Yesterday’s stock market surge is probably explicable, to the extent that market movements ever are, on the basis of the drop in oil prices or something of that sort. I’d like to imagine, though, that the real cause was a larger event, the unexpected removal of Sean Harrigan from the board of the California Public Employees Retirement System. As Calpers’ CEO, Mr. Harrigan was all that an investment manager shouldn’t be. Not only did he exhibit more zeal for political crusades than ROI, as when he tried to turn Abu Ghraib into a corporate meeting issue; he also had no qualms about blatant conflicts of interest, using Calpers’ resources to intervene against employers facing strikes by the United Food & Commercial Workers Union, of which he is a senior official.
Those flaws are widely recognized but were not perhaps overwhelmingly significant by themselves. The worst aspect of the Harrigan regime was one for which Calpers is frequently praised, even by savvy investors who ought to know better: its purported devotion to overseeing corporate management and taking action against incompetence. As a major Disney shareholder, Calpers was an early and persistent critic of Michael Eisner. More surprisingly, it tried to oust Warren Buffett from the Coca-Cola board, because it disapproved of his actions as a member of the audit committee. Overall, it has played the part of a well-heeled upgrade of the classic corporate gadfly, haranguing corporate leaders not just at annual meetings but all the year round.
Superficially, it may seem sensible for a fund that holds a large bloc of a corporation’s stock to kibbitz management actively. The shareholders own the company, their interests should be its managers’ foremost thought, etc. That is all true enough. But does it follow that the stockholders should substitute their judgement for management’s? While extraordinary cases may arise now and then, it is foolish to hire others to run an enterprise and then, on an ad hoc, amateur basis, without day-to-day familiarity with what is going on, question their decisions. If the results that they obtain are unsatisfactory, the modern system of corporate ownership furnishes the unhappy investor with an easy and adequate remedy: He sells his stock and buys into what he regards as a better run operation. If the market generally agrees with his valuation, the price of the poorly managed company’s stock will fall until it accurately reflects the quality of its executives.
Calpers’ preferred modus operandi has been the opposite: to hold onto its shares and try to use their influence to bludgeon management into performing better. Unfortunately, its board members lack the information, whether or not they possess the aptitude, to formulate business strategies. They can offer only specific ideas, some of which may be good but more of which are likely to be of secondary importance or, on account of their interaction with other, unrecognized factors, positively detrimental.
An instance is Calpers’ insistence that a company’s auditors should never, under any circumstances, be hired for non-audit duties. Disregarding that precept was Mr. Buffett’s mortal sin. Let us suppose arguendo that it is a sound principle (which I find rather doubtful, but that’s a debate for another day). Nonetheless, adhering to it in every conceivable case will mean sometimes obtaining lower quality services at a higher price. Sean Harrigan evidently believed that the sacrifice invariably brings compensating benefits. Warren Buffett, as a member of Coke’s audit committee and familiar with the company’s actual needs and the capabilities of the available consultants, disagreed. Did Calpers truly enhance shareholder value by insisting upon its principle?
This meddling approach is a bad idea even when it keeps clear of political fads. Once in a long while, the part-timer may be right and the full-time professional manager wrong. Much more often, “shareholder activism” wastes management’s time and, where it prevails, misdirects corporate resources to unprofitable ends.
The optimistic view of Mr. Harrigan’s departure is that it is the first sign of the demise of a foolish activism and a return by institutional investors to the concept of a division of corporate functions. It is the job of operating managers to attract capital and of managers of capital to discern which management teams will operate most profitably. Each of those roles depends upon different, to some extent incompatible, skills, as well as immersion in different kinds of data. The less they are commingled, the better for the economy. That prospect is a good reason for a stock market rally.
Today the market did nothing, so perhaps it isn’t so hopeful about the fate of the Calpers philosophy after all. Well, I can dream, can’t I?
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