Why Investors Push for Strong Corporate Boards

Abstract

CEOs who resist pressure for strong governance risk having institutional investors or regulatory bureaucrats tell them what kind of board they should have Trustees and staff of the California Public Employees' Retirement System are developing guidelines to grade companies in Calpers' portfolio according to the independence of their boards. Calpers cannot be ignored: its $80 billion in equities makes it one of the nation's largest shareholders and a force to be reckoned with in the governance arena. A study conducted with Diane Del Guercio at the University of Oregon shows that Calpers has the power to provoke significant changes, such as takeover attempts, shifts in turnover, restructurings, and asset sales. CEOs would be wise to embrace the idea of strongly independent boards. For if investors can't get boards to work well, they may resort to other measures: sitting on boards themselves, lobbying for direct government regulation, or supporting a return of corporate raiders. The battle for governance The growing power and independence of boards in the United States represents a reversal of a trend that dates back to the early years of this century. A seminal event occurred in 1914, when representatives of J. P. Morgan resigned from 30 company boards in a single day. They and other institutional investors had held sway in boardrooms for more than two decades, leaving CEOs with little real decision-making power. But as they came under critical public and political scrutiny, these investors beat a hasty retreat. Meanwhile, family owners were also losing influence as company founders aged and ownership tilted toward outsiders. So a new group of professional CEOs, bred in new management schools, took the reins of corporate America. Their grip loosened in the 1950s, when an economic boom drove a wave of investors into stocks. Increased individual ownership raised expectations and fed a belief in shareholder democracy. New regulations requiring the disclosure of senior management pay, along with the rise of the corporate raider, spurred a growing number of contested elections for boards, known as proxy contests. Following a concerted lobbying and publicity effort on governance issues by the Business Roundtable, new regulations introduced in 1956 clamped down on proxy battles, and CEOs prevailed at the end of the decade. Today, institutional investment is booming again. After falling as low as 15 percent in the 1940s, institutional ownership returned to turn-of-the-century levels of 50 percent and higher in the mid-1980s. Takeovers flourished in the 1980s environment of few regulatory restrictions and easy financing via junk bonds. Then public opinion turned against raiders, state regulations and court decisions made takeovers more difficult, junk bonds dried up, and management created innovative defences against takeovers. Many CEOs believed they had won the governance battle. However, institutional investors sought other ways to prod CEOs. In 1992, the Securities and Exchange Commission (SEC) made it easier for investors to coordinate on governance issues. Shareholders issued hit lists of under-performing companies, announced their own proposals, and communicated directly with management. But it didn't make sense for Calpers and other institutions to intervene in each of the thousands of companies whose stock they held. They turned instead to boards - shareholders' elected representatives - as management watchdogs. …