Editor’s note: This article appeared in the Jan. 11, 1993 issue of Fortune.
For God’s sake, let us sit upon the ground And tell sad stories of the death of kings, How some have been depos’d, some slain in war, Some haunted by the ghosts they have depos’d, Some poison’d by their wives, some sleeping kill’d, All murder’d. For within the hollow crown That rounds the mortal temples of a king Keeps Death his court …
—Richard II
Has it come to this? Consider: General Motors Chairman and CEO Robert Stempel unceremoniously unhorsed. Ditto Kenneth Olsen, founder, president, and principal executive officer of Digital Equipment. Chrysler’s Lee Iacocca beaten back after an 11th-hour attempt to keep the throne he reluctantly forswore. The former chiefs of Compaq, Goodyear, Hartmarx, Imcera, Tenneco—the list goes on—getting in more golf than they expected at this age, soon to be joined by American Express leader James Robinson. The candles burning late in the offices of John Akers of IBM, Edward Brennan of Sears, Paul Lego of Westinghouse, as each struggles to keep his orb and scepter, some of them sacrificing pieces of their realms in hopes of holding the rest. And in the encircling tents, their armor glittering, their coffers brimming with gold, the Bolingbrokes of the piece: institutional investors, activist shareholders, and even the boards of directors themselves, the king’s own court, to whom he gave preferment, now demanding his obeisance—if not his head.
Carnage on this scale does not occur just because of a long, painful recession or a noisy controversy about executive pay, though those have played a part. What’s manifest here is large, basic, and historic. Says Alcoa chief Paul O’Neill: “The imperial CEO is doomed.”
Attorney Martin Lipton, counsel to so many chiefs over the years, calls the phenomenon “a sea change in the relationship among management, boards, and shareholders.” Henceforth, says John Pound, a professor at Harvard’s Kennedy School of Government and an expert on corporate governance, “the CEO will look less like an emperor than like a Congressman, trying to represent his various constituents and, to the extent he succeeds, being reelected.” Talk about a comedown.
What’s happening is a reversal of the decades-old tendency of corporate power to gather in the hands of executive officers rather than directors or owners, a reversal that will change corporate America for a long time.
Three score and one years ago, Adolf Berle and Gardiner Means published their classic book, The Modern Corporation and Private Property. The passing of generations had attenuated the power of founding families, the two Columbia University scholars noted, while the rise of the public corporation had spread ownership among tens of thousands of individual shareholders, none of whom could cast a meaningful vote in the governance of their companies. The result, Berle and Means showed, was a new class of professional managers who owned little of the corporations they nevertheless controlled. The merest whim of the imperial executive echoed like thunder down a valley. The CEO has to be careful, ran an old joke at General Electric; if he asks for a cup of coffee, somebody might run out and buy Brazil.
In most corporations CEO accountability was a Mobius strip, always leading back to the big office where sat the man who headed the board that judged him. Strict federal rules barred shareholders from acting jointly to influence management. Until this year, notes Nell Minow, a principal of the Lens Fund, the investment group headed by activist Robert Monks, “the only times you needed a written release from Uncle Sam before you could publish something were for nuclear secrets and proxy initiatives.” The result was what Brookings Institution economist Margaret Blair calls “a classic agent-principal problem,” in which the agent (the manager) could serve his own interests whether or not they were the same as the interests of his principals
That era has ended. “We own the American economy now,” says Carol O’Cleireacain, New York City finance commissioner and trustee of four city pension funds with nearly $50 billion of assets. “We” means institutional investors—pension funds, mutual funds, insurance companies—whose portfolios hold 50.3% of all the stock of all the corporations of America. Such enormous sums swing big weight. Asks trustee O’Cleireacain: “Money and power—how do you separate them?”
You don’t. And as institutional shareholders—conspicuously public-employee pension funds—assert the prerogatives of ownership, they necessarily clip the power of corporate management. The most dramatic tokens of this change are those instances—13 from the FORTUNE 500 lists in the past 18 months—where a CEO has been dethroned. (Technically, most have abdicated, with board members observing a code of omerta.)
If not dethroned, the CEO may be reduced to far less than imperial powers. Consider Edward Brennan of Sears, heir to such Caesars as Julius Rosenwald and Robert E. Wood. At the beginning of 1991, Brennan held five jobs: chairman of the board, head of its nominating committee, chief executive officer, CEO of the Sears merchandising group, and trustee—one of three—of the employee stock ownership plan. Depending on which role he played, his responsibilities included criticizing his performance in the others. Following Robert Monks’s highly publicized, if unsuccessful, campaign for a board seat, Brennan gave up three of his jobs, remaining chairman and CEO. This autumn, facing the threat of shareholder votes to separate the two positions and continuing pressure from big shareholders to improve results, Sears announced it would spin off its financial services and real estate brokerages.
Or consider Westinghouse. In 1989, Chairman and CEO John A. Marous was asked about a small increase in bad real estate assets held by the company’s financial services division. A minor problem, he replied, noting that the company had little exposure to Texas real estate (in a swoon at the time). Then, among other problems, California fell into a sea of troubles, and the company went with it. This fall Marous’s successor, Paul Lego, spent many hours meeting with shareholder groups, some of whom handed him specific restructuring plans. When it was over, Lego had his titles and a vote of confidence from his board. But he had renounced any authority to nominate directors, set the terms of corporate governance, or influence his compensation; his board put up for sale divisions of the company that accounted for one-third of 1991 revenues; and the directors agreed that they all would stand for election annually, by secret ballot.
The fact is, the institutions’ fingerprints are on most celebrated CEO ousters of the past 18 months, even if no giant shareholder had specifically demanded them. An important reason boards are finally waking up is that a spotlight is on them as never before, exposing directors to embarrassment or even lawsuits if they don’t do their jobs. And the operators of the brightest spotlights are institutional investors, constantly seeking and highlighting poor corporate performance, self-dealing, and bad incentives.
They never used to do this—so what has changed? The size of their portfolios, for one thing. Assets in the giant California Public Employees’ Retirement System (Calpers) swell about $1 billion every two months, for example—in a year, more than four times the median market value of a FORTUNE 500 industrial company; in four years, enough to buy all the common stock of General Motors, with enough left to buy five tankfuls of gasoline for each vehicle it makes.
Frankly daunted by the task of investing that much money thoughtfully, most large pension funds, and a growing number of mutual funds, don’t try. You can’t beat the market when you’re so big that you are the market, the argument runs, so they try to match the composition of their portfolios—or most of them, at least—to various market indexes.
The paradoxical result of passive investing is active owning. Says James Dowling, chairman of Burson-Marsteller, the public relations firm that this fall established a corporate governance practice to advise CEOs and boards on how to operate in the changed environment: “The public funds have so much money that they find it’s harder to find new companies to invest in than to try to turn around poorly performing ones.” If that means forcing out the CEO, so be it. Says Jennifer Morales, executive director of the Houston Firemen’s Relief Retirement Fund: “We don’t want to sell. If a company can be improved, why should we be the ones who leave?” The funds therefore have begun to single out underperformers, demanding more say in their governance and, increasingly, proposing changes in board composition and strategy.
The emphasis on performance is recent. It was only in 1988 that the Labor Department ruled that pension funds must vote the shares in their portfolios for the exclusive benefit of plan participants; previously funds often abstained or routinely voted with management. What activism there was stemmed from the public-sector and union roots of many funds; they focused on political and social issues, urging companies to become more environmentally aware, pull out of South Africa, or open their boardrooms to blacks and women.
Though the social agenda hasn’t disappeared, it took a back seat after the stock market crash and the end of the takeover boom in 1987—coincidentally, the year Dale Hanson became head of Calpers. Ever since, more shareholder proxy resolutions have had to do with governance than with social issues, says the Investor Responsibility Research Center. Before, few fund trustees were knowledgeable enough to analyze performance. They didn’t need to be: O’Cleireacain notes that New York City’s pension funds averaged 15% annual returns in the Eighties, when the takeover market ruthlessly dug out the buried value in underperforming companies.
The gold rush ended when the value of what remained underground no longer exceeded the high costs—interest on borrowing, legal fees, investment banking fees—of getting at it. In addition, corporate defenses such as poison pills and staggered terms for board members grew stronger, and laws in some 35 states made hostile takeovers more difficult.
No longer able to rely on Henry Kravis and Carl Icahn, the institutions suddenly had to pursue value on their own. At about the same time, another change in the economy pushed institutions further into conflict with management. The argument, developed by Brookings’ Margaret Blair, is subtle but every bit as important as the raw voting power of growing institutions.
When real interest rates are low, as they were for most of the postwar era into the Seventies, managers’ tendency to build empires aligns beautifully with owners’ interest in maximizing value. Cheap money enables all sorts of businesses to earn a profit. Says Blair: “Nobody gave a hoot about corporate governance 15 years ago because a large part of what a company did to grow also increased shareholder value. In the same way, Japanese companies could pursue a market-share strategy as long as their cost of capital was low.”
That happy marriage fell apart when U.S. interest rates rose in the Eighties. Now the owners of capital that had been invested in assets with low returns wanted it back, or at least better used. Says Harvard’s John Pound: “It’s no coincidence that the governance stuff mostly comes up in industries with limited prospects. People forget that the capital markets aren’t just supposed to provide capital but also to deny it to companies that can’t make efficient use of it.”
Though interest rates have fallen from their peak, managers and owners haven’t patched up their differences. For one thing, real rates remain high. More important: Competition for capital is now global. Oxford Analytica, a British think tank hired by headhunter and consultancy Russell Reynolds Associates and three other firms to study corporate governance, reported in August that “intensifying international competition for capital” will force managers to cede some autonomy to the folks with money. Executives, the study says, must let institutional investors into the tent or face damaging proxy fights or—perhaps worse—uncertain access to capital markets.
Greater competition for capital weakens the CEO by increasing the chances that his performance won’t be good enough to attract any. Given excess capacity in almost every industry—think of airlines, automobiles, retail banking, defense, and computers—ever more managements find it tough to beat market-rate returns. Next thing you know, your secretary is telling you that a Mr. Hanson is on the line, wondering what you plan to do to protect his investment.
Though the power of large shareholders to pressure, shame, and ultimately fire managers is vast, they have few weapons beyond derision and the tumbril, and almost no ability actually to improve the performance of the companies they own. The handful of activist investors don’t pretend to be able to manage corporations. They couldn’t possibly inform themselves in depth about the hundreds of companies in their portfolios. It is doubtful that they can claim a seat on a board of directors, since that might conflict with their fiduciary responsibility to their members, for example by making it difficult for them to buy or sell shares because they would possess inside information. As a result, they are limited to a watching brief and to raising a ruckus when trouble comes. The Council of Institutional Investors is an organization of large shareholders whose total assets exceed half a trillion dollars. Even so, says executive director Sarah Teslik, “publicity is our most powerful weapon.” In the media age, that will do nicely.
If you show up on one institution’s “target list,” chances are you will appear on others. Organizations such as Institutional Shareholder Services, in Washington, D.C., have sprung up to help institutions analyze company performance and behavior, and advise them on voting. Robert Monks’s Lens Fund identifies targets using a screening process developed by Batterymarch, the Boston money management firm, combining it with data from FORTUNE’s annual survey of corporate reputations. Most analyses turn up the same names. Favorites for the 1993 proxy season include Caterpillar, Champion International, IBM, International Paper, Polaroid, Sears, and Time Warner (parent of FORTUNE’s publisher).
Only a few activist institutions and advisory firms compile these lists. But the media publicize them. Many other institutions and individual shareholders read them. So do directors—and the directors’ peers, golfing buddies, and neighbors. Soon the jungle drums begin to beat, investors of all kinds are voting against management in growing numbers, and directors are squirming. And all that pressure is focused on one person.
What will the CEO’s job be like in this new world? At many companies it will no longer routinely include the title of chairman of the board. To its advocates, the idea of a separate chairman is a matter of simple seemliness. Says James E. Heard, president of Institutional Shareholder Services: “Look at a poorly performing company. Who’s running it? Mr. CEO. And who’s he accountable to? The chairman. And who’s he? Mr. CEO. Huh? An autonomous, effective board is more likely if it has its own chairman.”
General Motors has separated the jobs of chairman and CEO; John Nash, president of the National Association of Corporate Directors, predicts that 50% of the FORTUNE 500 will have separate chairmen in ten years. But don’t bet on it: That drive starts on the two-yard line. In a survey of companies on FORTUNE’s lists of the 1,000 largest U.S. industrial and service corporations, executive search firm Korn/Ferry International found 20% of respondents had separate chairmen in 1992. That is down from 26% in 1979, and all but a half-dozen instances are special situations: a retiring CEO who stays on as chairman for a year or two, for example.
Those who defend combining the jobs argue that hard cases, such as GM, make bad law. The seemliness argument cuts both ways. Says Philip Caldwell, retired chairman and CEO of Ford, who sits on the boards of Digital Equipment, Russell Reynolds, and Shearson Lehman Brothers Holdings: “If you have to resort to that kind of organizational change, you have the wrong relation between the board and the CEO.” Caldwell, appointed chief executive of Ford in 1979, recalls how he had served six months in the post when Henry Ford II, who had continued as chairman, walked into his office and said, “This is nuts. You can’t do this job and not be on top.” With what Caldwell calls “an unusual sense of the propriety of organization,” Ford stepped down, asking only that he remain an employee till his 65th birthday.
Holding managers’ feet to the fire is one thing, and difficult to gainsay. Tying their hands is another, important to forestall. Says Martin Lipton: “If boards go too far, they will dilute the entrepreneurial activities of management. CEOs could become risk-averse.” He adds, “I hope CEO power isn’t a casualty.”
In some forms it already is. The struggle is over; shareholders have won. But paradoxically, executive leadership is becoming more indispensable than ever. Only the executive can mediate among the multitude of constituencies vying to influence every corporation: investors and lenders, communities, employees (who may be big investors), customers. The CEO may be on a shorter leash, but he’s a more valuable dog.
To succeed, the lead canine must first and foremost seek out and communicate with his employers. As Sarah Teslik says, “You kinda oughta tell us what you’re doing, ’cause it’s only polite.” It’s only prudent too: New rules on proxy solicitation promulgated by the SEC in October allow most kinds of private discussions among a company’s shareholders, out of view of the public and the company. Before, any meeting of more than ten shareholders was forbidden unless a detailed proxy statement had been filed with the SEC. If you aren’t out there talking to shareholders, you might be surprised when you learn that they have been out there talking about you.
Rather than complain that institutional investors don’t know your business, teach them. They have power: Would you rather they used it ignorantly or wisely? Strong, informed owners are an executive’s best allies. The governance subcouncil of the Competitiveness Policy Council, a prestigious Washington, D.C., advisory group set up jointly by the White House and Congress, argues that shareholders deserve extensive information about training, customer satisfaction, R&D, quality, and strategy. The more nonfinancial but solid information you give them, the more rope they will give you.
Says Philip Caldwell, thinking back to his days at Ford when he pulled the company’s (and the Ford family’s) chestnuts from the fire: “Concentrated ownership creates a potential for stability, a huge plus in almost any business I know. My years were turbulent—things were tough. Peace on the shareholder front gave us the time we needed.”
Use your board. Having a separate chairman or a lead director matters less than having a board that works hard to help you. “I bring the board my toughest problems, not my easiest,” says O’Neill, the only insider among Alcoa’s directors. “I don’t want a paperwork board, but one that thinks like owners.”
Manage for the long term. Your investors do—not just the pension plans but even mutual funds. The often-heard accusation that they look only for short-term gains isn’t true, according to detailed studies of their behavior reviewed by the Competitiveness Policy Council’s subcouncil on corporate governance and financial markets. Sure, some dart in and out like sparrows sneaking a crumb from among a flock of pigeons, but most sell just enough to meet liquidity needs or to time the market—or to get out of a company after they finally decide its long-term prospects have dimmed.
Above all, the CEO must stick to business. When shareholders lose patience these days, they can act much more quickly than before and are more likely to pressure the board to replace management than take the “Wall Street walk” and sell. Sputters a FORTUNE 500 CEO: “When Robert Stempel was hospitalized this fall he was at a Conference Board meeting in Washington. Can you imagine a guy with a $120 billion problem on his hands giving three hours to the Conference Board? If I’m a shareholder I don’t give a crap about that.” On the other hand, says Teslik, “If you meet our performance standards, we promise you’ll always get our vote.”
Of course if all else fails and you’re ridden out of town on a rail, you may be able to ride back in as a director. Then you can do unto others as they did unto you.
Reporter associates: Rosalind Klein Berlin, Jacqueline M. Graves, Thomas J. Martin, Antony Michels
American Express
James D. Robinson III
Tenure: 4/25/77-present
The smooth Southerner will end his reign as Amex’s flagship card unit fights to stop fleeing members. Last year’s $155 million charge at Optima and troubles at Shearson added to his woes.
General Motors
Robert C. Stempel
Tenure: 8/1/90-10/26/92
The first engineer to run GM since the 1950s, Stempel tried but failed to rebuild the company’s financial fortunes: North American losses for 1990-92 are an estimated $15 billion.
Digital Equipment
Kenneth H. Olsen
Tenure: 8/23/57-10/1/92
DEC’s founder blazed a trail in minicomputers, but his later failure to adapt to changing markets and to cut costs hurt profits. Looking at a $2.8 billion loss in fiscal 1992, the board asked him to retire.
Compaq Computer
Joseph R. “Rod” Canion
Tenure: 2/16/82-10/24/91
Canion’s reluctance to fight rivals by cutting costs and selling cheaper models was his downfall. The board moved quickly, partly because venture capitalist Ben Rosen serves as chairman.
Tenneco
Hames L. Ketelsen
Tenure: 7/1/78-5/31/92
Ketelsen became CEO of the huge conglomerate at 47. A 1988 restructuring failed to produce results, and the recession battered many divisions. Wall Street wanted Ketelsen’s former empire broken up.
Time warner
Nicholas J. Nicholas Jr.
Tenure: 5/8/90-2/20/92
Nicholas starred at Time Inc., running cable-TV operations and later HBO. But a co-CEO arrangement with Warner’s Steven J. Ross was uneasy. Nicholas got the bad news while vacationing.
Goodyear
Tom H. Barrett
Tenure: 12/6/88-6/4/91
A 37-year Goodyear veteran, Barrett had to fight heavy debt and a worldwide industry slump. He tried to cut costs, but the board got tired of waiting; the company lost $38.3 million in 1990.
