Shareholder Activism: Policy Battlefield of the Future

By Bart Mongoven

Activists demonstrated outside the offices of
university pension manager TIAA-CREF on July 18, calling for the massive fund
to exercise more power within the companies in which it owns stock. If
TIAA-CREF, which holds more than $300 billion in assets, starts to take this
sort of assertive stance, companies will have to listen. Meanwhile, on July
21, International Shareholder Services (ISS), an adviser on shareholder
proxy votes, announced that it had purchased the nation's leading social
investment advisory group, Investor Responsibility Research Center (IRRC).
This merger suggests that the mainstream financial community, ISS's
clientele, increasingly is asking about social-focused shareholder
resolutions.

The two events point to the increased role that
corporate shareholders will have in making public policy in the United
States, and suggest that corporate decision-making could change dramatically
in the coming years.

The coming shift will prompt most corporations to
exercise more caution in several aspects of their businesses, as shareholders
increasingly can be expected to demand that companies avoid social and
environmental pitfalls that could affect the long-term value of their
holdings. The caution will be apparent in corporate operations -- including
the products companies make, their advertising, the places they do business
and the relationships they have with certain governments. Though
issue-oriented activists will have an indirect impact on corporate policies,
the new social, labor and environmental policies that corporations follow
will reflect primarily the work of shareholder groups. These groups are
using increasingly sophisticated market analyses to show corporate managers
(and fellow shareholders) the wisdom of following a voluntary course of
action in areas of potential social criticism.

Since the 1970s,
social and environmental activists have used proxy voting and public
companies' annual shareholder meetings as a platform to push for new public
policies. The early shareholder activist and "socially responsible"
investment movements achieved their most significant victory in the 1980s,
when heavy pressure forced major U.S. and European multinationals to
withdraw from South Africa and contributed significantly to the end of the
apartheid regime. By the end of the apartheid era, few major multinationals
dared do business in South Africa lest they be seen as endorsing its racist
political, social and economic structure.

Shareholder activism does
not depend on gaining the support of the majority of a company's
shareholders in order to be effective -- proxy votes are nonbinding.
Instead, it changes corporate policy when management sees that a strong
minority of shareholders (usually 20 percent will do) find the company's
policies troublesome. Senior executives begin to fear that significant
amounts of management's time, energy and attention will be diverted to
addressing the issue. To reach that threshold of effectiveness, activists
try to recruit the support of as many large shareholders as possible --
beginning with small social-oriented firms such as Calvert, then progressing
to socially-oriented pension funds such as CalPERS (and potentially
TIAA-CREF, if the demonstrators get their way). Still, most successful
campaigns need significant rank-and-file shareholder support and that of at
least one major mainstream investor.

That said, shareholder activism
is poised to emerge as a central policy-making vehicle for three reasons.
First, there is the deregulatory political culture that dominates federal
policy-making. A second element is growing economic globalization -- coupled
with the removal of trade barriers -- which has led to a recognition of the
important role (positive and negative) that corporations can play in
developing countries. The third major reason is the increasing
accountability and transparency demanded by shareholders and required by
securities regulators in the wake of the corporate scandals of the 1990s.


The most significant catalyst of the emerging movement in
shareholder power is the deregulatory mood that holds sway at the federal
level. This trend toward deregulation (or at least a reluctance to impose
new regulations) began in 1995 and gained momentum when President George W.
Bush took office. With Bush's election, traditional liberal lobbies
concluded that new and more stringent federal regulation of corporate
activities was unlikely, so they began to focus on alternative areas in
which they could exert power over corporate activities. Most of these
lobbies determined that they would do better with calls for action at the
state level, through international treaties and through shareholder
activism. All three of these trends continue to dominate new regulatory
policy-making in the United States. Of the three, shareholder activism is
emerging as the most powerful avenue for changing corporate policy over the
long term.

This strategy is most visible in the climate change
debate, where a number of corporations -- including many energy companies --
have adopted climate change policies as a result of shareholder pressure. No
action is likely at the federal level on climate change for at least a
couple of years. Many influential shareholder activists argue that
regulation is inevitable and that, consequently, companies should begin to
change their internal mechanisms now in order to prepare for dramatic
regulatory changes and potential liability.

Under this kind of
pressure, some major oil and electricity generating companies have adopted
policies that commit, at the very least, to measure their financial
vulnerabilities in a "carbon-constrained" economy. Many have gone further
and adopted policies that give consideration to climate change in their
internal decision-making processes. The law has not changed, but under
shareholder pressure the vast majority of the energy industry is preparing
for the day when it will.

New arguments following this "climate risk"
logic -- that is, environmental and social concerns are not just public
relations problems, but carry serious financial liability risk for companies
and must be addressed in that light -- have been raised recently in various
industries, including against mining, chemicals and consumer products
companies. The central premise of these new shareholder campaigns is the
notion that society's ethics and mores are constantly changing, and the best
corporations will adjust their policies before they feel the brunt of
changing values. The use of child labor in developing countries, for
instance, recently was accepted practice in certain industries, but now
allegations of child labor represent significant risk to corporate brands --
just ask Nike or Kathy Lee Gifford.

Similarly, it was once de
rigueur for multinational construction companies and extractive
industries to build large infrastructure projects that required relocation
of significant numbers of indigenous peoples in developing countries. These
projects usually had World Bank funding. Now the Bank won't fund such
projects, and corporate managers are increasingly wary about these kinds of
proposals.

Merrill Lynch recently released a report titled "Energy
Security & Climate Change: Investing in the Clean Car Revolution," which
concludes that there are solid investment opportunities in those automakers
that have developed (or are developing) advanced clean technologies.
Although Merrill Lynch understands perfectly well that "clean tech"
investments tend to perform poorly in strict efficiency terms, it likely is
betting that the shifting line of acceptable industry behavior will render
these investments profitable nonetheless.

Examples such as these
reverberate throughout industry and shareholder groups. They suggest that
sound management requires acting quickly (and often on limited information)
to quell potential problems, and that there is considerable risk in ignoring
potential social problems. Nike's image has never completely recovered from
the allegations that it used child labor, even though it is now one of the
most transparent companies in the world when it comes to its supply chain.
Shell continues to spend millions of dollars to rebuild its reputation after
controversies in the late 1990s. (Interestingly, the cost to Shell is best
measured in recruiting difficulties: New graduates, particularly in Europe,
prefer not to work for a company embroiled in human rights or environmental
controversies.) And as Merrill Lynch's report suggests, socially responsible
shareholder groups are increasingly successful in bringing this same argument
to mainstream investors.

The degree to which shareholder activism is
emerging as an important element in policy-making is epitomized by ISS's
acquisition of the IRRC proxy advisory business. ISS specializes in advising
major pension funds and investment houses on the business implications of
important votes raised at corporate annual meetings. It prepares analyses of
mergers, of significant changes in pension fund management and of other
similar issues relating to corporate governance for its clients.


Only rarely has ISS taken positions on social or environmental
resolutions. IRRC, on the other hand, specializes in the analysis of
environmental and social shareholder resolutions. This merger signifies the
degree to which demands for restricting corporate behavior -- once seen as
the demands of an activist fringe and thus as issues that could be safely
ignored -- are now being incorporated into standard corporate-governance
conversations. With this merger, ISS is acknowledging that advice on
social-related shareholder activism is in sufficient demand that its
portfolio needed IRRC.

As the lines of communication and credibility
are strengthened between the socially responsible investment community and
the mainstream investment community, activists will be able to expand their
demands even further and leave their mark on how business is conducted.
Further, because of recent rule changes by the Security and Exchange
Commission, all financial services firms, including pensions and mutual fund
companies, must make their proxy votes public. This will ease the
politicization of proxy voting, as companies with strong brand names -- such
as Fidelity and Merrill Lynch -- will have to tell clients how they voted on
the social demands placed before shareholders.

Ultimately, these
changes likely will result in corporations adopting policies that are more
cautious, better thought out and significantly more responsive to public
concerns. They also will usher in a fundamental shift in policy-making in
government, particularly as business threatens to get far ahead of the
federal government in the United States. The two traditional types of public
policies -- those demanded by the marketplace regardless of law, and the
demands of government -- will at least for a time diverge. Whether this new
era of responsiveness satisfies society's need for regulation of business
practices, however, remains to be seen, as do the larger implications of all
of this for notions of democracy.

Send questions or comments on this article to analysis@stratfor.com.

© Copyright 2005 Strategic Forecasting Inc. All rights reserved.