or-merge, but it's really to explore any type of restructuring of the company," Goch said. "[I]f not [a merger or sale], an internal restructuring. That is to say, fixing some governance measures which we think lead to lack of accountability to the shareholders. I mean, we're talking about companies that have significantly underperformed a peer group." The IRAA was formed by Bill Steiner, the former chairman of the New York chapter of United Shareholders of America's, an investor advocacy group that started in 1986 but folded in February of 1994. USA was the brainchild of T. Boone Pickens, the chairman of Mesa Petroleum who became a national figure in the mid-80s when he made a series of spectacular but failed efforts to take over Phillips Petroleum Co. and Unocal Corp. In putting up $1 million to get USA started, Pickens said he wanted the group to become the "most effective grass-roots citizens lobby in Washington." And the group did eventually claim 65,000 members. But what it seemed designed to do, mainly, was get rid of the anti-takeover measures that had thwarted Pickens' ambitions. As THE WASHINGTON POST reported at the time, Pickens argued that the "decline of big business in this country is the fault of a selfish, entrenched, myopic management." The newspaper noted that he was "seeking support for a nationwide campaign to force top managers to be more accountable to shareholders. Run his way, companies would be leaner, smaller and more profitable, jettisoning operations that cannot keep up competitively. 'I think I can make a difference in the competitiveness of this country,' he said." "We will call attention to specific examples of management entrenchment and shareholder ripoffs," Pickens said in launching the USA. "In other words, we will be kicking butts and taking names. We're going to phase out the good ol' boys." The USA found natural allies in large public pension funds which were also becoming more active at the time. Indeed, the efforts of corporate executives in the mid 1980s to set up "poison pills" and other obstacles to hostile takeovers contributed a great deal to turning the often arcane issues of corporate governance into the grounds for a shareholder revolt. That's because poorly performing management was often protected by governance structures that made it hard for shareholders to exert power. USA played an active role in pushing for change at the large companies that had proved simply too large to experience the hostile takeover boom of the 1980s as a legitimate threat. For example, USA president Ralph Whitworth pushed for a transformation at IBM, even calling for the company to be split into parts shortly after Louis V. Gerstner, Jr. took over as CEO at IBM in July 1993. Whitworth also played a vocal role in sparking the ouster of Kay Whitmore, the CEO who had allowed Eastman Kodak to become a bloated conglomerate, slow to adjust to changes in the marketplace. When in April of 1993 turnaround specialist Christopher J. Steffens left his post as Kodak's chief financial officer after only 12 weeks on the job, Whitworth said simply, "The wrong guy left." He called on the board to take action. And they eventually did. The IRAA in many ways has continued on the path blazed by Pickens' USA. But the group has only recently begun tying governance issues directly to performance. In the past two years, the IRAA has focused almost completely on specific governance issues. These include the elimination of staggered boards; the elimination of outside directors' retirement plans; the use of stock rather than cash to compensate outside directors; the establishment of confidential voting; the removal of "poison pills"; the elimination of "golden parachutes"; and the promotion of independent boards not controlled by management. Last year, for example, the group filed about 120 resolutions with 80 different companies, focusing on the exorbitant pension benefits that companies sometimes pay outside directors. The previous year, the organization focused on doing away with "classified" or staggered boards where the entire slate of directors is not up for re-election each year. Classified boards tend to entrench management by making it difficult for large shareholders or outsiders to seize control of the company. And the threat of a takeover -- or the "market for corporate control" in the lingo of corporate governance -- is often considered the ultimate check on management performance. The IRAA has also tackled a number of other now familiar governance issues. One of the more popular proposals has been to require companies to pay directors at least half of their compensation in stock, a strategy meant to align the board members with other shareholders. The group has also sponsored resolutions to get rid of "golden parachutes," those contract clauses that give top executives very sweet deals in the case of a merger or buy-out. Golden parachutes effectively eliminate any disincentive for executives to wreck a company, since they know rewards will be coming even if they lose their jobs. Director compensation and pensions have also proved to be popular issues because they can often involve egregious examples of the misappropriation of shareholder assets. In one well-publicized case, for example, investors discovered in 1995 that WR Grace was paying five of its outside directors $200,000 to $600,000 a year in consulting fees, plus additional fees paid to these directors' consulting firms. Strong outside directors are the key to a board's independence, and that independence is surely in doubt when the directors are making a fortune from "consulting work" performed for the company's current management. The IRAA has been successful in large part because the group has been able to muster support from large institutional investors, such as public pension funds and union pension funds. Institutional Shareholder Services, a proxy advisory service for institutional investors, is increasingly advising clients to vote with the IRAA, in part because many institutional investors now have written bylaws indicating that their funds support the issues. For example, CALPERS, California's large public pension fund, has stated its emphatic support for doing away with staggered election of board members. Whenever a shareholder resolution on the issue makes it onto a proxy statement for a company the fund is invested in, CALPERS will vote for it. Of course, it's still remarkably difficult to pass shareholder resolutions. The IRAA has seen a few go through with majority support. But even gaining 30% to 45% of the proxies for a measure opposed by management can prove quite embarrassing to a company and lead to major changes. And to the extent that the IRAA has gained such wide support, companies have proved increasingly willing to negotiate settlements before the resolutions make it to a vote. Goch said the IRAA was "extremely successful" this past year in getting companies to take action on governance issues. He said the organization has negotiated with companies such as American Express, Anheiser-Busch, Digitial Equipment, Goodrich, Johnson & Johnson, McGraw-Hill, NYNEX, Time-Warner, Sun Oil, and Woolworth, and that these companies have agreed to withdraw their pension plans for outside directors as a result. But in the realm of shareholder activism, it has become increasingly clear that governance issues are in most cases simply a proxy for concerns about performance. And indeed, Goch said that the group is now combining both issues. About two-thirds of the companies on the IRAA's "sell-or-merge" hit list will also receive governance-related resolutions from the organization. "We're looking for long-term performance," he said. "If you look at the companies we've targeted this year, we don't look at companies that have had a bad quarter or a bad year. We're looking at long-term dogs. And what we want are long-term performance objectives. "We don't think the boards are good. And where we see that there are structural deficiencies in corporate governance, we're going forward and filing other resolutions with these very companies. They've been underperforming for so long that we really want to put the fire under the board there and say, 'Look. Do something!'" Goch said that of the 27 companies on the IRAA's list so far, he expects at least four and perhaps as many as six to be taken over in the next year. Tyco Toys, for one, has already received a premium offer from Mattel. And Johnson & Johnson is rumored to be interested in Bausch & Lomb. Still, he doesn't necessarily expect the various boards to put these companies up for sale even if the resolutions pass. The point is simply to provide a wake-up call to get the business in order. "If you can't clean up your own house, give someone else a chance," he said. Of course, there are grounds for skepticism. By the traditional laws of Wall Street, markets are seen to be working most efficiently when investors vote with their feet. Some would argue that shareholders faced with an underperforming company or an unresponsive board would do best simply to sell out and find another investment. Large institutional holders may be able to argue that such a course is not always practicable, but small investors don't have the same excuse. At the same time, it's possible to argue that the 500 or so individual investors of the IRAA are simply paying $25 a year in membership dues to participate in an investment strategy based on coercion. Pick out a litter of real dogs and then try to force a quick fix that stops the propagation of further losses and leads to a fast pay-off from a company being bought out. Yet Goch said the IRAA is really just aiming to provide a way for individuals already invested in these companies to be taken seriously. And there's no particular reason why "relationship investing" over the long haul can't work just as well for individuals as for large pension funds. On the other hand, the organization's success so far owes a great deal to how closely the IRAA's shareholder proposals mirror the performance-related concerns of the institutional investors who have driven shareholder activism over the last decade. While there is nothing particularly wrong with building coalitions, the area that remains largely underrepresented is that of a "stakeholder" activism that would aim to judge corporate "performance" within a broader context of the impact companies have on employees, customers, and the communities in which they do business. "We are strictly a shareholder advocacy group," Goch explained. "We're familiar with the conflicts of interest that can take place among the various constituents of corporations, from suppliers to bondholders to other lenders, to customers and communities. But our emphasis is on enhancing shareholder value." Whether these larger issues are truly incompatible with efforts to "enhance shareholder value" remains an open question. Nevertheless, the IRAA's remarkable success so far suggests that individual investors can indeed play ball with the big boys when it comes to the proxy game. And that success should perhaps inspire other individual investors to imagine themselves as potential owner-activists. -- Louis Corrigan (RgeSeymour)