Bull Market Charges Ahead,
Led by Activist Shareholders


Investors marveling at their stock-market returns might want to take a bow: Some of that performance may be due to the shareholders themselves.

The bull market of the 1990s has coincided with a surge in shareholder activism that appears to have spurred remarkable performance in many stocks and contributed to the overall market's gains as well.

Of course, there are sound fundamental reasons that explain much of the stock market's behavior in recent years: low inflation and interest rates and robust profits. That was in evidence Friday as investors saw little in the May employment report to threaten the economic outlook and propelled the Dow Jones Industrial Average up 167.15 points, or 1.9%, to 9037.71. It was the largest point gain since Feb. 2, and it put the average over 9000 for the first time in nearly two weeks, just 1.9% off its May 13 high of 9211.84.

While it is much more difficult to quantify, the fact that companies are simply paying more attention to what shareholders want appears to have given the bull market some extra oomph. Managements that fail to heed their holders' wishes increasingly find themselves subject to glaring scrutiny. Eastman Kodak, General Motors, Sears Roebuck and International Business Machines are all cited as blue-chip companies at which institutional-investor pressure has played a role in corporate shake-ups in recent years.

Outspoken shareholders have at various times lobbied for divestitures, stock buybacks, management changes, more stock-based compensation and more-independent boards. In recent weeks, stock in Marriott International rallied after its union and several major holders, including the California Public Employees' Retirement System (Calpers), defeated management's proposal to create two classes of stock. Utility company Entergy's stock, long a laggard, rose 7.6% as the company brought in a new chief executive officer after shareholders made their dissatisfaction with the share price known.

The activist torch now is being carried by specialized investors who buy stakes in undervalued companies aiming to shake up management. Last October, Storage Technology, a manufacturer of computer storage devices, announced an $800 million stock buyback several days after Relational Investors LLC, a La Jolla, Calif., shareholder-activist fund, went public with its ownership stake and demands for a hefty buyback. Since then, the stock has rallied 57%, while the Standard & Poor's 500-stock index is up 18%.

Two major factors have propelled the increased activism, says Anne Hansen, deputy director of the Council of Institutional Investors, which represents more than 100 pension funds, with assets exceeding $1 trillion. "There's been an explosive growth in the amount of stock held by institutional investors, so we now own more of these companies than we ever have before," she says. "Secondly, when the Securities and Exchange Commission loosened its proxy-communication rules [in 1992], it really paved the way for real communication between shareholders and management."

Since 1990, the share of domestic stock held by institutions has risen to 65% from 51%, according to Georgeson & Co., a New York firm specializing in shareholder analysis. "Activism is much more deeply embedded in the relationship between companies and shareholders," says John Wilcox, chairman of Georgeson. "Corporations look much more carefully at the impact of their decisions on how shareholders are likely to respond."

While the question is hotly debated, there is some persuasive evidence that this activism has helped stocks. Tim Opler of Ohio State University and Jonathan Sokobin of Southern Methodist University have found that both the stock prices and the profitability of the firms added annually to the Council of Institutional Investors' "focus list" outperform those of both their peers and the S&P 500.

Each year, the council produces a list of companies with long-underperforming stocks. The intention is for its members to bring pressure for change to bear on these companies. The academics compared the stock and profit performance of more than 100 companies added to the list between 1991 and 1994 with performance in the years after being added. The stocks' cumulative return jumped to an average of 53% in the two years after being added from 10.5% over the four years before. The issues went from underperforming to outperforming stocks of similar size and industry, the researchers found.

The focus companies also significantly outperformed laggard stocks that weren't on the list, suggesting that the focus companies weren't simply a play on undervalued stocks. And the performance seemed based on genuine financial improvement: Focus-list companies' return on assets and profit margins both expanded more rapidly than their peers' and the S&P 500's after being added.

Some observers, however, downplay the significance of shareholder activism. One academic, after reviewing numerous studies for the Conference Board, found that the link between corporate governance and corporate performance had been neither proved nor disproved. And Richard Mahoney, the former chief executive officer of Monsanto Co., says shareholder activism "is overrated. A good strategy and the right marketplace will work wonders every time, with or without governance."

Indeed, David Reid, a spokesman for Storage Tech, credits his company's stock performance since last fall less to the buyback than to investors' giving credence to the company's "growth initiatives."

Certainly there were activist shareholders in the 1980s, one of the most notable being T. Boone Pickens. But Ralph Whitworth, managing member of Relational Investors and a former aide to Mr. Pickens, says the landscape has changed. He says investors in his two-year-old fund, the largest of which is Calpers, are "very patient. They're willing to get into a situation and follow it for two to three years." By contrast, he says, in the 1980s activists made their investments and tried to get a quick tender offer on the table "and have the whole thing completed in four to six months."

Today's activism is also more pervasive, and thus benefits the stock even of companies that aren't subject to specific initiatives, Mr. Whitworth says. "There are conversations in the boardroom when the stock price is lagging for several quarters. They say, "Look, we'll become a target of either a classic acquisition or an activism campaign, so we have to make changes." There's much more heat at their seats."

But the returns from activism can be elusive and a long time coming. Since Mr. Whitworth's fund took a big stake last year in the struggling Apria Healthcare Group, the stock has continued to slide. Mr. Whitworth took over as nonexecutive chairman in April, and two weeks ago, at his urging, five of the company's 11 directors quit.

Mr. Whitworth, while arguing that "we have arrested some of the negative trends" in Apria's key financial measures, adds that its problems are greater than he expected when he invested. "Anybody would be kidding themselves," he says, "to think [that] over the one quarter that we've been involved, you're going to turn around a company as complex as this."