SACRAMENTO, Calif. - The bigger they are, the better the bounce.
In an unpublished study, three CalPERS officials found that placing companies on the pension fund's annual list of poorly performing companies with weak corporate governance practices gave a 12-percentage-point boost to those firms' stock prices in the 90 days following release of the list.
Continued, albeit smaller, outperformance in the following 90-day period further boosted shareholder wealth.
The study, "The Shareholder Wealth Effects of CalPERS' Focus List," is the first major evaluation of the $135 billion California Public Employees' Retirement System's 10-year-old "focus list" efforts. Findings also include:
* The bigger the company - and thus the more widely dispersed its shareholder base - the bigger the excess return. Large-capitalization companies returned nearly 24 percentage points above their custom benchmark on a cumulative basis, compared with only 10.5 percentage points for small-cap stocks.
* Firms with greater analyst coverage produced excess returns of 17.1 percentage points compared with 10.6 percentage points for companies with fewer than 10 analysts covering them, which tend to be smaller in capitalization size.
* Companies that had been perceived as poor performers before being placed on the focus list received a bigger bounce in their stock prices - an excess return of 19.2 percentage points - reflecting market views that CalPERS' involvement would help turn the companies around. On the other hand, corporations that previously had been viewed favorably had a much smaller bounce in their stock price - an excess return of 9.5 percentage points - since inclusion was viewed as bad news by the market.
First to examine list
Other studies have evaluated the success of CalPERS' shareholder proposals, but the new work is the first to examine the fund's focus list. The study - by Mark Anson, chief investment officer; R. Theodore White, director of corporate governance; and Ho Ho, quantitative equity portfolio manager - is slated to be published in the Winter issue of the Journal of Applied Corporate Finance.
The number of companies published each year varies. When the Sacramento-based pension fund issued its first focus list in 1992, it named 10 companies. Only five companies - including Lucent Technologies Inc., Murray Hill, N.J., and Qwest Communications International Inc., Denver - were named in last spring's list.
CalPERS officials negotiate with companies for months prior to the release of the list, and many alter their practices to avoid inclusion.
Companies make the list based on three major criteria. One is poor adherence to corporate governance principles, including lack of independence on the board and on key committees, failure to separate the chief executive and chairman's jobs and use of poison pills. Financial criteria are return on capital, based on economic value-added measures, and stock-price performance relative to a company's peers over a five-year period.
For example, A.G. Edwards Inc., the regional brokerage firm based in St. Louis, had underperformed the Standard & Poor's Midcap index and the S&P Midcap Diversified Financial Services index by 53 and 17 percentage points, respectively, in the two years prior to being listed on the 1999 list, according to the study.
Edwards turns around
After meetings with CalPERS officials, the Edwards board made key structural changes, including requiring that a majority of directors be independent, creating a nominating committee composed of independent directors and the chief executive, and banning the involvement of management in setting the CEO's compensation.
For the two years after being placed on the list, the company's stock outperformed the midcap and midcap financial services indexes by 25 and 65 percentage points, respectively.
The effect of current corporate-governance reform measures, on the whole, likely will enhance the market impact of the focus list, the paper added.
For example, recommendations by the New York Stock Exchange to enhance the independence of boards will improve shareholder wealth. But placing more voting power in shareholders' hands "might reduce the financial impact of CalPERS' Focus List because empowered shareholders may be less in need of a large institutional investor like CalPERS to champion their cause," the paper said.
On the other hand, the Sarbanes-Oxley Act of 2002, requiring CEOs and CFOs to certify corporate financial statements and establishing a new oversight board on auditing practices, will make corporations more accountable to shareholders.
However, the law will not boost shareholder power, thus heightening the effect of the focus list, the paper argued.
Similarly, adoption of investor protection principles requiring analyst independence, and new standards for sell-side analysts proposed by the Association for Investment Management and Research, Charlottesville, Va., will help analysts better understand the purpose of the list, the paper added.