Ownership and Sustainability: The Case for Shareholder Activism
Robert Monks is the world's highest profile shareholder activist. He founded Lens, an institutional shareholder activist fund, and Institutional Shareholder Services, now the leading provider of proxy voting and corporate governance services. He served in the Department of Labor as Administrator of the Office of Pension and Welfare Benefit Programs, having jurisdiction over the entire U.S. pension system, and has served on numerous corporate boards of directors. He is the author of several books, including The Emperor's Nightingale: Restoring the Integrity of the Corporation in the Age of Shareholder Activism, The New Global Investors: How Shareholders Can Unlock Sustainable Prosperity Worldwide, and Corporate Governance (with Nell Minow).
Multinational Monitor: The subtitle of your recent book is "How Share Owners Can Unlock Prosperity Worldwide." How can they do that?
Robert Monks: There needs to be a recognition, first by trustees, and secondly by the participants in pension plans and mutual funds, that they actually are owners of corporations. There isn't any real feeling yet that there is a connection between the pieces of paper that people have and ownership.
As soon as this concept becomes widespread and accepted, it then becomes possible for the trustees who collectively are the dominant owners of corporations to consider what kind of corporate policies are in the interests of their beneficiaries.
By far the largest category of shareholder are the pension funds. In the pension funds, on average, the beneficiaries have 18 years to work until retirement, and they are all anxious to have adequate money to retire; but they also want to retire into a civil, clean, safe world. That means that the trustees can develop corporate policies that are in aid of these long-term objectives.
In my view, when ownership becomes effectively asserted, the likelihood of corporations being run in a sustainable manner is vastly improved.
MM: To what extent are shareholders now exercising this power?
Monks: We are just beginning to see effective shareholder action. We've seen it on the downside in a couple of situations in the last five or 10 years: Salomon Brothers and Waste Management where rather well-known activist investors became involved and jobs were saved and money was saved.
This contrasts with situations like Enron where everything was lost because there really wasn't an effective ownership interest.
The beginning of ownership concern is evident in groups being formed by people such as Jack Bogle, the founder of Vanguard, who has begun to try to get the mutual funds to collectively recognize that they have substantial ownership position and that that bears with it certain responsibilities.
On the pension side, the trustees have been allowed to flagrantly violate the law, which has not been enforced, and avoid their fiduciary duties. Until the law is enforced by the Labor Department, it is unlikely that we will have participation by the pension funds to as large an extent as would be necessary to achieve a result.
MM: What is the mechanism for action? If shareholders, through mutual funds, or pension funds, or otherwise, decide that they are owners, what can they do to influence and shape corporate performance?
Monks: There is a descending scale of what they do. Ideally, they go talk to the chief executive officer and they have an idea of policies that they are interested in. If the CEO is not availing, they might talk to the directors. Failing that, they could file shareholder resolutions. Failing that, they could elect their own board of directors.
MM: What would shareholders do that is different from what management would do?
Monks: The first place where in today's world you can think that there would be a difference is in the compensation of managers. CEO pay has gone up 1,000 percent in the last 10 years. That probably would not have happened if owners had been effectively involved in the governance of corporations. I think this would be a place where they would want to start.
MM: What about other areas? In what ways would shareholders have a different approach than management?
Monks: I think that managers, with a preoccupation for fairly short-term profits, would be unlikely to share the same kind of objectives for value that shareholders have.
But managers can be compensated to achieve the results that shareholders want. It is really a matter, then, of designing the compensation arrangements so that the incentives create the kind of activity that the owners want, rather than leaving the managers to work at cross purposes to what the long-term owners want.
This process is quite far advanced in the United Kingdom. In over the last two or three years, there have been requirements for owners to set forth what they expect of companies, and the companies have been required to set forth how they are responding to this.
MM: You talk in the book about a framework of long-term ownership and a clear fiduciary framework to advance this agenda. What do you mean when you talk about long-term ownership?
Monks: I mean basically the 18-year period that the pensioners have to serve until they retire.
The problem has been that everyone has talked very loosely about corporations being run for the benefit of the shareholders. But there has been almost no attention paid to the incredible range of shareholders. There are shareholders who are index shareholders, who are there not because of any volition on their part, but because of a mathematical formula; there are shareholders who are part of in-and-out trading programs every day; there are shareholders who are arbitrageurs; there are shareholders who are in for mutual fund accounts. Each of these groups has a different interest.
I have suggested that the pensioner is the shareholder for whom the corporation ought to be run, and that the frame of reference ought to be 20 years. That is simply because that is the amount of time until the pensioner retires.
I have on my web page a computer model that we have worked out, called Brightline, which attempts to show the implications of what I would call societally sensitive conduct of a corporation, as contrasted with a corporation that externalizes liabilities over a 20-year period. The thing that is interesting is that, while a more ruthless company does better in the short run, in the longer run, the companies that are compliant do better.
MM: But, assuming that is true, isn't it in the shareholder interest to reap those benefits for the short term and then get out before the company suffers long term damage?
Monks: My premise is that it is the pensioners who are the shareholders. By and large, the pension holdings are indexed and therefore, a pensioner will always have a piece of Shell, they will always have a piece of General Motors, they will always have a piece of Microsoft.
The idea of trading is really a theoretical one. It is good for brokers and it is good for short-term trading strategies, but in the pension accounts, the pensioners are by and large permanent owners.
Public pension funds, like state funds and FERS, the Federal Employee Retirement System, are in the case of FERS legally obligated and in the case of the states practically obligated to be indexed.
That is because in order to get the higher rate of return that traditionally is attributed to equity in contrast to debt investment, they have to deal with the American aversion to socialism. By and large, Americans do not want government owning business. If government, through the medium of pension funds, becomes the significant or controlling owner of businesses, that looks like backdoor socialism. The only way that can be coped with is if they buy an index and simply have a neutral attitude about industry and companies.
So there is going to be a very substantial portion of the ownership that is going to be permanent ownership. That is a very important grounding element as one develops the policies as to how to run a corporation.
MM: The second portion of your formula is a clear fiduciary framework. What does that mean?
Monks: Well, suppose you own stock in a company. Nobody can tell you that you have got to vote. You don't have to vote. You have a piece of paper, you can throw away your vote if you want to.
A trustee, on the other hand, has a legally enforceable obligation to manage the assets of the trusts for the long-term benefit of either the plan's participants or the beneficiaries of the mutual funds. They are not legally entitled to ignore the voting responsibility. A trustee must manage with an eye to all aspects of value, and it is increasingly clear that ownership has value.
It is not a matter of will. It is not a matter of people wanting to exercise the power; they have to, they are legally obligated to. That is the fiduciary framework.
MM: That is the legal obligation that you said is not being enforced.
Monks: Yes, it is not being enforced.
I was the official in the Labor Department 20 years ago who developed this doctrine, so I followed it quite carefully. The Labor Department [which enforces pension law] has never brought an enforcement action.
A very interesting case in point is the recent Hewlett-Packard/Compaq merger. The question there was whether Deutsche Asset Management was acting properly in voting their stock in favor of the merger and at the same time accepting a fee from Hewlett-Packard for inducing other people to vote in favor of the merger. When this was decided in the Delaware court, the Delaware court said you have not demonstrated that there was corruption here.
But if the Labor Department had been involved in the case, they would have thrown out Deutsche Asset Management's votes because they are plainly contrary to ERISA [the Employee Retirement Income Security Act, which sets U.S. standards for pensions]. And the results of the Hewlett-Packard/Compaq merger vote would have been different.
The problem is that the trustees of the pension funds and the trustees of the mutual funds are usually big financial conglomerates and they all have many business relationships with the company whose common stock they own in their trust portfolio. They are very concerned that they not act with respect to these companies in such a way so as to make the managements apprehensive or hostile, because they want to get additional business from those companies. While this makes very good business sense, it is absolutely, plainly, unmistakably illegal.
The language of ERISA is as clear as English permits. The trustees are obligated to administer the assets for the exclusive benefit of plan participants. They are directed to make decisions in the sole interests of trust beneficiaries. There aren't words that could be clearer, and yet, neither the Department of Labor nor the SEC, which has authority over mutual funds, has ever enforced the law.
MM: In the Hewlett-Packard/Compaq merger, wouldn't Deutsche Assets have just said that, although they have multiple interests, they made the decision to support the merger on behalf of the mutual fund on the merits and that, had they made a meritorious decision the opposite way, they would have voted against the merger?
Monks: There wouldn't be any obstacle if that is in the record. In the case of Deutsche Asset Management, it was part of the court record that they had been paid by somebody to create a certain result. This cannot be compatible with making an independent decision.
MM: So is your remedy for this to enforce the law, or to have a more structural prohibition on these kinds of conflicting obligations by mutual fund managers?
Monks: If the law is going to be enforced, there will be a need to address exactly your question. Does this mean that the financial conglomerates will have to decide: do they want to be in the trust business or do they want to be in the other businesses they're in? Or does it mean possibly that they will do what one of the trustees in the Hewlett Packard case did, which is to delegate the ownership responsibility to a third party? That would probably create a new industry.
It is an open question, but we're not going to have ownership until there is enforcement of these laws.
MM: Is this just a matter then of convincing the Labor Department or other government agencies to enforce the laws, or are there opportunities for private enforcement?
Monks: Private enforcement is very difficult.
In America, so many things are theoretically a right, but when you settle down to actually who is going to do it and what is the cost-benefit ratio for the individual, you find that as a practical matter nobody except for a philanthropist, who is somewhat insane, is ever going to put up all the money, take all the risk, and only get a miniscule portion from the return.
You pretty much have to have government involvement here to enforce the law.
MM: Has there been any indication since you left government of anyone oriented towards doing that?
Monks: Yes. There has been Olena Berg, who was the assistant labor secretary in the Clinton administration, and was very much inclined in this direction. There is an old-fashioned expression: Good times make bad law. And bad times make good law. It was very difficult to try to get people to change what they were doing in 1990s, because everybody would say, you have a clever answer, but what is the question? Now, in a falling situation, there is a far more receptive audience to listen to ideas.
MM: Do you think that the trust obligation of the pension fund managers is sufficient, or should there be internal mechanisms of accountability within pension funds operations that make the managers more directly accountable to the beneficiaries?
Monks: Technology has made possible the communication between trustees and beneficiaries with a speed, effectiveness of interaction and cost that enables a great many things that were never possible before. It isn't yet clear how that is going to work out, but it is possible and it is certainly a good idea that the actions of the trustees of either the pension funds or mutual funds be communicated to the beneficiaries. Certainly the intention of the beneficiaries is a very relevant factor for the trustees to take into account. I think with intranet possibilities, we're at a point where that could be done.
It is very important that the openness of the shareholder community be clear and that the base of ownership be as wide as possible. If 100 million Americans, for example, have some interest in securities, it is in everybody's interests that they be involved. If that's going to be something other than rhetoric, there ought to be notification and involvement.
MM: That would also require changes at least in some areas of pension funds, right? Aren't the beneficiaries excluded from any kind of meaningful control over the funds themselves?
Monks: Well, it's not a matter of control. The reason you have a trust is so that the beneficiaries are in effect protected. A trust arrangement is a paternal arrangement. The beneficiaries ought to be communicated with and they ought to be able to signify their intent, but I did not and do not suggest that they should have control.
MM: What would you see as an ideal balance? Would you would want to see the trust managers elected by the beneficiaries?
Monks: No, I don't think I would. The idea of the trust is to be sure that there is some money available when the person retires and that there be somebody who is responsible for that. If you are going to have a meaningful kind of accountability, you cannot have people appointing their own trustees.
MM: Would you want to see the trustees put to vote of the beneficiaries how they should vote on shareholder proxy votes?
Monks: Yes, I would. It wouldn't bind them, but it would be a very good idea. I am interested in creating an ownership culture. Capitalism is a dicey business in a free society. There is much too much authority centrally located that is too little accountable to anybody to make one comfortable about capitalism in a free society. But the legitimacy of capitalism, as it were, is the inclusion of such a large portion of the population in the process. That participation is only meaningful to the extent that people are notified and have some sense of participation.
MM: Why is it that the market is not working in the way you suggest already? Why doesn't the normal buying and selling that takes place, push in the directions that you are talking about?
Monks: It's very simple. The reason is that management controls the people to whom they are accountable. So there is no real market. In other words, management appoints the trustees of the pension funds. And collectively, the pension fund trustees agree not to question management.
The largest single factor in ownership is in the control of management. So you have, in effect, sterilized the accountability that is the theoretical justification for the power that CEOs are given in law.
MM: In what way does management choose the pension managers?
Monks: There is no legal obligation for a company to have a pension fund. If a company decides to have a pension fund, then the managers appoint the trustees.
MM: What about the portion of the market that is not indexed? Obviously there is a huge volume of trading that does go on every day, prices do go up and down. Why doesn't that push management in the direction that you are talking about?
Monks: Management isn't really pressed by abstractions like the market.
Management is pressed by people with information and power urging on something different.
Individual holdings are so small that the collective action problem makes it virtually impossible for any individual shareholder effectively to protest. A collective action problem is a situation in which it is plainly in the interest of the whole group that something be done, but it is plainly against the interests of every single individual who comprises the group to take the leadership to do it. So nothing is done.
MM: And in the case of a disaster like Enron, the problem is that the new global investors haven't really risen to the scene yet?
Monks: Right. Take Waste Management, Inc., which was another horrible situation where the management was corrupt and Arthur Andersen was even worse than they were in the Enron case. In the Waste Management case, as it turned out, the shareholders made money and the employees kept their jobs. What happened was that first my group, Lens, in connection with George Soros, became involved. And then we got another group called Relational Investors and a man named Ralph Whitworth involved. Between us, we must have fired three CEOs and three CFOs [chief financial officers]. Finally Ralph Whitworth became the chairman, and settled down and made the company work. That is an indication of what is possible at the end of the day; if you have competent, focused owners you are able to avoid an Enron situation.
MM: You talk at the start of The New Global Investors about Westinghouse as an example of a company that has successfully transformed itself. What happened in that case?
Monks: In that case, you had a very gifted manager who understood his mandate was to make money for the shareholders. In a very logical way, he considered the various alternatives for Westinghouse. Ultimately, he rearranged these businesses so that they had all of their resources focused on a piece of the spectrum that was the most promising, which was the communications piece. And then he merged that with Viacom. And the result was that the Westinghouse shareholders had a far better result than would have been possible under any other scheme.
This is really the essence of capitalism in my view--a tangent to Joseph Schumpeter's famous theory of capitalism as creative destruction. Businesses are really the one institution in society that faces up to the need to change.
MM: But if you look at Westinghouse, the shareholders did well, but from a social standpoint, what really happened? It was just a particular set of financial assets that moved from one set of investments to another, but nothing changed--CBS and Viacom already existed, and they still exist, and the Westinghouse operations on the manufacturing side still exist. They are part of a different corporate entity now, but what is the social benefit in that?
Monks: If you postulate capitalism to start with, the social benefit is that the various Westinghouse units are now being administered by people who can optimally add value.
Westinghouse, for example, had world quality operations in broadcasting and refrigerated storage. Well, what does refrigerated storage have in common with broadcasting? One thing we've learned is that the conglomerate model really doesn't work. So each of the assets was rearranged in a more efficient way, and more value was created for society by that happening. I have suggested that the pensioner is the shareholder for whom the corporation ought to be run, and that the frame of reference ought to be 20 years. That is simply because that is the amount of time until the pensioner retires.
The trustees of the pension funds and the trustees of the mutual funds are usually big financial conglomerates. They are very concerned that they not act with respect to these companies in such a way so as to make the managements apprehensive or hostile, because they want to get additional business from those companies.
Does this mean that the financial conglomerates will have to decide: do they want to be in the trust business or do they want to be in the other businesses they're in? Or does it mean possibly that they will delegate the ownership responsibility to a third party?
Management controls the people to whom they are accountable. Management appoints the trustees of the pension funds. And collectively, the pension fund trustees agree not to question management.
© Multinational Monitor July/August 2002