Background

Shareowner activism is crossing borders. For years, shareowner activism and the concept of corporate governance was largely a U.S. convention, but held down overseas by long-held customs, practices or laws. In many countries, companies have tended to be controlled by insider ownership or through other companies. This reduced the available shares and limited the power of outside shareowners.

The landscape is beginning to change. Heavy fund flows from U.S. institutional investors have helped propagate standards for corporate governance and the way minority shareowners expect to be treated. According to a recent news report in the American trade press, international investing by 200 of the largest US pension funds grew to more than $299 billion in 1998.

The pressure brought by shareowner activists is being magnified by the fact that pension funds and mutual funds are becoming a growing vehicle for savings in the United States. Plan sponsors of these funds have a fiduciary responsibility to a large number of constituents who depend on the financial growth of wise and prudent investments. The result of this pressure has created a louder voice for shareowner rights.

Please note that I use the word shareowner, not shareholder. In my opinion, we are long-term owners of these companies – the patient capital – not simply passive holders of shares. 

1. Why Corporate Governance?
   

Let me first mention a few facts about CalPERS. We are the largest pension fund in the United States and the world. Our assets under management are valued at approximately $155 billion US Dollars.

The majority of our equity assets are invested using a passive indexing strategy. Today, 24% of the fund is targeted for international investments (with 20% targeted for equities, and 4% for fixed income). We currently have about 22% -- or about $32 billion US Dollars – invested internationally. Approximately $6.5 billion of that is invested in the Pacific Rim, with $175 million invested right here in Singapore.

CalPERS is administered by a 13-member board of trustees. I'm an elected board member and represent retirees of the System. I have served on the CalPERS Board of Administration for 27 years, including 10 of those years as President of the Board.

Under the constitution of our state, CalPERS trustees have a primary obligation to act solely in the best interests of our 1 million participants. This is similar, I know, to the responsibilities of trustees in many other countries.

CalPERS seeks to accomplish this primary duty to our participants by adding value to our portfolio through corporate governance.

Corporate Governance is one of our programs that fulfills our primary duty. It is clearly innovative; its very purpose is to produce added returns for our investment program; and it provides us with the power to influence government and private sector decisions that affect our organization and participants.

CalPERS defines "corporate governance" to be the "relationship among various participants in determining the direction and performance of corporations". The primary participants are: shareowners; company management (led by the chief executive officer); and the company board of directors. We recognize that, on its face, this may sound like an overly "American" definition because it does not expressly mention other stakeholder groups, the community, company employees, and its customers. In CalPERS view, companies that are operated with long-term shareowner returns as the primary goal will, ultimately, also reward other stakeholders. Companies that are driven by short-term goals don't reward anyone in the long-term.

As a large institutional investor with stock in over 1,600 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.

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.

To fulfill these duties, we use corporate governance activism to improve company performance in the United States and abroad.

2. How does CalPERS implement it's corporate governance program in the United States?

We began our corporate governance program in the early 1980's as a direct response to "greenmail" and the takeover frenzy in corporate America. It began simply as objections by a few shareowners to certain company actions that were considered to be self-serving. Companies created anti-takeover devices and procedural obstacles that were viewed more as protecting the corporate status quo than serving the long-term interests of shareowners.

A debate quickly ensued over whether shareowners -- particularly institutional investors who were accused of being transitory and only interested in short-term profits - had a right to participate in decisions concerning the long-term viability of a corporation.

In late 1989, CalPERS began working closely with the US Securities and Exchange Commission. This relationship led to the 1992 reform of executive compensation disclosure and proxy solicitation reforms. These reforms paved the way to elicit support from other shareowners through communication and to work together to bring about change.

As our corporate governance program evolved, we moved away from a specific-issues approach to focus on company performance.

Today we review the performance of the US companies in our portfolio, and identify those companies that are among the lowest long-term performers relative to their industry peers. The review results in a "long list" of companies that may potentially be publicly identified as a CalPERS Focus Company. CalPERS meets with the directors of each of these companies to discuss performance and governance issues. The CalPERS Focus List contains those companies that, at the end of the process, continue to merit public and market attention.

How do we pick these companies? We look at three factors when selecting the companies we target in our corporate governance program. These include:

• Market Performance
• Corporate Governance Practices
• Economic Performance

Our process selects companies which have suffered poor market performance relative to their industry peers, have corporate governance policies which are less than favorable to shareowners, and have suffered poor economic performance – or EVA -- economic value-added. A chart which shows this process is included in your handouts.

Those companies that perform poorly in all screens are then individually analyzed to determine whether CalPERS, through engaging in governance discussions with the companies board and management, could

potentially add value and improve performance.

Our corporate governance program in the United States has exceeded our own expectations over the past decade. We have witnessed changes at corporations such as General Motors, American Express, Sears and Kmart, to name a few. Within 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.

One of the most prominent studies of economic value achieved through shareowner activism 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 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 89 percent. But with CalPERS first contact five years later, the companies outperformed the S&P 500 by an average 23 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.

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, nor any director – 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.

CalPERS Board reaffirmed this belief by adopting a set of US Corporate Governance Principles and Guidelines last year. These principles represent the evolution and ongoing development of CalPERS corporate governance program. They also represent the foundation for accountability between a corporation's management and its shareowners and will serve as a tool to further advance this relationship. I've included a copy of these principles in your handouts.

Internal and external factors led to the decision.

Over the last decade, we have witnessed a change in capital markets worldwide. Continually, we see a move away from traditional forms of financing and a collapse of barriers to globalization of the capital markets.

The end result is that corporations from around the world are beginning to compete with each other in every market. This competition is forcing corporations to reduce labor and capital costs, improve productivity and change the way they do business. In order to survive, corporations are tapping capital in the international markets.

There has also been a dramatic change in the level of institutional investment in the international markets as well. As I mentioned earlier, international investing by 200 of the largest US pension funds grew to more than $299 billion in 1998.

CalPERS entered into the international security markets in the late 1980s to seek better returns and achieve diversification of the Fund's investment portfolios. In December 1994, we decided to increase the System's asset allocation to international equities from 12 to 20 percent of the Fund's total portfolio.

Our increase in international ownership combined with the rapid globalization of markets has had a number of important consequences for CalPERS.

As the size of CalPERS international holdings began to grow, we asked ourselves -- if we are going to exercise our ownership rights to increase returns to our trust fund in the United States, should we not extend these efforts to our investment in the international markets? Given our fiduciary responsibilities, are we free to ignore international corporate governance? No.

At the same time, we recognized that globalization was largely causing countries to reassess and adapt their corporate governance systems to a more competitive environment. The realization that economic and capital markets were quickly breaking down barriers to globalization presented a significant opportunity for us to share our domestic corporate governance experiences. Our hope was to influence the discussion as these countries adopted corporate governance.

As a first step in understanding the unique differences of the global markets, we conducted a study on the role of international corporate governance and increased performance monitoring of our international stock holdings. Based on the study, we adopted a formal international corporate governance program in 1996 focusing on the four countries with the System's highest equity exposure: Japan, France, Germany and the United Kingdom.

We followed the study with the adoption of a set of global governance principles. The principles focus on six basic concepts that are fundamental to free and fair markets throughout the world. They also reflect the core of the corporate/shareowner relationship. However, they do not impinge upon the legal, economic and cultural traditions of each country. Specifically, the six global principles address:

• director accountability to shareowners;
• transparent markets;
• equitable treatment for all shareowners;
• easy and efficient proxy voting methods;
• codes of best practices that defined the director-shareowner relationship; and
• long-term corporate vision which at its core emphasizes sustained shareowner value.

In order to narrow our focus, we've also adopted market-specific corporate governance for the United Kingdom, France, Germany and Japan. These principles are designed to complement the governance work already performed by investors within these countries -- the Cadbury Code and Greenbury Report in Britain, the Vienot report in France, the guidelines outlined by the Duetsche

Schutzvereingung Fur Wertpapierbesitz – Germany's largest shareowner organization, and the principles identified by the Corporate Governance Forum in Japan.

Our Global, France, Germany, United Kingdom and Japan corporate governance principles are in your materials. These principles embody the growth and changes inherent in the corporate governance systems of these countries. Ultimately, they will serve as a tool to assist us in monitoring

our international investments while pursuing better corporate governance for the companies in which CalPERS invests.

All of these principles embody the growth and changes inherent in the corporate governance systems of these countries. Ultimately, they will serve as a tool to assist us in monitoring our international investments while pursuing better corporate governance for the companies in which CalPERS invests.

4. Why is good corporate governance vital in today's emerging markets?
   

The recent Asian financial crisis underscores the need for countries to exercise good governance in pursuit of their economic and social development.

Governments provides a number of essential services, from setting macroeconomic and social policy to delivering critical goods and services, such as health, education and infrastructure, to promoting an enabling environment for private sector growth. Good governance involves the way policies are selected, and the efficiency, effectiveness, ad evenhandedness with which they are implemented – factors that have a profound impact upon the ability of nations to achieve sustainable and equitable development.

A recent annual report issued by the Asian Development Bank says it best. Regardless of economic orientation, strategic priorities or policy choices, Asia's recovery will depend on the four pillars of governance that are universally applicable: accountability, transparency , predictability and participation. The Bank cites the need for these conditions to help restore investor confidence and bring an end to currently turmoil, corporate bankruptcies and declining stock markets.

I site the comments of the Asian Development Bank because their corporate governance philosophy mirrors that of CalPERS. In fact, we have applied this philosophy to some of our emerging market investments. Let me explain

5. How does CalPERS apply its corporate governance philosophy to emerging markets?

In December 1996, CalPERS formed an historic partnership with the Asian Development Bank, committing $225 million to make long-term, direct private equity investments in the emerging markets of the Asian-Pacific region. This strategic alliance was an international first, both for CalPERS and the international multi-lateral bank. The investments were targeted to finance a variety of ventures, including industry and financial services in the region.

The unique aspect of the partnership is its investment criteria. The Asian Development Bank won't invest in companies that don't have good corporate governance practices, among other criteria. The criteria are considered to be an important part of the investment strategy. The Asian Development Bank and CalPERS believe that good corporate governance will give the partnership an important competitive advantage when competing for attractive investments.

More recently, we made a $100 million investment commitment to establish an "Asian Recovery Fund" to invest in privately negotiated distressed Asian securities.

This new fund, which is being established by the global investment bank Rothschild Inc., will invest up to $300 million in Asian companies that are in, or emerging from, bankruptcy or reorganization proceedings.

The turmoil in Asia's economy and financial markets has contributed to a large number of bankruptcies and severe banking crisis throughout the region. The governments of Japan and Korea plan to provide assistance to the banking sector, which would allow banks to write-off substantial bad loans and sell them into the market.

To help the fund navigate its investment strategy through the cultural and legal structures in various Asian countries, Rothschild has developed a strategic relationship with Daiwa Securities, Japan's second largest banking firm. Daiwa will bring familiarity with Japan's cultural and legal structure as well as its sourcing and evaluation capability, while Rothschild will provide investment strategy and its restructuring skills.

CalPERS investment in this fund is timely and presents valuable investment opportunities to purchase securities at historically low prices. But more importantly, it represents our commitment to participate in Asia's recovery and to bring about formidable economic change. 

VI. What will be some of the new corporate governance initiatives in the next century? What will the millennium corporate board look like?

As we move into the 21^st century, I would like to offer several final thoughts on the current corporate governance landscape.

Clearly, CalPERS has a "pocket book" interest in expending resources to investigate corporate functions. We have the power to effect change. We are international in scope, operate with great flexibility, and with government mandates act as fiduciaries for one million Americans. We possess the characteristics essential for an effective corporate monitor -- a growing party to whom management can be held effectively accountable.

In the future, I believe that the focus will be on the evaluation of individual directors; are they people with integrity and diligence?; are they people who are truly independent of management and recognize the value of that independence?

I expect that the boards of the future will be populated with people who have diverse backgrounds and international experience. They will need to include people with international experience. The right skill mix will become an essential component of board composition.

I believe the director of the future will have to work ten times as hard than today. Directors will have more responsibility, and potentially more liability, than in any time in the past. As a result, we need to expect that some of our current directors will chose to withdraw. We will need to find quality replacements, and perhaps even consider the feasibility of smaller boards. We will need to squarely face the issue of director liability -- how much is appropriate to instill accountability, while not too much to discourage qualified participation.

I believe corporations around the world will need to adopt good corporate governance practices to attract and retain foreign capital and compete globally. Global markets will only become more attractive to investors with corporate governance standards that are more representative of shareowners interests. Experience tells us that those willing to adapt and change will be rewarded.

Corporations will also need to be prepared when shareowners come knocking on their door. While corporations must be adaptive and remain flexible to industry changes, they must also have a well thought out process in place to address corporate governance issues. Most of all, corporations will need to keep fully abreast of the philosophies and strategies of their shareowners.

Conclusion

Asia has excellent promise for the future. I believe the recent financial crisis offers opportunity to instill good corporate governance practices that will make tomorrow's Asian market a better one.

However, Asia is still far from being fixed. The critical regultory and economic reforms needed to sustain a rebound are only half-done. The reforms advocated by the International Monetary Fund and the Asian Development Bank wil have to be fully implemented to prevent a relapse in the Asian recovery. Unless they are completed, hopes of reviving double-digit growth are misguided.

My hope is that CalPERS confidence in the Asian economy and our international corporate governance program will stimulate further debate and discussion about proper corporate governance practices and bring about positive economic change.

My promise to you is that we will continue to be missionaries of good corporate governance, sharing our words, our experiences, and our ideas. We want to be a part of Asia's opportunity, by investing not only for the economic benefit of this region, but for the fundamental financial benefit of our members' future financial security.

Thank you.