Can shareholder activism make a positive difference? Based on our experience at TIAA-CREF, the answer is yes. In the October 1996 issue of Director's Monthly, John H. Biggs, then chairman and CEO, described TIAA-CREF's corporate assessment program. Since then TIAA-CREF- through this program and our other governance initiatives- has made significant progress in advancing active, independent boards and other 'good governance' practices.
TIAA-CREF is the largest private pension system in the nation. With assets of approximately $275 billion, it serves more than 2 million participants employed in education and research. The Teachers Insurance and Annuity Association (TIAA) and the College Retirement Equities Fund (CREF) are the two components of the system, which was created in 1918 to provide retirement income and life insurance to college professors. With an increasing diversity of products- including annuities, insurance, mutual funds, trust services and tuition financing-TIAA-CREF is changing rapidly. But our basic goals remain constant, including our commitment to good corporate governance and strong shareholder rights.
In fact, in the last ten years we have stepped up our corporate governance activities by adding resources to our corporate assessment program, filing friend-of-the-court briefs on cases with important implications for shareholder rights, and developing new initiatives like our effort to end a form of take over defense called the 'dead hand poison pill.' We have helped transform the process and approach by which equity compensation is awarded to executives. Globally, we are seeking to foster more meaningful international standards for corporate governance, shareholder rights and corporate transparency.
The TIAA-CREF staff and consultants conduct activities in conjunction with the committees on corporate governance and social responsibility of TIAA and CREF. These committees consist of individuals who collectively bring an extraordinary breadth of experience and background from law, finance, economics, the humanities and corporate management.
We believe that in the long run, our corporate governance program produces positive investment results. Our bottomline success in the following examples demonstrates that our program is serving a worthwhile purpose for our beneficiaries and for corporate America in general.
Particular Past TIAA-CREF Actions
We are willing to take significant steps to protect our rights and interests as shareholders. In a much-publicized case, TIAA led a successful effort to oust the board of Furr's/Bishop's, where directors appeared indifferent to shareholder concerns. Earlier, we engaged in high-profile efforts at W.R. Grace and at Eramet, a French company.
At Grace, where we had a major position, we were concerned in 1995 about the sudden departure of the company's CEO at a time when we backed his business strategy. We questioned the independence of the board, which seemed too close to the company's chairman and former CEO. Our shareholder activism led to a substantial reconfiguration of the board, with its size reduced to 12 from 22, and hastened the retirement of many long-term directors, including the chairman. We believe our action helped to keep the strategic refocusing of the company on track, with substantial benefits for shareholders. The Securities and Exchange Commission later found that the board of Grace, at the time of our challenge, did not meet its responsibilities under federal securities laws and otherwise acted improperly.
In 1997, we objected when the French government, a major shareholder in Eramet (in which we also were an investor), planned to promote a sale of one of the company's mines at less than fair value for non-economic reasons. TIAA-CREF insisted that the mines belonged to shareholders in common, and we introduced a shareholder resolution that won support from Sociètè Gènèral, a leading French bank, and other investors. This initiative subsequently produced an agreement among all parties that led to significant positive corporate governance changes at Eramet, and increased share prices.
At Walt Disney, following the award of extraordinary pay packages to CEO Michael Eisner, we led the fight to increase board independence, a long process that now seems to be paying off with the addition of genuinely independent directors to a board that had been much too close to management. We went through a similar, initially frustrating and ultimately productive, exchange with the leadership of H.J. Heinz.
In 1999, we had important successes in efforts to get companies to roll back their dead hand poison pills. A number of companies have eliminated this pernicious provision, discussed below. TIAA-CREF shareholder resolutions on the issue at Bergen Brunswig and Lubrizol scored very substantial victories, winning the support of 74% of the shares voted at Bergen and 68% at Lubrizol.
Deal Hand Pills
TIAA-CREF has long considered the appropriate role shareholders should have in relation to mergers and acquisitions, particularly tender offers and takeover defenses. In particular, when shareholder rights plans (also know as 'poison pills') were introduced in the 1980s, TIAA-CREF mounted a shareholder resolution campaign asking that they be submitted to shareholder votes, a position we continue to advocate.
Poison pills permit shareholders other than a potential offeror certain rights to acquire new shares at extremely low prices. Such 'rights' can be redeemed by the board of directors if the board approves the acquisition; unless that occurs, the tender offer is not viable. Boards may implement pills unilaterally, without shareholder approval.
We do not necessarily disapprove of poison pills, which in some cases can lead to higher premiums for shareholders. On a number of occasions we have either voted for pills or given support to managements that have demonstrated concern for shareholders and respect for shareholder value. Generally, board independence is an important factor as to how we view the pill at particular companies. But pills can deny shareholders their basic right to sell shares at the highest price then available, and therefore shareholders should be given the prerogative to approve or disapprove the maintenance of a pill. Shareholder resolutions requesting a shareholder vote now receive average voting support in excess of 50%.
In 1999, we turned our attention to a type of poison pill that we find particularly objectionable. The 'dead hand' poison pill provides that only 'continuing directors' -essentially those directors on a board before a proxy fight, or their designated successors -may vote to redeem a poison pill.
Dead hand pills deny shareholders the right to replace the board with new directors empowered to redeem the pill. Our campaign was aided when the two Delaware courts ruled that dead hand pills are invalid as a matter of Delaware law, both on statutory and fiduciary grounds. Unfortunately, however, deal hand provisions remain in place at many non Delaware companies. Our challenge thus focused on non- Delaware companies. After the corporate community came to see the level of shareholder support for our resolution, a sea change of attitudes took place and virtually all companies abandoned the dead hand feature.
Behind The Scenes
Despite these high-profile examples, most of our governance activity is conducted quietly and confidentially, and we usually achieve positive results from our discussions. As John Biggs described in the October 1996 DM, through our innovative corporate assessment program established in 1995, we monitor portfolio companies and talk with management and boards when we have concerns about the functioning of the board. Most of our interactions with companies involve 'gentle prodding,' sometimes over a period of years, urging more independence, suggesting procedures to renew and revitalize a board, and encouraging stronger evaluation practices.
B. Kenneth West, our senior consultant on the program, has had contacts with more than 100 companies, and many of the interactions have resulted in significant board changes. Nearly all of these discussions have taken place in private, an aspect of the program that we believe has been an important component of its success. We only resort to public shareholder resolutions when we come to an impasse.
The central question we seek to answer in our corporate assessment program is this: Does the company have a vital and independent board performing a vigorous and challenging role in overseeing management's conduct of the business? Writing early on in the development of the program, John Biggs said we thought in most cases the answer would turn out to be 'yes'. And this is indeed our experience. But there are a significant number of corporations-some, unfortunately, quite large companies-with lackluster and/or less-than-independent boards or other governance shortcomings. When such companies surface through our corporate assessment program analysis, we seek to engage them in discussion. Sometimes, we learn that problems are less serious than they initially appeared to us on the outside. In other cases, we seek reform.
To help select companies, we have developed an extensive corporate governance database, using information from the Investor Responsibility Research Center (IRRC) on 1,900 of the larger U.S. corporations among the 3,000 in our portfolio. We tend to mainly focus the attention of our governance staff on companies in our passive portfolio. The relatively few companies in our active portfolios already are monitored closely by our investment professionals so that they may raise governance issues. (Some $115 billion of the $130 billion in our equity holdings are in CREF's main stock account. About twothirds of this is invested in U.S. equities chosen through indexing. Our actively-managed U.S. segments account for about one-fifth of the account, and most of the rest is in overseas securities.)
Once companies are identified through the database, we do more analytical research to decide on those where we believe we can engage in fruitful discussions. Up until now, Ken West generally has been the person to contact the company, frequently seeking visits with top personnel. Mr. West, the retired chairman and CEO of Harris Bankcorp, has been a tremendous asset to the program. He has an avid interest in board structure and processes, and has been able to engage company officials very effectively. In 1997 we added another senior consultant, Dolph Bridgewater, who retired as chairman and CEO of Brown Group. Aside from their experience leading companies, Mr. West and Mr. Bridgewater have a wealth of outside boardroom experience.
Our discussions tend to be carried on with the chairman, CEO, chief financial officer and/or corporate secretary. Although some investors contact independent board members with concerns, and we potentially could do so, we prefer to go through the CEO. Discussions with independent directors can raise trust issues and other sensitive questions of concern to management that we may prefer to avoid. Sometimes, through the CEO, we do reach independent directors. An open attitude toward such discussions by management and directors can be an indicator of board independence.
The discussions are based on our Policy Statement on Corporate Governance. This evolving document guides and explains TIAA-CREF's governance actions. The assessment procedure varies depending on our perception of problems and opportunities, but in general we follow this checklist:
• Review of the quality of the board, including independence, diversity (of experience, gender, race and age), organization, selection procedures, director compensation and director and board evaluation.
• Examination of shareholder rights and proxy voting procedures, including the nature and extent of takeover defenses, limitations on 'sweetheart' preferred stock issuances, confidentiality of shareholder voting and other provisions.
• Review of management evaluation processes and succession planning.
• Review of the strategic planning process of the company and the board's role in overseeing that process.
• Review of the board's attention to good corporate citizenship, and attention to preventing deliberate and knowing exploitations of any non-shareholder constituencies.
• Review of procedures for setting executive pay, particularly where we perceive that pay is unusually lavish compared with industry norms or where we question the structure of pay and its relation to share value. We ask about how performance is recognized, the relationship to peer institutions, the appropriateness in relationship to shareholder and employee rewards, and the independence of and procedures followed by the board's compensation committee. We are skeptical about repricing of stock options, and we strongly believe that option programs should be submitted to shareholders for approval.
• Examination of the board's fiduciary oversight, including the independence and approach taken by the audit committee, the encouragement of high ethical standards, and strong internal controls.
These last two areas-compensation and fiduciary oversight -are particularly important to us. Executive pay has been a major concern for me. I have participated on task forces established by the New York Stock Exchange after it enacted a rule that reduced the need to obtain shareholder approval for stock option plans. Along with other institutional investors, we were dissatisfied with this measure and have worked with the exchange to come up with a policy that is fairer to shareholders.
We also have a strong interest in the proper functioning of audit committees, an area of considerable current concern. John Biggs participated in the Blue Ribbon Committee on Audit Committee Effectiveness, sponsored by the New York Stock Exchange and the National Association of Securities Dealers.
The private nature of these discussions prevents us from making the wider world aware of changes for which we rightfully could claim some credit. Public awareness comes when we are unable to make progress with a company, as occurred earlier with Disney and Heinz. In 1999 we did reach a public agreement with Advanced Micro Devices that resulted in a substantial majority of independent directors on AMD's board and the complete independence of the company's audit, employee stock and nominating committees.
Global Corporate Governance
TIAA-CREF is extending its corporate governance initiatives abroad, as indicated by our action in the Eramet case (discussed above). Significant current developments in global corporate governance are taking place, with reasonably good prospects for long-term improvement of standards. Such developments are occurring nationally, and transnationally through the work of the Organization for Economic Co-operation and Development (OECD) and the World Bank.
In the last few years, we have explored governance issues with investors, corporate officials and organizations in overseas markets, particularly in Europe. A central point we have tried to get across in these private meetings in that the longterm interests of each country would be better served by fairer treatment of minority shareholders and better corporate governance practices. We undertake these conversations with appreciation that in many countries, the phrase 'Anglo-Saxon model' is viewed sometimes as suggesting insensitivity to long-standing cultural views on the role of the corporation. Nevertheless, based on our reputation in corporate governance, we have been well received.
In many countries, study communications have been organized to consider ways to improve governance. In France, for example, the first Vienot Report dealt with the obligations of directors towards shareholders and other corporate governance issues. Disclosure as to compliance with Vienot Report recommendations is now required for exchange-listed companies, and a prior Korn/Ferry International study found that nearly all the CAC (Cotation Assisèe en Continu) 40 index blue chip companies listed on the Paris stock market have embraced the Vienot recommendations. According to Korn/Ferry, independent directors now account for nearly 30% of the seats on French companies' boards.
In May 1999, the OECD ministers considered the OECD Principles of Corporate Governance developed by a Task Force on Corporate Governance, consisting of government representatives from each of the 29 member countries and a limited number of other individuals representing specific organizations. I was invited to serve on the task force as a representative of the International Corporate Governance Network (ICGN). In 1999, I was elected chairman of the ICGN and served in that role for three years.
The principles are intended to assist governments in evaluating and improving the legal, institutional and regulatory framework for corporate governance in their countries. They also provide guidance and suggestions for stock exchanges, investors, corporations and other parties that have a role in the process of developing good corporate governance. (To review the principles online, see http://www.oecd.org/daf/governance/principles.htm).
The principles, although not perfect from an investor's point of view, are a significant recognition of the need to improve governance standards. Acceptance of them by member countries and individual companies should in the long run bring positive results.
The TIAA-CREF Policy Statement
As previously mentioned, TIAA-CREF's fundamental views on governance matters are articulated in its Policy Statement on Corporate Governance, first developed in 1993 and revised in 1997. The statement guides and explains TIAACREF's corporate governance activities. It is modified over time, based on experience and discussions with corporate officials and others.
In the introduction to the statement, TIAA-CREF states its belief that 'good corporate governance must be expected to maintain an appropriate balance between the rights of shareholders -the owners of the corporation-and the need of management and the board to direct the corporation's affairs free from distracting short-term pressures.'
The statement places great emphasis on the board of directors, stressing that the board should be composed of a substantial majority of independent directors, and that the committee structure should include audit, compensation and nominating committees that consist entirely of independent directors. TIAA-CREF says the board should be composed of qualified individuals who reflect diversity of experience, gender, race and age. The board should have a mechanism to evaluate its performance and that of individual directors, and independent directors should hold periodic executive sessions. Where the company does not separate the role of chairman and CEO, the board should consider the selection of one or more lead independent directors.
The Policy Statement stresses certain voting rights. It recommends confidential voting, the principle that each share of common stock has one vote, and the avoidance of issuing previously authorized shares with voting rights to be determined by the board unless there is prior shareholder approval for the specific intended use. The board should adopt equal financial treatment for all shareholders, and should submit for shareholder approval any action that alters the fundamental relationship between shareholders and the board. TIAA-CREF opposes supermajority vote requirements that interfere with shareholders' right to elect directors and ratify corporate actions. The Policy Statement recommends a number of other actions as well, including opting out of state laws offering takeover protection and avoidance of bundling into one vote issues for consideration by shareholders.
The statement addresses executive pay, stressing 'pay for performance' that is not excessive and is fully disclosed and arrived at through a sound process. The statement discusses elements that should be considered in setting compensation. An appendix describes TIAA-CREF's guidelines for voting proxies on executive compensation, including 'red flags' that call for further research and that can lead to negative votes. Recently, TIAA-CREF has opposed about one-quarter of compensation proposals, based on such factors as excessive dilution, certain reload options, below-market option exercise prices, redundancy in the compensation structure, repricing and excessive discretion.
Other elements discussed in the Policy Statement include CEO performance evaluation, strategic planning, fiduciary oversight and social responsibility issues.
In the aftermath of the Enron and other company scandals, TIAA-CREF focused heavily on two issues that we came to see as related: executive compensation and accounting and auditor regulation. Executive compensation levels have exploded in recent years, primarily as a result of substantial increases in equity compensation in the form of fixed-price options. At the same time, the major accounting firms came to be seen more as full service consultant organizations than auditors. The model of regulation of the accounting firms was self-policing.
These scandals exposed imbedded corporate governance problems concealed by the strong bull market of the 1990's. The executive compensation excesses made short-term share prices the driving force for realization of large gains. It should not have come as a big surprise that with this motivation and incentive, all too often executives pushed the accounting envelope to aggressive limits-and in many cases beyond those limits into fraud. Executives were able to time their option exercise to coincide with high apparent earnings based on aggressive or fraudulent accounting and then immediately sell the exercised stock, leaving long-term shareholders to bear the ultimate effects of the market collapse.
The TIAA-CREF response was twofold. First, in 2002 we filed shareholder resolutions requiring shareholder approval for all equity compensation plans. The two major xchanges, NYSE and Nasdaq, then permitted plans to be adopted without such approval. Our resolution came to a vote at one company, Mentor Graphics, where it received 57% shareholder support. Our resolution did not come before other companies because the SEC initially held our resolution excludable as ordinary business, a position it subsequently reversed. More importantly, our position was later incorporated into new listing standards of NYSE and Nasdaq, which have now received SEC final approval. In the future all equity plans will need shareholder approval, a process we hope will lead to more moderation in such plans.
A further initiative on executive compensation in 2003 seeks to transform equity compensation by linking rewards to long-term shareholder interest. We are urging companies -through quiet diplomacy, but if necessary through shareholder resolutions-to adopt plans that are performance based rather than fixed price, and require substantial holding periods after exercise so that executives bear the same downside risks as shareholders. Our campaign is linked to our strong participation in efforts at FASB and the International Accounting Standards Board to require expensing of all equity compensation. Under current rules, only fixed-price options do not require expensing, and this is a strong factor in the choice of plan.
On the accounting front, we were leaders in strongly advocating that a new accounting regulatory body be formed with real power to regulate the accounting profession and limit practices that cast questions on auditor independence. The recent enactment of the Sarbanes-Oxley Act, with the formation of the Public Company Accounting Oversight Board, should ultimately achieve these goals.
A strong corporate governance program continues to be an important priority for TIAA-CREF. We believe that our investment performance is enhanced and well-served by our ability to identify issues that vitally affect shareholder rights and implement our objectives by a proper balance between private and public initiatives. We have achieved much through quiet diplomacy, but without a public presence through shareholder resolutions and active participation in the legislative and regulatory processes, our efforts would be deprived of the potential leverage such activities produce. We believe the business community understands our efforts to be carefully thought out. Our goals are compatible with our respect for the prerogatives of the management in the companies in which we invest. We do, however, insist as the owner of these companies that boards and executives be responsive to legitimate shareholder concerns and rights. We will try to continue striking the proper balance on issues as they arise.
This article was reviewed by Peter Wall and Alex Barkawi. Selected reviewer comments can be viewed at journalofindexes. com.