Good evening. It is my pleasure to welcome you to the roundtable on the Economic Value of Good Corporate Governance Practice.

I would like to thank those involved in coordinating the third annual International Corporate Governance Network for including CalPERS and inviting me to speak here today and chair this discussion. It's important to gather like this to share ideas and generate dialogue, such as I hope we will engage in this evening.

Roundtable procedures and chair's initial remarks.

I would like to begin our discussion today by focusing on what I believe to be the "heart & soul" of corporate governance – the economic value and positive impact of ownership activity. Further, I would like to address how corporate governance activity fits in with the fiduciary duties of CalPERS as a cost effective investment strategy to earn greater returns to our portfolio. Lastly, I intend to briefly discuss the role of relationship investing in CalPERS investment portfolio.

Nearly anyone who follows corporate governance in the United States acknowledges shareowner activism has been a prominent theme in Corporate America for the last decade. The movement is created in the United States with curbing excessive salaries for executives, bringing increased board oversight and independence, and improved performance to companies. The primary impetus for these changes has come from institutional investors like CalPERS.

At CalPERS we have no greater responsibility than the prudent management of our portfolio. We are under considerable and constant pressure to increase returns by pursuing every possible strategy to increase the value of companies in which we invest. As fiduciaries, CalPERS must discharge our responsibilities in accordance with the twin duties of loyalty and care. This is analogous to the duties of the directors of a corporation to its shareowners.

The duty of loyalty is sometimes referred to as the "sole purpose" doctrine. This means that the board and other CalPERS fiduciaries must act solely in the interest of members and beneficiaries. For this reason, CalPERS cannot base its corporate governance activities on social or political causes. Instead, we must focus on the "bottom line" of enhanced shareowner returns.

Under the duty of care, the board and other CalPERS fiduciaries must manage the fund as a "prudent investor" -- this means with the care, skill and diligence that a prudent person, familiar with the matters, would exercise under similar circumstances in managing a pension fund of like size.

To fulfill these duties, we use corporate governance activism to improve performance in the United States and just recently began to express our principles abroad in countries where we have the largest financial interests. Why do we do it?

Corporate governance is simply an enhancement technique that we use to improve returns of our largely passive equity portfolio. Because of our size, we cannot simply sell the stocks of companies that are poorly performing, without negatively impacting the market as a whole. This would also be contrary to our indexing strategy, and even more importantly, deprive us of the "upside" when the companies begin to improve. CalPERS Board strongly believes that using a passive strategy to select stock does not mean that we have to be a passive owner. We believe that we have a duty to our participants to put just as much effort into being an active owner as in deciding to become an owner in the first place. And we have been successful.

Our corporate governance program in the United States has had several successes over the past decade with corporations such as General Motors, American Express, Sears and Kmart, to name a few. With each company, there are internal forces who are working to effect necessary change. CalPERS, and other investors, represent catalysts for change; our attention on the company management acts to empower these internal change agents, who ultimately have the power to produce results.

A review of some of the academic research presents a persuasive argument for the value of shareowner activism. Steven Nesbitt, Robert Monks, Michael Smith, Carolyn Brancato, McKinsey & Company, and most recently Mark Huson all suggest that shareowner activity has had a positive impact on the bottom line of corporations and on us.

One of the most prominent studies of economic value achieved through shareowner activism thus far is documented in a study performed for CalPERS pension consultant Wilshire Associates. The study, which was published in the Journal of Applied Corporate Finance in 1994 and later updated in 1996, demonstrated that CalPERS corporate governance efforts targeted at underperformers substantially improved our return on investments. It looked at the stock performance of the 62 companies that we targeted between 1987 and 1995. During the five years immediately before our first contact, these companies underperformed the Standard & Poor's (S&P) 500 Index by an average of 85 percent. But with CalPERS first contact five years later, the companies outperformed the S&P 500 by an average 33 percent.

More importantly, we have estimated that the improvement of the 62 companies has resulted in approximately $150 million US dollars, annually, in added returns at a cost to run the program at less than $500,000 annually. This is a very important point.

As a large institutional investor with stock in over 1,500 American companies and over 750 companies outside the United States, we have become long-term shareowners of major corporations. High transaction costs associated with selling equities, larger portfolios, and more money to invest have all created incentives for us to buy and hold. In a sense, we have become the patient capital of companies. The idea of simply selling shares in the face of disgust – at a considerable cost to the System – has given way to the realization that being an agent for change makes better economic sense.

We believe that the impact of the corporate governance movement within the United States goes beyond the stock price of these 62 companies. No company – and no CEO of a company – wants to receive close scrutiny from CalPERS. Boards and management are voluntarily and proactively taking steps to improve their own accountability and independence. Simply put, the American corporate culture has changed; good governance is now something that is being institutionalized and valued.

As successful as corporate governance has been for CalPERS in adding value to the System, we realized we could do even more. In an effort to leverage our governance efforts, we implemented relationship investing to our investment strategy.

In the summer of 1995, we approved a $200 million commitment to Relational Investors, L.P. that placed CalPERS more directly in the business of improving companies. Relational Investors invests in four to six underperforming companies where corporate governance or "relational investing" can unlock the intrinsic value in underperforming publicly-traded U.S. companies. When compared to the broader market of their industry peers, these companies invariably exhibit inferior performance in one or more areas such as operations, financial structure, long-term strategy, corporate governance or management.

Once an investment has been identified and made, Relational Investors will initiate a program of communication with the company's management, board of directors and other shareowners. At the management level, the fund will focus on strategic and tactical issues, clearly setting forth investment objectives and views regarding the company's performance. At the board level, the fund will focus on strategic, governance and management issues. And since the fund typically acquires equity positions of less than 10 percent, direct communication to gain the support of other shareowners is important to its investment strategy.

In cases of persistent underperformance or where other factors warrant, the fund may employ additional strategies such as sponsoring shareowner proposals or seeking board representation.

We believe that the relationship investment strategy complements our current corporate governance policies. A key difference between relationship investing and corporate governance is that relationship investing specifically targets for investment companies with troubled management policies or other repairable problems, whereas corporate governance policies are aimed at improving or holding accountable companies in which the fund already invests.

As of December 1996, our relationship investing strategy has exceeded our expectations. We have invested approximately $63 million of our $200 million commitment and the fund has successfully exited two investments with large gains. Both gains resulted from the purchase of undervalued shares and a rise in their stock price. (Net IRR to December 31, 1996 – 174.4%)

I hope that I have been successful today in sharing with you the essence of our experience with corporate governance and the supporting evidence that suggests that ownership activity adds economic value. As a trustee and a fiduciary, I am certain that this solid foundation of support will prove to be a key factor in the continued use of corporate governance to improve our economic bottom line.

Thank you.