Power of the Purse: Pension Investors Are Shaking Up Corporate America
Phil Angelides is treasurer of California. He is also considered the "anti-Schwarzenegger" because he is the top Democratic contender for governor. He spoke with NPQ editor Nathan Gardels recently.
NPQ | Public pension funds-the largest investors in America-have become very active lately pressing management on corporate governance issues, joining the revolt against Michael Eisner at Disney and more recently against the management of Safeway, the food giant. The California's Public Employees Retirement System (CalPERS) is so powerful, that it forced Richard Grasso, director of the New York Stock Exchange, out of office over the issue of excessive compensation.
What is the scale of these public pension funds nationwide? What accounts for this new wave of investor activism?
Phil Angelides | Public pension funds are a major force in both the national and global economy. CalPERS and CalSTRS (State Teacher's Retirement System) are, respectively, the first and third largest pension funds in the country. Together, they have assets of $270 billion. When you combine that with the state's investment fund, California has a portfolio of over $300 billion.
Across the nation, public pensions, all told, have assets of around $2 trillion. These funds dominate the secondary market for mortgages and are the largest investors in America's largest corporations.
Why the activism? The answer is very simple. Over the last three years, the United States has endured the greatest wave of corporate scandals since the market manipulations of the 1920s. Ordinary investors lost trillions of dollars. Thousands of employees at companies like WorldCom and Enron saw their pensions wiped out, their family's hope decimated.
CalPERS and CalSTRS lost $850 million in the WorldCom fraud alone.
In the wake of this wave of scandals, we have an absolute obligation to stand up and ask questions and push for more accountability and transparency in corporate boardrooms.
There are three essential reasons why it is important to act:
First, large public pension funds have an abiding interest in the overall performance of the market. We are not day traders. We are institutions invested in all sectors of the economy for the long term.
To the extent, therefore, that the market is seen as a place of fair dealing-where investors can take market risk, not honesty risks-they do better over time.
In the wake of the 1929 scandals, there was a whole generation of Americans who never invested again in the stock market. They regarded it as a casino rigged to benefit insiders. It wasn't until 1954 that the Dow Jones industrials again succeeded the 1929 peak.
So, it is in our interest that investors across the world see American financial markets as an open and honest forum where they can confidently calculate their risks.
Second, what became clear over the past three years of scandal is the extent to which corporate managers and boards were jiggering the results to look good in the short term to the long-term detriment of the company, the economy and the long-term interests of investors.
To the extent we can imbue more long-term thinking in corporate boards, then we will serve ourselves and the American economy well, which, of course, is the single biggest variable for our long-term performance.
What we saw in this country in the 1990s was short-term thinking in which many companies were trying to hide quarter-by-quarter returns in such a way that was destructive of long-term values. By speaking up and pushing management to take the long-term view, we can help return the corporate world and the American economy to long-term thinking.
The third reason we became active was out of simple necessity: We sustained terrible damage by the way companies were being run. We were defrauded and suffered from malfeasance and abuse. We have vowed to do our best to ensure that it won't happen again.
The more we rattle the cages in the boardroom, the less likelihood there will be more scandals.
NPQ | After the market crash of 1929, a whole slew of new regulations ensued. And there have been some proposals now. The difference between '29 and '99, though, is the huge presence of institutional investors. You seem to be suggesting that their power in the marketplace is a better guarantee than regulation for honest and accountable capitalism.
Angelides | There are two bigger differences now from the late 1920s and early '30s. First, Frankin Roosevelt is not in office, George Bush is. When Roosevelt came to power the very notion of free enterprise was at risk. He was smart enough to realize he had to restore confidence in a regulatory framework that would allow confidence in the market. That is why he created the Securities and Exchange Commission and the FDIC (Federal Deposit Insurance Corporation)-to create a public framework around our private markets.
At the critical moment in this current wave of scandals, the Bush administration has been a day late and a dollar short. They ignored Enron. Only when WorldCom exploded was it forced to seriously support reform legislation in the Congress. All along the way, the Bush administration and the SEC have been behind the curve.
Investment bank and mutual fund regulatory reform has come from the states, not Washington. In short, today we don't have a federal government that fully embraces its regulatory responsibilities in a time of crisis.
Second, as you note, about 50 percent of the capital in America is held by large institutional investors such as the California public pension funds. As such a potent force they have the opportunity and, perhaps more important, the responsibility to move the markets toward more openness, honesty and transparency.
It is our "power of the purse" that is forcing change. In July, 2002, we joined with the comptroller and attorney general of New York, Merrill Lynch and the treasurer of North Carolina to adopt a set of investment protection principles. It sets standards that investment banks had to meet if they wanted to do business with our states. These are now mandatory standards to which every investment bank which wants to do business with California must comply. They all do, because they don't want a black mark of being ruled out of our business.
California's funds and other institutional investors have also joined together over the issue of corporate expatriation, which is also a matter of corporate governance from our perspective. There is a small set of companies like Tyco and Ingersoll-Rand that set up phony mailboxes in Bermuda, the Bahamas or Cayman Islands to avoid US taxes and weaken shareholder rights.
This kind of behavior is outside the rules of conduct by which all others in the community are expected to play, including the average citizen and taxpayer. For us, this is corporate conduct below the threshold of acceptability. So, we mounted a "come home America" campaign that gathered 27 percent of Tyco's shareholders in support of this position, and 41.6 percent of Ingersoll-Rand's shareholders.
The seminal moment of action was when on Sept. 16, 2003, I joined CalPERS and CalSTRS in calling for the resignation of Richard Grasso as head of the New York Stock Exchange. He resigned within 24 hours.
There is nothing more damaging to free enterprise and financial markets than a small, elite class of insiders with excessive compensation. That sends the wrong signal to the marketplace. Free enterprise is about taking risks, inventing new products and building companies, not insiders making many millions of dollars a year for just showing up at work.
Institutional investors will continue to be active because reform is not about a set of rules and regulations, but a way of thinking. It is about shareholders and board members asking questions about management. Its about making sure auditors audit and don't consult. It is about thinking of the long-term health of companies.
As a result of our insistence, a kind of counterrevolution is taking place. The Business Roundtable, the Wall Street Journal and the Republican Party are accusing us of going too far. My response is that they all ignore the lessons of the crash of 1929. And they've already apparently forgotten the wave of devastation to our economy by the scandals three years ago. We have no intention of stopping.
NPQ | John Kenneth Galbraith has long worried that too much power has been given to management in the modern corporation. "The temptation for personal enrichment" is just too great, he has warned. "The managers are stealing capitalism." Is that your view?
Angelides | I agree. Frankin Roosevelt saved free enterprise by bringing its credibility back to the average person. We have a similar responsibility today to stabilize and bring credibility back to a system in danger of being engulfed by crony capitalism. George Bush and his government, in many ways, embody that crony spirit.
NPQ | The other side of the coin for the founders of Google is their fear that investors will push them to perform for the quarterly bottom line instead of the long term. Yet, don't large pension funds with a long-term horizon to meet actuarial assumptions naturally share Google's perspective?
Angelides | I think institutional funds can do a better job of shooting for the long term. By doing that we can give management a better ability to make the right decisions. It is too easy to lay all the blame on corporate managers. The short-term fixation is an American cultural problem.
Ordinary investors as well as institutions have been guilty of expecting double-digit annual returns on a quarterly basis. What made America strong was not this mentality, but patient investment for the creation of real wealth that is broadly shared. That is what has distinguished America from other countries.
Gardels | CalPERS recently announced that India had met its criteria for investing in emerging markets. How do you arrive at these criteria?
Angelides | We undertook a study beginning in 1999 to assess what really led to growth in emerging markets, in which CalPERS had more or less been investing blindly.
Many of the markets had capital flowing in, but lacked the fundamentals to handle that capital efficiently and transparently-stable political system, democratic institutions, free markets and free press. Without these, growth would not be sustainable.
And the returns at CalPERS showed this-they were mixed at best, poor at worst.
So, we established a new way of looking at the emerging countries. For example, we examined the maturity of their financial markets. Do they have good accounting practices and basic shareholder rights? Do they have the ability to transact a trade so you can get your money out? And does the emerging country have the characterstics-for example, democratic institutions, political stability and courts to which shareholders can appeal and get redress-that will allow it to move from an emerging market into a developed market?
In short, if a country is becoming the kind of place capable of sustaining long-term growth, then we think we can do business there. Beyond that, then, we look in those countries for particular companies with sustainable practices, that don't use child labor, are improving workplace safety and, in general, treat their workers well.
The result of all this is that not only have we improved our returns, but countries seeking our investments are now striving to meet our standards.
NPQ | Again, the long-term perspective in investing and wealth creation....
Angelides | Our interest is to get the best long-term returns for our pension funds. To do that we encourage the most responsible, long-term conduct in the corporate world and in our investment practices.
We are a set of institutions that have a 30-year horizon. It is in our interest to be investing in ways that build real, broadly shared wealth. We are not day-trading. We will not succeed by doing well for a couple of quarters and then getting hammered. Our abiding and overwhelming interest is in getting long-term returns. Those returns can only be made in an economy of sustainable strength over time. It is one of the reasons for our "double bottom line" program, in which we invest in "emerging markets" within California's poorer communities. We get good long-term returns on these investments. In turn, they create jobs and sustain the tax base. It is the reason for our "green wave" initiative, which invests in environmental technology. Across the board, we focus on long-term returns and sustainable economic progress.
NPQ | New state-of-the-art regional airports are going up all over China. Millions of miles of highways are being built. Maglev rail lines are operating. In South Korea, more than 50 percent of households have broadband access. K-12 education remains strong.
How can a short-term, tax-averse consumer democracy like California under Gov. Schwarzenegger prepare California to compete for the future?
Angelides | This question is at the heart of whether America will still be a preeminent economy and society by the middle of the century. A society living just for today, running up debt beyond its means and mortgaging the future without investing in the long term is a society that will struggle to compete in a tough global economy. It is not a society that is likely to prevail.
I am the child of immigrants. Like so many others, my parents and grandparents sacrificed everything so the next generation could do better. The reigning idea was that you used today's wealth to create more wealth for the future.
This contrasts with the lie being told by right-wing ideologues now that all America's success is due solely to the creative genius of a wealthy few in the private sector. Our real genius is that we have managed to combine a wealth-creating, risk-taking innovative private sector that produces new products, new technologies and jobs with smart public investment in infrastructure and education. There was a public foundation for America's economic expansion.
We seem to have forgotten this. We are now in a country with a $500 billion federal debt. For what? To be energy independent? No. To build infrastructure? No. The debt is because we have lived beyond our means.
As treasurer of California, I, unfortunately, had to issue $15 billion in bonds recently. To build university or community college campuses? No. They are to pay off today's debt. At the very time when China and India are training tens of thousands of engineers every year, here in California the governor has proposed a budget that means there is no room in our universities for 22,000 students who have passed all the tests, met the grade criteria and want to go to college but must be turned away.
A society that is not willing to invest in the future is not a society that is going to be competitive. Clearly, we need to reimbue our culture with a sense of the long term or we will lose out.