8/28/89
Institutional Fund Managers and Other People’s Money
By: Shepard D. Osherow
Chairman & Chief Executive Officer
Osherow Siegel Capital Corporation
There was a time when a share of a corporation’s stock was considered to be an investment in its future. As idealistic as this may sound today, it is (or was) a concept at the heart of the capitalist system. The purchase of a stock made the bearer a partial owner of that company and therefore entitled to a proportionate voice in issues brought before the shareholders. Years ago, when the market was predominately comprised of individuals who placed their own money into equities, the assumption was that whatever voting power accrued to the shareholder would logically be used to enhance the performance of the firm, (and hence the investment) over time.
In 1989, however, between 50 to 70% of all publicly traded stock was “owned” by institutions and/or invested via professional managers and arbitragers who vote with no regard for anything but immediate profit. More importantly, however, through the powers extended to the fund managers via proxy voting institutions are fast becoming a highly vocal factor in the corporate board rooms of public companies, exercising increasing control over issues ranging from their day to day operations to long-term business strategies.
What’s wrong with this picture? Plenty. Because the so-called “managers” who are exerting this influence on corporate structure and strategy are, first, not professional business managers at all but private or government employees rewarded largely for their attempts to generate increased returns over short periods of time. Secondly, these people invest (and vote) with money that actually belongs not to them, but to the wage-earners who have virtually no say in where their pension money is invested or how that investment may ultimately affect their own job security in the years to come.
The reality is that this deferred voting power could have a lasting and quite possibly detrimental effect on the very people the pension funds are supposed to benefit: the pensioners themselves.
What we are witnessing is the institutionalization of American business. It was inadvertently spawned by ERISA and Federal and legal constraints making it virtually impossible for pension funds not to take a higher price on a company under hostile or otherwise leveraged attack. This has placed unchecked power behind institutional investors to influence and undermine corporate management’s control over businesses they’re paid to run. Their understanding and utililization of this phenomenon has provided the impetus (and resources) necessary to encourage complex legal buyouts and hostile M&A arrangements among corporate raiders and aggressive financial exploiters alike. Many of these deals couldn’t happen without the supporting power institutional funds wield through proxy power.
How did this come about? By encouraging the Funds to vote and sell to the highest immediate bidder, government, legal and performance fears have focused the institutions toward short term market performance. This offers scant incentive to finding the competent business managers to lead American companies, the best of whom operate towards disciplined, long range objectives. Instead, it has become commonplace to read about takeover coalitions of institutions, bankers, and M&A speculators manipulating even successful businesses for immediate profits and huge fees. This attitude has become so pervasive through the availability of tax deductible debt we’ve come to casually accept such absurdities as Pan Am’s bid to acquire NWA, or investor groups leveraging ownership based on massive “junk bond” issues and bank loans.
Corporations which have endured withering proxy fights over the last few years are, of course, a matter of rapidly expanding public record. On many levels the investment community and major institutions specifically, have been aroused into a frenzy of so-called “shareholder” activism. This has been supplemented through mutual collaboration among the fund managers, imbuing them with make-or-break prerogative at the board room table One such cooperative pairing, forged initially during the battle for Texaco, recently surfaced again in a situation which broadly illustrates the issues at stake”.
In May of 1989, Honeywell Inc. management unsuccessfully fought an aggressive shareholder action intended to contain the company’s efforts to protect itself from hostile takeover. Spearheading the assault were two public pension funds and a group of Texas financial specialists. Together they not only succeeded in neutralizing the firm’s anti-takeover measures, they also demanded strategic changes in the firm’s approach to its business, including recommending divesture of assets and repurchase of stock.
Who, exactly, were Honeywell’s new, self-appointed business “advisors”? One was a 26 year old former takeover analyst at Goldman Sachs; another a Labor Department pension administrator who is a self-proclaimed shareholder’s rights advocate and institutional consultant. The California Public Employees Retirement System (CALPERS) and the Pennsylvania Public School Employee’s Retirement, (well acquainted through their successfully united efforts during the Texaco affair), rounded out the group. As of early May, these combined entities held 4.5% of Honeywell’s outstanding shares on behalf of their constituents. Yet their assertive action in winning the proxy fight with Honeywell management infused them with powerful leverage over the basic composition and direction of that company.
Who elected these people to this exalted and influential position? It’s certainly doubtful whether California’s public employees or Pennsylvania’s school workers even know who their fund managers are, let alone their qualifications to manage either their money or a business. Never-the-less, the “Fund Financiers” and a growing number of their contemporaries have assumed a power and authority based not on their own assets but on those of the pension contributors they are hired to serve.
What knowledge, experience and talent in their respective backgrounds qualify them to take major, long-term business decisions on behalf of a billion dollar corporation? Has any one of them actually run a multi-national business?
Does a career as a Labor Department administrator, take-over artist, or pension fund manager hone executive skills worthy of board room level influence over a company as diversified and globally significant as Honeywell? Is their “advice” good for Honeywell? Is it good for the country? (Honeywell is a leading defense contractor). More to the point, is it good for the working people whose jobs and future retirement security depend upon these decisions?
To be fair, Honeywell itself has not demonstrated strong performance of late under its existing leadership, having suffered significant losses in 1988. Yet its management is currently making a sincere effort to refocus and reposition itself against its strongest, most profitable opportunities. Whether successful or not in the end, it can be reasonably assumed their intentions are to preserve the firm as a profitable, individually managed and publicly owned entity over the long-term.
By contrast, it is difficult to imaging the moves recommended to date by the proxy group are strictly designed with the prolonged health and independence of the firm in mind. One might easily conclude, in fact, given the history of the players involved, that their objective is merely to enhance Honeywell’s viability as a takeover target.
The fundamental question in this and an escalating number of similar situations remains whether these recommendations are to the long-term benefit of the people who really made this power play possible, in this case California’s public employees and taxpayers and Pennsylvania’s educators. Were they consulted about the repercussions from a potentially dismantled Honeywell? Have they pondered over what happens to their own job security if Honeywell is forced to divest itself or divisions, subsidiaries, or manufacturing plants in California and Pennsylvania?
These are difficult, far-reaching considerations. Yet sadly, it is too frequently short-term profit that seems to drive today’s aggressive pension fund strategies. Though professing to be a “quintessential long-term investors”, the average fund officer is unlikely to be around and accountable by the time most contributors are collecting their pensions. He is apt to be far more concerned whether return on the assets he manages exceeds the markets’ this quarter or next; or, in the case of government officials, how such decisions will affect his political aspirations. It’s “bird in the hand” decision-making, built upon the realities of the business and the regulations which govern it.
As these investment professionals flex their expanding muscle and crow about their new-found clout, one must wonder---who’s looking out for the guy whose money is really on the table? How many of the funds’ beneficiaries truly reap the rewards from excess returns created by an LBO or corporate raid? Most pension plans offer fixed benefits to their participants anyway! Who, then, actually reaps the profits? The answer is obvious: It is the investment bankers, LBO/M&A specialists, corporate raiders, and pension fund manager engineering these deals that have the most to gain, along with the arbitragers and a few fortunate stock speculators.
Who loses? All of us, in some way. Jobs and careers are destroyed or displaced as mergers and/or highly leveraged firms are forced to sell off their assets to cover awesome debts, resulting in unemployment and closed factories. As taxpayers, we lose vast revenues as these firms finance themselves through debt instruments written off at public expense due to substantial interest accruals to tax free institutions. And, as a nation of producers, we suffer a debilitating corporate and investment mentality which rewards short-sighted, self-protective business thinking instead of commitment, planning, and reinvestment for the future. It is the legacy of too much power concentrated in too few hands.
Not surprisingly, this burgeoning usurpation of economic might has come under congressional scrutiny. The new Chairman of the Senate’s Budget Committee, Senator James Sasser, has taken an active interest in whether pension fund managers are prudently serving the interest of both their contributors and American industry as a whole. Even Secretary Brady of Treasury has reportedly been considering ways to encourage these managers to invest, with a more long-term view of the country. To date, however, Government is clearly nervous about the repercussions of taking serious action and risking tremors on Wall Street. Yet failure to address this issue squarely could result in a crisis on the magnitude of the savings and loan industry as we continue to officially sanction highly leveraged debt as a viable means to own and manage major businesses. Sooner or later the bill comes due, and it will be the taxpayers and true stockholders who are left holding it in the end.
Why not, instead, cut to the source of the issue? Why not ban voting entirely for institutional fund managers and arbitragers who invest other people’s money? It would compel a less proactive evaluation of investments, encouraging analysis based on real earning power over time rather than how they might be manipulated for quick gains. Secondly, eliminating proxies should help curb abuse of shareholder power for the benefit of risky LBO’s offering dubious benefit to employees and shareholders alike. Finally, if there is an issue of critical importance to pension fund shareholders, it will be the obligation of both the fund overseer and corporate management to marshal the vote directly. This means, of course, devising an efficient method of polling fund constituents on the virtues of whatever issue(s) are at hand. No small consideration, certainly, but hardly impossible given the agility of electronic communication today.
Concurrently, it is also time to review the rules of ERISA, with due consideration given to ways to stimulate long-term investing. Perhaps if pension managers’ incomes were tied to five and ten-year annuity payouts, based on their fund’s performance over that period, we might witness more attention paid to the broader implications behind institutional “macro-investments”. The shareholder can thus retain some control over his own benefit program through direct voting, while the pension manager can focus on that which he is presumably best equipped to do: manage investment allocations for long-term safety and growth.
Business as a whole would benefit, as well. Such natural obstacles to amassing vast proxy leverage might gradually impede the near desperate “urge to merge” afflicting corporate America today. Despite the jargon of Wall Street’s players, sound investing for the future of one’s business or personal life is not a game. Virtually every LBO or M&A deal arranged behind backroom doors eventually affects the lives of hundreds, even thousands of people whose opinions were never consulted.
Exposure to the facts and possible repercussions of a highly leveraged takeover might give shareholders pause before opting for the easy, short-term gain. Perhaps an aware constituency will respond as the Northwest Airlines pilots did to the financial harpies hovering over NWA Inc. In a national ad in the Wall Street Journal they warned: “We will not willingly place our future in the hands of an unknown party whose highly-leveraged acquisition plans can only be financed by the breakup value of all or part of this corporation”.
This frequently buffeted group is all too aware of the consequences of Wall Street gamesmanship. They’ve learned the hard way about leaving their fate in the hands of a few financial quick-turn artists. Similarly, as long as the public remains apathetic about its investment rights, it will be left to the few to assume authority and stir the pot at their discretion…and for their benefit.
If “shareholders’ rights” is to be truly meaningful and representative issue, it must be made applicable to the actual shareholders themselves. It should refer to their right to vote as they invest, rather than as a cover for blatant corporate extortion by a select few. It is time we expose the ironies at play here and uphold the principles upon which our nation and its commercial enterprise system were founded. When it’s other people’s money at stake, those other people ought to have the right to vote their choice!
