If you are not performing, you are out. That's the message US institutional investors are sending the managements of companies they hold a stake in. And it could soon be echoing round British boardrooms, too.
Michael Price doesn't look particularly frightening. Stocky, fit, impatient he certainly is, but you don't get the impression when talking to him that he is the kind of fund manager who bites the heads off little babies. You have to remind yourself that this is a man of whom some of America's biggest corporate executives live in dread.
He has recently stepped into the British arena as a partner in Paul Reichmann's purchase of Canary Wharf. In America, however, he is best known as the man who precipitated the merger of Chase Manhattan and Chemical Bank to form the largest banking group in the US. Shortly before that he had put Michigan National Bank into play - it was bought by National Australia Bank. Price is, in short, the doyen of America's new style of institutional investors, whether they are private fund management companies like his, or mutual funds or pension funds. When he takes a stake in a company, the company's management know they are on the spot. If they don't perform, their company is likely to be sold from under them.
This, to be sure, is at the more aggressive end of institutional investment behaviour in the US. But Price is nevertheless representative of the new wave of US institutional thinking which puts shareholder value above everything and does not shrink from taking drastic action against companies that persistently fall short. It is a movement that gained momentum when CalPERS - the Californian Public Employees Retirement System - adopted a new investment philosophy 10 years ago and is now embraced by a wide range of US institutions.
It also stands in sharp contrast to practices in Britain. Although British institutions have been moving cautiously in the direction of greater intervention, the debate about corporate governance and shareholder value has generated more words than actions. The Cadbury report is viewed with respect in the US, but the way companies continue to flout it, and the way investors let them get away with it, is not. US investors like Price and CalPERS demand that issues of corporate governance are acted on with concrete results or they resort to strong-arm tactics.
In Britain, institutional investors almost never speak publicly about misgivings they may have about a company. It is regarded as bad form and may disrupt the investors relationship with the company which UK institutions often seem to regard as a kind of sacred pact. Everything is dealt with in the privacy of corporate luncheon rooms where investors have 'a quiet word' with management. Which, as often as not, is completely ignored when lunch is over and the investors have gone.
Make no mistake, however, that things will stay that way forever. Price, for example, has been investing in the UK since 1985 and is likely to become considerably more high-profile following the Canary Wharf deal. CalPERS, meanwhile, has recently decided to extend its corporate governance philosophy to its investments overseas - including the UK - which amount to several billion dollars. Other US institutions are certain to follow suit as they diversify abroad and bring their own investment culture with them. It is usually unwise to ignore the dictum that what happens in the US sooner or later comes to Britain.
The basis of the US approach is that the ownership rights of shareholders are not just theoretical but should be exercised, and that company managements must be accountable. A few years ago, when CalPERS started its campaign, this seemed far from obvious. 'Often when we were worried about a company in which we held shares, the management would not even see us,' says William Crist, head of corporate governance at CalPERS.
In Britain the attitude among most fund managers is still that the share price says everything. If you don't like a company you sell its shares, much as you would sell any other commodity that looked like a bad investment. That is what the stock market is for. The company is then supposed to see its falling share price and mend its ways.
But CalPERS had a problem. It was a large and rapidly growing pension fund - in the last eight years it has trebled from $30 billion to $90 billion. 'When you are that big, you cease to be a stock-picker,' says Crist. 'You buy the market.' The majority of CaLPERS funds are therefore indexed. 'We cannot just sell out of a company if we think it is badly managed. We're too big. Just to dump our stake in a company would hurt the share price, which would hurt us and the company.' Treating shares as if they were mere commodities to be bought and sold on a whim - a process known in the US as the 'Wall Street Walk' - therefore ceased to be an option. Moreover, it was the late-'80s and many executives were treating their companies like personal fiefdoms. The greenmailers and the corporate raiders of the 1980s who had been seeking slices of the coporate pie disproportionate to their capital risk had been discredited. What was a large institutional investor to do if it thought a company in which it had shares was seriously underperforming?
The answer found by CalPERS and an increasing number of other investors in the early 1990s was to tackle the management head-on. Over the last few years CalPERS has been involved in a series of very public confrontations with companies, and many more private ones. To begin with, it was operating mostly on its own but the climate has changed and now a large portion of the investment community has adopted the same strategies. Funds as diverse as the Wisconsin, New York and Florida state retirement schemes, the Teamsters Union funds and the Campbells Soup pension scheme practise intervention.
What they were looking for was underperforming assets that could either be better used or sold: inefficient corporate structures; boards packed with friends of the chairman instead of independent-minded directors who cared about shareholder value; an inability to communicate the company's strategy with the stock market.
The linchpin of this movement is the Council of Institutional Investors (CII), set up 10 years ago by like-minded funds to co-ordinate their fledgling efforts to deal with corporate governance problems. The CII started out mainly with pension and state funds - non-commercial investment managers who were not competing with each other but merely wanted better returns. Gradually, however, commercial fund managers such as mutual funds (the US equivalent of unit trusts) have seen the value of joining and the CII has become a key player with more than 150 funds as members, in the drive towards more shareholder intervention in company affairs.
Early in its life, the CII asked to meet General Motors chairman Roger Smith, says Peter Gilbert, investment officer for the Pennsylvania State employee retirement scheme, to discuss the company's problems. Smith refused point blank to meet his investors. In October this year, by contrast, the chairman of Chrysler came to the CII annual conference to deliver a spirited defence of his policies in the face of attacks by Kirk Kerkorian, one of Chrysler's shareholders. Clearly, Chrysler feels it needs the CII's good opinion.
Not everyone has joined in this movement, of course. Fidelity, the largest fund manager in the US with around $350 billion under management, still prefers the Wall Street Walk. 'We generally don't get involved in intervention,' says a spokesman. 'Meetings with management are very important for us, but if management won't listen we can always sell the stock. We're not trying to reform corporate America or change the corporate governance world.' He concedes, however, that the efforts of the interventionists has created a better atmosphere for investors.
The usual complaint heard from British institutions is that intervention is simply too costly in management time. But the significant discovery made by CalPERS and others was that intervention actually makes money. An outside study of its investments commissioned by CalPERS in 1994 concluded that 42 companies targeted for intervention by the fund between 1987 and 1992 underperformed the Standard & Poor's 500 index by 66% for the five years before the fund acted. In the five years following intervention, however, they outperformed the index by 41% This, ultimately, is why intervention has caught on among US investors.
The New York State pension fund is another investor that has started assessing companies on the basis of whether they require intervention. Key factors included whether the companies under-used assets, and whether they had a management structure capable of rectifying their underperformance. In 1994, for example, it came up with a list of nine. Within six months, two of these had been taken over and one was the subject of a hostile takeover. In some cases, this type of analysis often throws up companies that are about to see a sudden rise in their share price anyway. 'Performing the stock selection analysis with an eye towards future intervention, ironically, often means that intervention is not necessary,' says Jon Lukomnik, controller of the New York fund.
And few have become such enthusiastic and profitable exponents of intervention as Michael Price. For more than a decade he has owned and run Heine Securities as its funds under management have grown from $5 billion to more than $11 billion. Through a policy of extreme intervention, Price has grown so rich that he will not, for example, admit just how many polo ponies he owns on his estate in the exclusive part of New Jersey where he lives. His firm operates from a nondescript office near his mansion in Short Hills, but his investment policy is anything but characterless.
Last April he bought a 6.1% stake in the problem-ridden and poorly performing Chase Manhattan Bank. In his filing to the Securities and Exchange Commission (SEC) announcing the purchase he stated baldly that the bank should now 'seriously consider taking steps to realise the inherent value in its business in a manner designed to maximise shareholder value'. To Wall Street, this meant Chase was in play and its shares raced up $20. Within months, the bank was merging with Chemical which most analysts agree is a sensible and long-overdue move.
Price insists, however, that he is not indulging in some disguised form of corporate raiding. 'We don't tell managements how to do their job. But every now and then we find a company that is doing something wrong. We ring them up and ask why they are doing it this way.' Only occasionally does this lead to forcing the company to sell itself. 'You can't be too interfering or you end up with a situation like Saatchi & Saatchi where the top guy walks out and all the business with him.' The point is simply to keep reminding company managements that their duty is to make the most of the capital under their control for the benefit of their shareholders.
Price has played in the UK stock market since the mid-1980s, having invested in the likes of Bass, Lonrho, Thorn EMI, and RTZ at one time or another. The experience has left him with the conviction that British investors are still way behind the Americans in corporate intervention. 'The problem with London is that the investment community is so small. The institutional investors are all competing against each other so they don't talk to each other enough. In the US, the investment community is very diverse and we spend a lot of time talking.' In a few telephone calls, he says, he can discuss the problem company with its other leading shareholders. A crucial factor in this was a change in the SEC's rules in 1992 which lifted a ban on large shareholders talking to each other. Now shareholders can communicate with each other to their hearts' content, enabling them to reach a consensus about what is wrong and what should be done. This may mean blocking a deal proposed by management, changing its business policy or even sacking some directors. It is a stark contrast to the secrecy and fragmentation of the City which often allows company managements to play one set of investors off against another.
The effect of the new interventionism, however, has not only been seen in the companies targeted by investors. In the opinion of many analysts, much of corporate America is now looking over its shoulder to check the reactions of shareholders. According to Rick Escherich, managing director of J P Morgan's M&A group, the current wave of corporate takeovers in America is driven largely by the desire among corporate managements to deliver higher shareholder value. Gone are the crazy, highly leveraged, junk-bond financed deals of the 1980s. Now there is a new sobriety in which take-overs must be justified by clear strategic goals and supported with sensible, conservative financing. Most executives now know that if a deal turns out to have done nothing for their shareholders, their shareholders may put them out of a job.
US Poor performers
Little list of offenders whose managements may soon be missed
In the US, as in Britain, there is no shortage of underperforming companies. Since 1991 the Council of Institutional Investors has been regularly publishing a 'Focus' list of 20 of what it considers to be the worst performing large companies. It is the corporate equivalent of being put on the school detention list.
The CII measures all companies in the Standard & Poor's 500 index - the standard US stock-market index on a one-and five-year measure of total returns to shareholders. It then compares each company to the average of its particular industry sector. Companies are measured against the averages for their particular industry on one-and five-year total returns to shareholders. The bottom 20 are then published for all to see. 'It is a clear and simple methodology so no one can dispute our results,' says Alyssa Machold, deputy director of the CII. 'The companies on the list get a letter from us asking them to explain why their performance is so bad.' The list is meant as a kind of warning shot across the bows of companies named. 'You can see it is a gentle reminder or a kick in the pants,' says Machold.
CII members can then use the list to decide which companies among their investments need improvement. Many members, however, have lists of their own which they make public, depending on how negotiations go with the companies involved. 'After screenings we get 10 target companies a year,' says William Crist, head of corporate governance at CalPERS. 'We tell the managements of each company and try to meet their managements.
'If they are responsive, understand our worries and listen to our suggestions that's OK. We watch them for a year to see how they do.' If they are not responsive, CalPERS raises the ante. It publishes the names of the recalcitrant companies in the press, talks to journalists about its concerns over the companies and generally makes its concerns known to the public and to other shareholders.
If even this is not enough to shame or frighten a company management into paying attention, CalPERS wheels out the heavy guns in the form of shareholder proposals and proxy votes. By then it is likely to have started a groundswell of opinion among other shareholders so it is rarely acting alone.
Over the last few years even such massive companies as General Motors, ITT, Sears and K Mart, the retailing chain, have been forced to adopt new corporate strategies by these methods.
If this still does not work, investors may turn to the nuclear option of sacking directors. This is no idle threat. It happens quite often and corporate executives have come to regard it as a serious risk.
CalPERS, indeed, now finds that the best results often come from focusing directly on the executives themselves. With its target companies it has recently started a programme of monitoring the performance of the individual senior executives. It has a questionnaire of performance criteria for each individual which it requires the company to fill in. If an executive does not seem to be pulling his or her weight, CalPERS wants to know why. If the company's replies are not satisfactory, the executive involved will probably have to start considering employment elsewhere. Suddenly, personal responsibility is not just a theory but something that shareholders want to see proven, particularly when executives are earning telephone-number salaries. US investors are finding that the option of 'perform or get out' often has a magical effect on the returns executives produce for their shareholders.
The CII Focus List 1995 (in alphabetical order) Alza Corp.
Cooper Industries Inc.
Cray Research EG&G Inc.
Genuine Parts Co.
Longs Drug Stores Inc.
Morrison Knudsen Corp.
NACCO Industries Northern Telecom Ltd Ogden Corp.
Toys 'R ' Us Inc.
Tyco International Ltd United States Surgical Corp.