ICGN 1998 CONFERENCE PROGRAM – MARKET INFLUENCES ON CORPORATE GOVERNANCE

The Fairmont Hotel
July 9, 1998
San Francisco, CA
Robert A.G. Monks, LENS

"CREATING SHAREHOLDER VALUE CALLS FOR MORE TRANSPARENT CORPORATE GOVERNANCE TO ALIGN MANAGEMENT INCENTIVES WITH SHAREHOLDER EXPECTATIONS."*

The world market place is sending a clear message to managers and investors alike – maximum value will be accorded to companies with the best governance, or to put it another way, the best governed companies will have the lowest cost of capital. Such an unmistakable message creates opportunity.

My colleagues and I have determined to progress from our successful six year investment with the LENS fund in the United States to a world wide partnership with Hermes focusing initially on companies in the UK. The informing premise is that if we can improve the governance of certain companies, we can create value for all shareholders and adequate profit from management fees for ourselves. We style ourselves "institutional activists" as we act for the entire class of ownership and do not accept directors or investment banking fees from "focus companies."

HLAM – Hermes Lens Asset Management Company – has been organized as the majority owned subsidiary of the B T Pension Scheme, the largest pension fund in the U.K. Hermes, as the manager of BTPS and much of the Post Office pension funds, is one of the largest pension managers in the United Kingdom with $65 billion under management. Because most of these funds come from just two major customers, Hermes is able to pursue shareholder activism without the distraction of other relationships in the market place. The Blair government has made it clear that institutional investors are expected to demonstrate an increased level of responsibility for portfolio companies. Because of its size and its unfettered business plan, Hermes may well be in a unique position to fill this function. The LENS group has been one of the leading American activists for over a decade. During the last six years, it has operated an activist investment fund with superior – in the sense of being significantly better than the averages – performance. BTPs had committed to invest between 50 and 200 million pounds and the initial selling effort has gone so well that the scheduled starting date has been put back three months to accommodate demand.

Circumstances for activist investing are more favorable in the United Kingdom than elsewhere. Much of the effort of American activists has been expended in order to get what the law plainly confers on British shareholders – notwithstanding provisions to the contrary in corporate charters, 10% of the shareholders may call an Extraordinary General Meeting; at such a meeting 50% of the shareholders may remove any and all directors; and the Take Over Panel enforces a climate in which shareholders – not directors, as in this country - make the ultimate decision. There are about twenty institutional investors who each own more than 1% of the total market and who have comfort and familiarity with active shareholder involvement. Many have developed distinctive styles. Legally and structurally, effective control over publicly owned UK companies by their shareholders is an accepted fact. It will be HLAM’s intention to provide a new capability –activism will be our entire focus and we are not tormented by conflicting interests.

Our style is familiar. We are "value investors". Using techniques developed by LENS, HLAM first identifies underperforming companies with particular characteristics. Value investors customarily select stocks because they conclude the existence of ephemeral constraints on value, which can be predicted to disappear in time. HLAM eliminates the two elements of conditionally in its focus companies – it assures that the constraints will be addressed and it assures they will be addressed immediately. Removing uncertainty and compacting the time help explain why LENS’ record has outperformed other value funds over the last five years.

I will briefly touch on a particular instance of the market impacting corporate governance. A principle concern is to assure that top management compensation is effectively aligned with the enhancement of owner’s long term wealth. This is an area in which our experience in the United States suggests caution in relying blindly on the "market". Conventional wisdom suggests that current CEO pay levels are largely set by competitive considerations in the market place. One has to take note of the subordination of the Financial Accounting Standards Board ("FASB"), the accounting profession and compensation consultations in concluding whether the apparent market is real or "rigged".

CEOs have a hard job. There are many constituencies who claim their attention and priority. We represent a new phenomena in the activist world. No matter how successful HLAM is in its activism, clients of Hermes – the parent company – will continue to own 1 1/3% of the company’s outstanding stock in its indexed accounts. Hermes is an activist and its clients are "permanent" investors. This is the perspective that we take to CEOs and boards. We believe along with the authors of the article appearing in the McKinsey Quarterly cited above that there is a ".. virtuous cycle of shareholder value creation." And that "… contrary to the prevailing European view, a focus on shareholder values boosts productivity and liberates resources that benefit stakeholders of all kinds in the long term"· It is not only shareholders who benefit from institutional activism, it is society as well. This is not surprising as reintroducing an informed and effectively involved owner to the modern corporation is the answer to concerns of profligacy and misdirection that have haunted the corporate world since the admonitions of Adam Smith.

In conclusion, Hermes Lens Asset Management Company has been organized to fill a need dictated by the market place. We hope in future years to come back and tell you about the expanded scope of our operations.