Focus on the ‘Focus List’

An interview with UC Davis Finance Professor Brad Barber

For more than a decade, CalPERS has issued an annual “Focus List,” which is the pension fund’s official roster of companies that are their targets for reforming various practices by management and the boards of directors that CalPERS believes contribute to lower-than-expected stock values. As a substantial shareholder in these targeted firms, CalPERS takes action based on analyses showing that the stock prices of these companies are under-performing relative to the true value of the company. CalPERS has a formal process by which it first engages a company’s management or board in a dialogue on these matters. When the result is non-responsive to CalPERS’ concerns, the company may become publicly identified on the Focus List for further action. The 2007 Focus List, which includes Sara Lee, the Tribune Company, International Paper and Dollar Tree, can be viewed at:

Brad Barber, a professor of finance at the UC Davis Graduate School of Management, conducted a recent study on the actual financial results of CalPERS publicly issuing its focus list. The study analyzed both the short-term share price of the companies on the Focus List, and their long-term performance. Published in April, 2006, the study is entitled, “Monitoring the Monitor: Evaluating CalPERS Shareholder Activism.” In essence, Professor Barber, who regularly teaches a course on socially responsible investing, was attempting to measure whether or not CalPERS’ Focus List program achieved the desired results in short-term and long-term stock performance.

SN&R sat down with Professor Barber last month to discuss his study and its findings.

What was the nature of your study on CalPERS’ performance?

Brad Barber: I analyzed the Focus List which they come out with on an annual basis. They identify the Focus list based upon a combination of underperformance by the firms and governance-related issues. They’ve tended to target specific items at firms. So, for example, they’ve tried to get firms to change their boards, so that their boards are elected in one election rather than a staggered election where a third of the board can be replaced each year. They’ve also looked at trying to repeal “poison pills.” [This denotes a method by which corporate management attempts to avoid hostile takeover attempts, but which often results in a lower stock value for existing shareholders.] This proxy season they’re focusing on open access, to make sure that it’s easy for investors to get a proxy resolution on the proxy ballot for investors.

So these are the types of corporate governance reforms with which they generally go after these Focus List firms. I analyzed two things: One, what was the market reaction to the announcement of the Focus List? Presumably, if CalPERS was sensibly targeting firms, then the market would react favorably to the announcement that CalPERS was trying to make reforms at those firms. That is, the stock prices of the firms should increase when CalPERS says we’re trying to change things at these firms. Indeed that seems to be the case on average. It’s not a huge effect. There is some question about how robust it is. But I think on average there’s a positive market reaction to the CalPERS announcement.

The second thing I looked at was the long term performance of these firms, how they do relative to a benchmark [a comparative measure]. Basically, one would argue that if they’re making sensible reforms, they should see improved return performance following the identification of these companies. Again, there’s some evidence that this is the case. But it’s difficult to conclude scientifically that the performance is reliably greater than an appropriate benchmark. Here you have to lean on the science and the statistics a little bit. The bottom line is, they do out-perform a benchmark, but not by such a large margin that you couldn’t ascribe the out- performance to mere chance.

So you can’t say it’s directly a result of the CalPERS action?

That’s exactly right. So it’s very difficult in these sorts of studies, particularly over long horizons, to establish that the stock doing well was because of CalPERS intervention. Stock prices vary a lot in the best of circumstances, and trying to ascribe those variations to a systematic cause is very difficult.

So is this something that’s of value to CalPERS or is it more of value to other traders to look at the list and find opportunities there?

It’s more really targeted at: does the intervention that CalPERS engages in make sense? So it’s really not a trading strategy.

So the stock price is not a measure of that?

Well, I think ultimately that’s what CalPERS is after, is to improve performance. The philosophy is that CalPERS is such a large fund, they hold essentially the market portfolio in public equities. The only way to improve their performance is to make sure that those publicly traded companies do well. So by becoming involved in an activist way in the governance of those companies, the theory is that they can improve the value of those companies. Again, there is some evidence that that’s the case. More importantly, the vast majority of initiatives that CalPERS has sponsored with respect to the Focus List have been targeted at shareholders’ rights initiatives. For example, repealing staggered boards or amending the board elections or repealing poison pills that might hinder acquisitions that would improve shareholder value.

Is it the equivalent of the theory that democratic countries will do better in their economic markets than undemocratic countries?

Essentially that’s right. I mean, the idea, and this has strong roots in economics, is that companies that provide shareholders with a lot of rights will provide better value to shareholders because it will be more difficult for managers basically to abscond with the company’s resources. That’s the basic idea. So if you give shareholders a lot of sway over how a company is governed, then you will improve the value of the company.

What I hear you saying is that the evidence is actually inconclusive?

I’d say that the evidence points in the right direction, but scientifically it’s weak. I consider myself a scientist, so I don’t want to go out on a limb here and say the evidence is a slam dunk in CalPERS’ favor on this. But I think it points in the right direction. In other words, the returns on announcement are positive, and the long run returns are positive. But they’re not so overwhelmingly so that you can conclude scientifically that there’s causation.

What’s the difference between the range that you’re finding in fact and the range that would show it to be overwhelmingly so?

For example, on the announcement returns, historically we’re observing an announcement effect of about 20 basis points on a one-day performance, or .2 percent. That’s close to reliably positive for a one day return. But you probably would need a bigger effect, on the order of 40 basis points or roughly double that, to say scientifically that it was a robust finding.

When did you do this study?

I completed this study about a year ago. I have not updated it for the last two years of the Focus List. 2006 was actually a bad year for the announcements. The announced firms did not respond favorably in 2006. 2007 was a better year. So the firms responded favorably in 2007. I intend to update the study later this year for a paper I’m writing for the pension research council of Wharton. So I’ll probably be doing an update that will probably be released early next year.

Did you do this study under contract to CalPERS?


Who funded the study?

Me. The University of California and my research budget.

Did you make a presentation of your findings to CalPERS?


They have it featured on their website as a significant study.

I frankly wasn’t aware of that.

When you mentioned CalPERS having a market portfolio – how should we understand their size?

Well, CalSTRS [California State Teachers Retirement System], their neighbor, is roughly as large as CalPERS. Both of those funds each hold over $200 billion in assets. My guess is that they both hold about 1 percent of the public equity markets – or close to that.

Are there mutual funds larger than those two?

The largest mutual funds are probably Vanguard’s index fund – last I looked, it was under $100 billion. You should check that, though. The Vanguard S&P 500 index fund and the Magellan fund have historically been some of the largest equity mutual funds. So they’re quite large but still smaller than CalPERS.

In your study, did you make any recommendations for changes that CalPERS should make in its Focus List activity?

In terms of the Focus List, I think the Focus List program works pretty well. I think that you need to be careful about judging the Focus List only on the return performance of the companies they go after. I think you also have to dig down and look at the issues they’re tackling. Generally, over the last decade, the issues that they tackle have been sensible ones. For example, amending board elections, repeal of poison pills, outside representations on the boards, issues like that.

However, one of the things I do point out in the discussion that I have in the paper is that in a situation where you have a board or management that oversees the operation of a large fund, you need to be careful that politics or other influences don’t effect the types of activism that goes on within the fund.

One can clearly argue that going after governance-related problems can increase shareholder value. So there your incentive to reform the companies is well aligned with your incentive to get the best return for your beneficiaries in the fund. However you might also imagine these days that we might be tempted to go after companies who are polluting a lot of CO2 emissions because of concerns about global warming. There it’s much less clear whether doing so would be in the benefit of shareholders, because you might actually be hurting the value of the companies that you engage. So there may be temptations to go after political issues, and there I think it comes down to whether you are acting in the best interests of your beneficiaries or consistent with the moral and political values of your beneficiaries.

I see you teach a class on socially responsible investment [SRI] funds. Generally speaking how have those funds done?

Generally, the SRI-type funds have basically matched market rates of return on average. Some do better, some do worse. That’s pretty much what one would expect. They’re not a huge section of the market, but they’re a growing section. Essentially the political and moral issues like CO2 emissions or labor laws or investing in Sudan or Iran, all of these sorts of political and moral issues are related to SRI investing. And it’s a question of whether that’s the right place for a public pension fund, which is representing the interests of millions who may have very diverse views on these issues. I think sometimes these moral issues are so clear that maybe they want to take a position on them. But the right way to think about it is whether the underlying beneficiaries have those interests.

So it’s different if you’re a private individual in an SRI fund than if you’re a public pension fund?

Absolutely. I think the problem is that the public pension fund and the folks who manage it are simply agents of the beneficiaries. They need to act in the collective interests of those beneficiaries. With millions of beneficiaries there of course can be a huge divergence of opinion. But I, on my own, may reasonably decide that I don’t want to have anything to do with companies that pollute in a significant way or do business in Sudan, and I might divest of those companies in my personal portfolio. When you take that to the level of a pension fund, though, you have to ask yourself whether that is something that the beneficiaries of your pension fund want.