The challenge of governing for value.

• Author: Gordon, Lilli A.
• Position: Chairman's Agenda: Governing for Shareholder Prosperity

In the next five years, managers and boards will find themselves faced with new challenges from the stock market. Instead of episodic, confrontational challenges for control, CEOs and directors will find themselves subjected to continuous, ongoing scrutiny from both active investors and major long-term institutional investors, who will seek to engage in substantive debate about specific corporate policies and overall corporate performance.

This shift creates an unprecedented opportunity for corporations to create new mechanisms and new processes that allow them to govern for value. If this challenge is met, the result can be the attainment, perhaps for the first time in this century, of a truly cooperative, value-based corporate governance process.

We are in the midst of a revolution in American corporate governance that has been under way for over a half-decade now. One cause is the demise of hostile takeovers; the other, the growing activism of major institutional investors. Together, these changes are transforming corporate governance from an market-driven process to a more political one. The old regime was characterized by fragmented ownership, high turnover, and broad investor apathy broken by episodic, confrontational control battles. The new governance process is increasingly based on continuing dialogue and debate among key, long-term institutional and other investors about specific, substantive aspects of corporate policy.

In this newly politicized environment, managers will face two types of outside pressure for change, both very different from the takeovers of the past decade.

The first will come from active investors - the takeover practitioners of an earlier era - who will invent new mechanisms through which to influence corporate policy. These mechanisms will be based on negotiation, suasion of leading investors, and/or voting challenges aimed at seeking board representation rather than control. The goal will be to increase value through convincing shareholders that management should alter specific practices and strategies. For active investors seeking profits, these new goals are made necessary by the increased cost and tactical disadvantages that now attend full-control tactics. The new goals are made attainable by the increased ownership concentration of institutions that have the sophistication and expertise to judge complex dissident cases.

One can already observe this change at work in the market. Last year, there were only two large hostile tender offers for control - those for NCR and Square D - and both were launched by corporation, not active investors. But concurrently, there was a series of substance-based voting challenges. NYCOR sought three seats on Zenith Electronic's board; Harold Simmons sought representation on Lockheed's board; Carl Icahn nominated an independent, minority director slate at USX; investment fund manager Julian Robertson elected five independent directors at Cleveland-Cliffs. As we write this article, this trend is continuing in 1992. There have been no hostile tender offers announced yet this year; but in one recent week, investor groups announced their intentions to seek board representation to change current policy at three large public companies.

Activism Is Changing

The second type of outside pressure that management will face is economically motivated oversight by institutional investors. Five years ago, institutional activism began as a reaction to the excesses of the takeover era. The agenda was entirely governance and process-oriented, and often seemed divorced from value considerations. Now, with the virtual disappearance of takeovers - and also as a consequence of a concentrated...