Investor Capitalism: How Money Managers Are Changing the Face of Corporate America.

• Author: Coffee, Jr., John C.

By Michael Useem. New York: BasicBooks. 1996. Pp. vii, 332. $30.

Ideally, Thurman Arnold should review this book. In his The Folklore of American Capitalism,(1) Arnold dissected the ideology and rationalizations by which the business community of an earlier day defended its legitimacy and perquisites. Michael Useem, a sociologist at the Wharton School, also has an interest in the ideology of the business community: how corporate managers view the new institutional investors, how they justify resistance, and the tensions and inconsistencies between their critiques of money managers and their own behavior. This is an underutilized perspective (which law and economics inherently tends to overlook), and Useem is at his best when he compares the rival lenses through which corporate executives and money managers view each other.(2)

Useem is, however, neither Thurman Arnold nor even the first qualitative social scientist to focus on the relationship between institutional investors and corporate executives. Preceding him were William O'Barr and John M. Conley, cultural anthropologists at Duke University and the University of North Carolina, respectively, who earlier in this decade published a significant and ground-breaking work, which reported that the style of decision-making that they observed within pension funds was vastly different from the stereotypes reported in the popular press.(3) Based on field work at nine large pension funds, these researchers found that money managers were not aggressive, performance-oriented, or preoccupied with short-term results, but rather were risk averse, extremely desirous of avoiding personal responsibility for their decisions, and generally eager to seek protection within the herd by adopting investment management strategies, such as indexing, that effectively minimized individual choice.(4) Surprisingly, the pension fund managers that they studied gave highly personalized and idiosyncratic explanations for decisions that they had reached and seldom engaged in explicitly economic reasoning when asked to defend their decisions or their investment strategies.(5) More to the point, Conley and O'Barr's pension fund managers were extremely reluctant to become involved in the corporate governance of their portfolio companies.(6) Public fund managers, they did find, were somewhat more prepared to be activists, but even these fund managers also pleaded time and informational constraints as a justification for their passivity.

Possibly because their findings were so counterintuitive, the Conley and O'Barr study has encountered some sharp criticism, chiefly on the grounds that its authors were economically naive and brought much value-laden intellectual baggage with them.(7) Still, given that they are Useem's immediate intellectual precursors, one naturally looks to him to confirm or rebut Conley and O'Barr -- or at least to contrast his work with theirs.

Yet, Useem ignores Conley and O'Barr.(8) This is especially surprising because both books were sponsored by the Institutional Investor Project of the Center for Law and Economic Studies of Columbia University. Although these two books thus sadly pass each other like ships in the night, Useem does have a perspective that contrasts sharply with that of Conley and O'Barr: subject to only marginal qualifications, he buys eagerly into the proposition that corporate managers are effectively constrained by institutional investors.

Different as their perspectives are, there is no necessary contradiction here. Their rival views may be partly explainable by the different populations that they are studying. Despite his title, Useem's real focus is on the corporate executives who now negotiate and interact with institutional money managers. To research this book, he interviewed senior executives at some twenty large public corporations (the identities of these corporations are kept secret and code names are used, but some seem clearly identifiable). In common, each of these firms had experienced institutional activism and was learning to cope with it. Useem's qualitative approach to the interaction of money managers and corporate executives offers genuine insights -- principally as to the tactics and techniques by which senior corporate executives are learning to "manage" these relationships. Still, this technique has its obvious limitations. If one wants to understand fully the new institutional investor, this methodology of interviewing primarily the executive cadre of selected public corporations is roughly analogous to that of studying divorced husbands by interviewing principally their executives. One will predictably hear that ex-husbands are a disagreeable and abusive group, but this may be only half the story. As a result, Useem inevitably tells much more about the thought processes and world view of senior corporate executives than about the money managers to which he refers in his title. This is not without value, but it makes his title a misnomer and also suggests who the audience is that he principally wishes to reach.

Logically, the differing focuses of these authors also raise the possibility that both studies could conceivably be right: that is, money managers could have only weak incentives to monitor, but corporate executives could feel threatened and therefore invest heavily in "managing" this new relationship. This observation will lead to some final remarks on which this review concludes.

One last prefatory observation: Useem brings an idiosyncratic perspective to his analysis of money managers that may distort his focus, in at least two respects. First, like many business school professors, he is very much the academic entrepreneur. Correspondingly, his voice and perspective waver: sometimes he is the disinterested scholar; other times, the street-smart, savvy practitioner. At its worst, this book occasionally reads like a how-to-do-it manual on the care and feeding of institutional investors: how to keep them docile and compliant.

Second, as a former student of the civil rights movement and grassroots community activism,(9) Useem recurrently analogizes the more aggressive public pension funds to the liberal and radical activists who galvanized the 1960s civil rights movement and eventually mobilized the initially lethargic liberal wing of the American middle class.(10) But the administrators of public pension funds are largely mid-level, underpaid public servants operating within state bureaucracies and subject to a variety of political and logistical constraints. Whether they should be viewed as the intellectual catalysts of this movement -- in effect, the vanguard of the financial proletariat -- seems doubtful. As later discussed, private money managers may prefer to let the public funds lead the initial assault in any battle with corporate managers in order to minimize their own costs and maintain their own financial camouflage. More generally, while Useem conceptualizes institutional investors as an awakening political movement, the logic of their collective action may be more determined by economic incentives than by political ideologies. In any event, the role played by the public funds may resemble more that of Don Quixote than that of Paul Revere: when they are supported by allies, they can win, but otherwise, they are tilting at windmills and destined to lose. Seldom can they awaken a more broadly based shareholder movement.

Useem's central thesis starts from the perception that we have moved from an era of managerial capitalism to one of "investor capitalism," in which institutional investors have substantially reduced the agency costs in corporate governance. This is, of course, the conventional wisdom. No one doubts that managements are much more constrained today by investor preferences than in a prior era when corporate stock was largely held by individual shareholders. But what does it mean to say that the era of investor capitalism has arrived? It sounds reassuring, even legitimizing. But just how constrained are managements and how far can managements deviate from investor preferences (or the market's judgment) without incurring a shareholder revolt that ousts them? Useem focuses very little on this question, because his preoccupation is with how to "manage" this relationship.

Yet, the possibility that the relationship can be "managed" suggests, at least to a cold-eyed reader, that the agent can manipulate the principal. Useem in effect tells how, but not how much. Here, the principal problems with this book are, first, that it focuses very little on the costs of collective action by shareholders and, second, it never examines the underlying forces that generated the current structure of relationships between institutional investors and corporate managers or that may limit its future evolution. Nonetheless, this is a factually rich book, and it is useful to consider the evidence that it amasses, much of which points to conclusions that differ from those that it offers.

1. MANAGERIAL ACCOUNTABILITY TODAY: HOW CLOSE ARE WE TO INVESTOR CAPITALISM?

   Early in this book, Useem paints the following word picture of CalPers, which he describes as the "premier activist shareholder" (p. 181), and its chief executive, Dale Hanson, at a 1993 conference between corporations and institutional investors:

   When Calpers executives spoke, business listened. Their patience

   might allow a troubled chief executive some breathing room. Their

   impatience might bring the boot. . . . By midday . . . Calpers commanding

   presence became evident even to the uninitiated. The chief

   executive, Dale Hanson, was introduced at a ballroom luncheon as a

   man who required no introduction, and once he finished . . . a dozen

   people pressed forward, pencils and notebooks at the ready.(11)

   This is, of course, exactly the sort of commentary that one reads every day in business page journalism. But if reporters who need to meet daily deadlines...