Investors Of The World, Unite! It's up to institutional owners to fix corporate America, says the dean of shareholder activists.
(FORTUNE Magazine) – Not too long ago--when the bull market was roaring, when business magazines treated CEOs like superheroes, when Enron was winning awards for innovation (who knew?) and Tyco was going to become the next GE--a dogged crusader named Robert A.G. Monks sat down to write a gloomy little book called The New Global Investors, about the owners of big corporations and how they are failing to live up to their obligations.
The 68-year-old Monks, the most important shareholder advocate of his generation, had been marginalized by the 1990s. No one whose portfolio was up by 30% cared about corporate governance. But he toiled on, writing chapters with titles like "Corporate Hegemony Threatens a Free Society" and sticking to his well-honed message: That CEOs have too much power. That boards of directors aren't minding the store. That corporate democracy is a myth. That no one, in the end, is willing to take responsibility when things go wrong in business--least of all the institutional shareholders like pension funds and mutual funds that collectively own much of the FORTUNE 500.
As he wrote, Monks did not know that Gary Winnick, the CEO of Global Crossing, was cashing in $735 million in stock and options while his company careened toward bankruptcy. But he did know that options, which were originally intended to align the interests of executives and shareholders, had perversely become a way for managers to get rich at the expense of investors. Nor did Monks know about the phony accounting at Enron, abetted by Arthur Andersen. But as a shareholder activist at Waste Management, he had helped to unmask deceptive accounting--abetted by Arthur Andersen. Finally, Monks could not have known that stock market values would sink and that the downturn would be accompanied by a rash of corporate scandals, misdeeds, and excesses. But he did warn, in unmistakable terms, that the unchecked power of company executives was a disease that would strike at the heart of American capitalism.
"The original idea of management accountability to boards and shareholders has been stood on its ear," he wrote. "This corruption at the core is a cancer to the legitimacy of the corporation."
Yes, Monks saw trouble ahead. "To me it was a certainty," he says. "It was just a matter of when. It wasn't a matter of if."
"Bob can see over the horizon a lot farther than most people, maybe because he's as tall as he is," says Jamie Heard, the CEO of Institutional Shareholder Services, an influential shareholder advisory firm that was founded by the 6-foot-6 Monks.
Now, when others see only wreckage at companies like Enron, Global Crossing, Adelphia, Qwest, and WorldCom, Monks sees an opportunity for reform. He knows it won't come easily. Boards have always been clubby and self-perpetuating, and institutional investors often have conflicts of interest. But the imperial CEO has fallen from his pedestal, and shareholders are passing resolutions at big companies like Bank of America and EMC designed to curb executive pay and promote independent boards. Some big companies, like Disney, are getting religion when it comes to good governance. Even the long-dormant mutual fund industry, stung by scandal-related losses, is showing signs of awakening.
What's more, bad times, it is said, can make good law. The abuses of the robber barons led to antitrust laws, and protections for investors were enacted after the 1929 stock market crash. Regulatory bodies like the SEC and the New York Stock Exchange are proposing accounting and governance reforms, hoping to restore faith in the integrity of corporate America.
"Who's kidding who?" says Monks. "The system isn't working."
Robert Augustus Gardner Monks, the scion of a long-established, well-to-do New England family, made up his mind long ago that something was wrong with the way corporations were run in America, and that his mission was to fix it.
He was an unlikely rebel. Monks graduated from Harvard, where he rowed for the varsity crew, and Harvard Law School. His wife of 49 years, Millie, is a descendant of the Carnegies. He inherited money, became a partner in a Boston law firm, and made a second fortune running a coal-and-oil company.
His transformation into a corporate reformer began in 1972, while he was campaigning unsuccessfully as a Republican for a U.S. Senate seat in Maine. The story goes that, stopping beside the Penobscot River, Monks noticed big, slick white bubbles of industrial foam, damaging vegetation along its bank. He wondered why the owners or executives of the Great Northern Paper Co., whom he knew, would let that happen. Several years later, after becoming chairman of the Boston Safe Deposit & Trust Co., Monks decided that he was part of the problem. As trustee for $7 billion in assets managed by the bank, he was glancing through proxy statements and preparing to do what he had always done--vote automatically with management--when he came to a proxy from Great Northern.
"My God," he recalls, "it was the same company that was floating the foam. So, as the English say, the penny dropped. I understood that myself and maybe 50, 60 people like me owned enough of an interest that we could actually have an impact. I began thinking of ownership in very human terms."
There was nothing radical about this idea--that shareholders should take responsibility for the corporations they own, which in turn should be run for their benefit. It's the way the system should work. But without immediately realizing it, Monks had stumbled upon a problem that economists and corporate lawyers have wrestled with since the rise of large-scale public corporations early in the 20th century: the separation of ownership from control. Essentially the problem is that a firm's nominal owners, the shareholders, are so numerous and dispersed that they exercise no control over its operations and feel no responsibility for its actions. As Monks would later write, "A corporation with a million shareholders has no owners."
There are two things you should know about Bob Monks at this point in his story. First, he's a clergyman's son. "People like me who were taken to church eight times a day during their adolescence remember things like 'Unto whom much is given, much will be required,' " he says. Second, he is unusually purposeful about his life. When he sold the coal-and-oil company in 1970, he and a partner hired Peter Drucker, for $1,000 a day, to talk with them about what they might do next. Ten years later, after losing a second Senate bid, Monks spent most of a summer at his oceanfront home in Cape Elizabeth, Me., researching the role of corporations in a democracy. He learned, among other things, that pension funds had become the largest owners of U.S. companies, thereby beginning to reaggregate the fragmented base of shareholders. Hoping to transform them into the responsible owners he thought the system lacked, he wrote a mission statement of more than 100 pages that has guided him ever since. "One of the great virtues of my life," he says, "is that I had this epiphany, as it were, when I was about 50, and rich, and I belonged to whatever clubs I ever wanted to join."
By then the groundwork for shareholder activism had been laid. Corporate gadflies like the Gilbert brothers, Lewis and John, had persuaded the SEC to enact the first rules governing shareholder proposals in 1942. Later, social reformers like Ralph Nader and Saul Alinsky, along with church groups and foundations, had used shareholder resolutions to pressure companies on social issues like the Vietnam war and apartheid in South Africa. Still to come were the corporate raiders of the 1980s, a more mercenary brand of owners, who took stakes in poorly run companies, threatened takeovers, and drove up their stock prices. They often got rich by taking "greenmail," or payments to get them to go away.
Monks had a broader agenda. He wanted to empower institutional owners to hold corporate managers accountable for their actions. As a first step, he used his Republican connections to get a job in the Reagan Administration regulating pension funds under the Employee Retirement Income Security Act (ERISA). There, he set into motion regulations that required pension fund trustees to vote their proxies solely for the benefit of recipients; until then trustees could ignore the proxies or, if they managed corporate pension funds, allow them to be voted by CEOs, who usually supported management. "That sounds very minor, but it was cataclysmic," says Nell Minow, Monks' longtime partner in activism.
Even so, pension funds and other institutional owners could not be expected to monitor all the companies in their portfolios. To solve that problem, Monks in 1985 created Institutional Shareholder Services to sell research and advice on proxy voting. Today ISS has 300 employees, 750 institutional clients, and real clout; its support for the Hewlett-Packard/Compaq merger, for example, is said to have tipped the balance in favor of the deal. To test his theories, Monks also became a key behind-the-scenes advisor to the trustees of California Public Employees Retirement System, or Calpers, which then and now the most influential institutional investor. Calpers has opposed staggered boards and poison pills that are designed to prevent takeovers; it has promoted more independent boards and objected to excessive pay for CEOs. "Bob has been way out in front on many of these issues," says Richard Koppes, a former general counsel of Calpers. "He's been a real thought leader." To spread their gospel more widely, Monks and Minow wrote four books on corporate power and accountability, including a widely used textbook. (Their writings can be downloaded free from either Monks' Website, www.ragm.com, or Minow's, www.thecorporatelibrary.com.)
Finally, Monks had to prove to the institutions that becoming more active as owners would generate shareholder returns. To that end, he and Minow created an investment fund called Lens in 1991 that bought shares in lackluster performers, including Sears, Waste Management, and Stone & Webster, and then agitated for management changes or board seats. During its ten-year life, Lens has narrowly outperformed the S&P 500; other activist funds, like Michael Price's Mutual Series and Ralph Whitworth's Relational Investors, which is backed by Calpers, have done even better. "You'd be amazed at the changes in the dynamics when you have a large shareholder in the boardroom," says Whitworth, who has sat on the boards of Waste Management, Mattel, and Apria Healthcare. "When they're thinking about building a heated garage for management or a golden parachute or whatever, it's a whole different discussion." Conversely, Monks argues that CEOs lacking supervision eventually destroy shareholder value.
Gentlemanly in his manner, Monks can play tough. He once spent $250,000 of his own money to run for the board of Sears, and took out a full-page ad in the Wall Street Journal picturing the Sears directors under the headline NONPERFORMING ASSETS. While he lost the election, Sears soon adopted governance reforms and sold off weak divisions. And Monks had made his point, which is that the so-called elections of corporate boards are mostly a sham, and will remain so until dissidents can get access to the company proxy statement to challenge the management slates. Says Monks: "American corporate law doesn't really give shareholders any power."
Shareholder proxy resolutions, for example, are nearly all "precatory" (from the Latin word for "entreat") under SEC rules, which means companies don't have to carry them out. Even so, disgruntled shareholders are winning more votes during the 2002 proxy season than ever before. At Bank of America, where top executives Hugh McColl and David Coulter left with enormous severance packages, a resolution filed by the Teamsters union asking that future "golden parachutes" be approved by shareholders passed with 52% of the vote. (It had lost in 2001.) Shareholders at EMC recently approved a resolution calling for a majority of directors on the data-storage firm's board to be independent. "This is clearly one of those companies that doesn't get it," says ISS's Patrick McGurn, the firm's director of corporate programs. "They view shareholders as the enemy."
CEO pay has been another hot-button issue. TIAA-CREF, an active institutional investor that manages pension and mutual funds, sponsored resolutions at 14 companies asking that significant options grants be submitted to shareholders for approval. (The New York Stock Exchange would require that under proposed new rules.) Most refused, but four companies agreed, and at Mentor Graphics, the only company where the resolution came to a vote, it passed. Monks and other shareholder activists have argued for years that the huge jumps in CEO pay and options grants prove that most boards are dominated by the CEO. "Show me an overpaid CEO, and, typically, I'll show you a lousy board," says Charles Elson, director of the Center for Corporate Governance at the University of Delaware.
You'd think Monks would be celebrating those victories, but he is not.
Instead, he's focused on what remains to be done. Notice, for example, that most shareholder campaigns are led by church groups, unions, socially conscious mutual funds, and public-sector pension funds like Calpers. By contrast, corporate pension funds are inert. "It is the ugly not-so-secret reality that corporate pension funds are operating contrary to law," Monks says, meaning that they are not exercising their ownership rights. "The CEO of one company says to the CEO of another, 'My pension fund will not raise questions about your company if your pension fund will not raise questions about my company.' They have neutered themselves intentionally." Because corporate pension funds don't disclose their proxy votes, his claim cannot be proven, but most shareholder advocates believe it. Says ISS's Jamie Heard: "I don't know of a single corporate pension fund that has become a governance activist."
The same goes for most mutual funds. Monks says they have failed to act on behalf of their investors because they want to manage corporate pension money or operate 401(k) plans for big companies. In fairness, a few fund groups--Fidelity is the name most often mentioned--work behind the scenes to promote better governance, but most won't even tell their own shareholders how their shares were voted. "We have a suspicion that some of these funds vote in lockstep with management, but there's no way of knowing," says Conrad MacKerron, director of corporate social responsibility for the As You Sow Foundation, a shareholder advocacy group.
As it happens, while researching this story, I received the annual report of the Weitz Partners Value fund, a mutual fund in which I'm invested. Wallace R. Weitz, the portfolio manager, wrote that the fund's holdings in Qwest and Adelphia Communications, whose stocks have been battered by accounting and governance problems, had cost Partners Value about 3.5 percentage points of performance during the first quarter of 2002. (It was down by 0.4%.) I called to ask Weitz how much attention he paid to governance. "We've been almost totally passive," he told me, with admirable candor. "We haven't put a lot of energy into reading executive compensation plans and that kind of thing. But I'm thinking harder about these issues and paying more attention."
He isn't alone. Weitz was one of a half-dozen or so fund managers--the others included Bill Miller of Legg Mason and Chris Davis of the Davis Funds--who met recently to see how they might become more active owners. John Bogle, the retired founder of Vanguard, who helped organize the get-together, has been urging mutual funds to rouse themselves; he points out that just 75 managers of mutual funds, pension funds, and other institutional accounts held $6.3 trillion in stocks, the equivalent of roughly 44% of the market capitalization of the U.S. stock market in early 2001, the most recent figures available. That's real clout.
Bogle says that the fund industry has dropped the ball on governance for two reasons. First, most fund managers are short-term speculators, not long-term owners, so they don't have the patience or incentive to exercise oversight. Second, he says, there are those pesky conflicts that Monks talks about. "The firms that make up corporate America are, as it happens, our biggest clients," Bogle told me. "You're going to be apprehensive about taking on corporate America." The experiences of the public pension funds offer a cautionary tale in this regard; when Wisconsin's fund filed a shareholder resolution at General Motors in the late 1980s, the CEO of GM visited the governor to suggest that plants under consideration for the state might be at risk. The resolution was withdrawn.
What Bogle wants to do is organize long-term investors, particularly those who manage index funds, to lobby big corporations as a group to improve governance. "We have very, very few corrupt people in the financial world," he says, "but I believe we have a corrupt system." That, of course, is music to Monks' ears. "John Bogle's great," he says. Another hero of his is Warren Buffett, whose track record proves that an involved owner can make a big difference. "That's what I want to create," Monks says, "a culture of ownership responsibility."
Monks, as usual, has a slew of projects in the works. He's playing a behind-the-scenes role in a shareholder campaign against Exxon Mobil, focused mostly on environmental issues (see box). Using software created at the Santa Fe Institute, he has developed a simulation program called Brightline that's supposed to track the relationship between corporate social responsibility and shareholder value. He is writing another book, called To Harvard With Love, exhorting his alma mater to become a more active investor. "Harvard is in the money-raising business," he says. "They are not in the business of setting an ethical example." And while he sometimes appears frustrated to be rehashing the same arguments after all these years, his heart is still in the fight. "This has not been self-executing," he says, wryly. "It's been hard. But I've found it makes me very happy." While pensions funds have been a focus of his life's work, retirement does not seem a likely option for Bob Monks.