What CalPERS Should Mean To Indian Corporates
To me, the most important business news in the last fortnight was the decision of the California Public Employees’ Retirement System (CalPERS) to invest a small part of their huge portfolio in Indian equity. CalPERS is the USA’ largest public pension fund. It has assets of over $166 billion, and provides retirement and health benefits to more than 1.4 million public employees, retirees, and their families.
At present, approximately $2 billion of CalPERS’ portfolio is invested in emerging markets. You may argue that $2 billion spread out across several “emerging market” countries is small beer, especially from the perspective of India, whose foreign exchange reserves are at $117 billion and rising. So, why am I excited about CalPERS coming into India?
The answer is simple. Over the last decade, CalPERS and some other pension funds like TIAA-CREF and Hermes have forced key corporate governance issues onto the forefront of America. To understand how this has occurred, it is necessary to begin with an understanding of shareholder wealth in the US.
The largest owner of corporate USA is its employees. According the US Department of Labor’s National Compensation Survey of March 2003, 49 per cent of all employees in the United States in the government as well as in the private sector subscribed to some retirement benefit plan or the other; and 70 per cent of employees earning over $15 per hour subscribed to such plans. As you can imagine, that translates to a sizeable amount of money — many times the GDP of India. This huge pool of investible resources is managed by pension funds. And, unlike our antediluvian Employee Provident Fund systems, US pension funds invest a large portion of their pool in equity. The world’s largest capitalist system has, therefore, become a paradigm of Marxism: the workers of the US are the country’s biggest capitalists.
Unlike shorter term mutual funds — who book profits by constantly churning their equity portfolio — most pension funds are longer horizon players. Thus, it is in their interest not only to choose companies carefully, but also to regularly monitor their performance so as to maximize long term shareholder value. This is where pension funds like CalPERS have taken the lead as a careful monitors as well as major shareholder activists.
As the largest public retirement system in the US, CalPERS concluded over a decade ago that good corporate governance leads to improved long-term performance. It believes that good governance requires the attention and dedication not only of a company's officers and directors, but also its owners. And, as shareowners, CalPERS is not a passive holder of corporate stock. In its own words, “We are a shareowner, and take seriously the responsibility that comes with company ownership.”
To understand its activist governance role, let me take you through a couple of things that CalPERS does vis-a-vis US companies. The first is the monitoring aspect through the so-called “Focus” companies. Every year, CalPERS uses three screens to review the performance of the US companies in its portfolio, and identifies those that are among the poorest performers. These screens are (i) shareholder returns for the past three years, (ii) economic value added (or EVA) devised by Stern, Stewart and Company, and (iii) corporate governance issues. Further research hones the list to 15-17 companies, of which the worst are tagged as “Focus” companies — where CalPERS tells their management and the board what it expects of them in the future.
Among the “Focus” companies have been major Fortune 1000 entities. In the past eight years, there have been Apple, Novell, Reebock, Cummins Engines, J.C. Penney, Lucent and Gateway Computers, to name a few. The recent biggie is Xerox. According to CalPERS, “Xerox has one of the most ineffective boards”. The company was fined by the SEC and forced to restate earnings from 1997 up to 2000, and its board has been publicly accused of financial manipulation by its own former employees. Between 1998 and 2001, Xerox’s EVA fell by over $1 billion. CalPERS has “requested” Xerox to add three new independent directors, maintain 100 per cent independent directors on the Audit, Compensation and Nominating Committees, separate the posts of Chairman and CEO, adopt transparent board evaluation processes, and seek shareholder approval for its executive compensation policy. Xerox is still foot-dragging.
Most “Focus” companies, however, have had the good sense to follow CalPERS advice. The data suggests that it pays off. A study by Wilshire Associates on 95 "Focus" companies targeted by CalPERS during 1987-2000 shows that while the share prices of these companies trailed the S&P 500 Index by 96 percentage points on a cumulative basis during the five years before CalPERS intervened, the same stocks out-performed the index by 14 percentage points over the subsequent five years.
The second form of shareholder activism is by proxy voting. As a large corporate shareholder and a powerful voice of good corporate governance, CalPERS solicits proxies to vote against those general body resolutions it thinks are inimical to good governance. For instance, it is voting against Abbott Lab’s, American Express’ and Anheuser Busch’s resolutions to ratify their auditors, because the firms performed key non-audit services; against approving the entire board of Apple because of what it considers to be corporate governance failures; and against some directors of Chubb Corporation for poor attendance as well as related party transactions. The proxy voting list is large, and in public domain. It tells the world how a huge institutional investor thinks of some companies.
At this stage, we don’t know whether CapPERS will use its stringent screens and procedures while picking Indian companies. But you can be pretty sure that if this fund were to increase its exposure to India, it will apply strong corporate governance principles on its investing companies.
The fact that CalPERS now considers India as an investment destination shows that we have corporate governance mechanisms worth talking of. For instance, China, Thailand, Pakistan and Indonesia are still off the radar screen of CalPERS. We can either use this opportunity to showcase ourselves differently and do what needs to be done to attract high quality global capital, or be like the Chinese and say, “The hell with it.” I think in today’s world of global capitalism, the former is the better option.
Published: Financial Express, April 2004