France: American Pension Funds In France - Corporate Governance

The globalization of financial markets, the saturation of the investment opportunities in their domestic market as regards the sums collected through the alternative retirement systems have led the American pension funds (the "Funds") to seek geographical diversification of their investments by favoring access to the markets of the major economies outside the United States.

The Funds, both public and private, are subject to a "distribution" logic that does not have an equivalent in France. The Funds are required to adopt a carefully targeted investment policy by reason of the obligation to pay out to their members at the end of a long period of contributions a sum which is at least equal to the sums paid in, adjusted for inflation. This policy, based on a multifaceted approach, cannot ignore the economic fundamentals of each company or industrial sector. Beyond those criteria, the moral obligation of the Funds to obtain a certain result has led them to consider the totality of the parameters of long-term investment management.

Among these parameters are the principles of corporate governance. In fact, according to an Anglo-Saxon concept, which developed during the period following the stock market crash of 1929, the methodology employed prior to any decision to invest in a company should not constitute the only basis for the long-term nature of such investment. Beyond the economic analysis, the Funds consider that becoming a shareholder is only a first step, but that it is just as important to ensure that throughout the period of investment their obligations towards their members lead them to make use of all the prerogatives of a shareholder.

The "hold period" for an investment by the Funds is quite different from that of other institutional investors. The turnover rate of the investment portfolios of the Funds is approximately ten years, whereas the average is two to three years for mutual funds. This longer term approach, unlike approaches based on a higher turnover rate which permit recovery of the gains resulting from the volatility of shares, results in a close correlation between the performance of the Funds and the creation of wealth or of shareholder value which a company would normally achieve only over a longer period.

The actual exercise of the voting rights which attach to the shareholdings is compulsory for the Funds within the United States. In order to enable them to express their votes fully, the Funds have developed a permanent dialogue with the governing bodies of American companies. This dialogue is intended to facilitate: (a) the distribution of information to the entire market; (b) taking account of the sensitivity of the Funds; and (c) an understanding of the shareholder value created by the management of the particular company. As a result of this dialogue, the draft resolutions presented in the shareholders' meetings have been refined or amended. The Funds, which willingly define themselves as "shareowners" and reject the generic label "shareholders" have, through their policy of permanent dialogue, often sought to encourage the development of proposals allowing American companies:

• to separate the functions of Chairman and Chief Executive Officer;
• to provide greater transparency as to the conditions for granting stock options;
• to prevent conflicts of interest which may arise in the course of company activity;
• to reaffirm the principle of equality among shareholders by means of removing all by-laws provisions contemplating differentiated voting rights or limitations on voting rights; and
• to remove all provisions allowing a company to render a takeover more difficult (poison pills).

In the recent past, the harmonization of the policy regarding the conforming of the rules relating to corporate governance with the wishes expressed by the Funds has often had a direct effect on the valuation of companies. The California Public Employees Retirement System ("CalPERS"), the largest public pension fund in the United States, willingly places itself in the category of "activist shareholders," to cite a term whose ambiguity leaves room for multiple interpretations. For the year 1995, CalPERS estimated at $150 million the return on investment generated by the adoption by certain companies of rules of corporate governance which were in compliance with the Funds' standards.

While France is considered as an opportunity for diversification, the Funds would not seize those investment opportunities if it meant diverging from the criteria and the requirements which they apply across the Atlantic.

Globalization also applies to the principles of corporate governance. The work done in France as from 1995, and in particular the two Vienot Reports and the successful completion of the work of the OECD could only be welcomed by the Funds which considered these as the first steps in a reconciliation between French market practices and the current norms in the United States or in other countries, and which were formalized in 1999 through the work of the International Corporate Governance Network.

The French Law No. 2001-420 on the new economic regulations which was enacted May 15, 2001, and which appears likely to go down in history under the name "NRE Law", is substantially based on the recommendations of the Vienot Report of July 1999.

Beyond certain modifications which could only be made by law, this text was intended to lay down the principles of an expanded regulatory regime even though "institutionalized" regulatory bodies already exist (in particular the Commission des Opérations de Bourse and the Conseil des Marchés Financiers) as do non-"institutionalized" elements (such as the "financial market" and the players on that market, in particular).

It would appear that, from the standpoint of the Funds, such intervention in a field normally left to administrative regulation could be interpreted as a new demonstration of the concept of the "French exception".

The NRE Law should be welcomed by the Funds, inasmuch as it:

• authorizes the existence of a chief executive officer dedicated to managing the company's business and freed up from the functions of the Chairman of the Board of Directors. This new distribution of roles within a monistic structure (which has proved to be more flexible than the dualistic structure, i.e. Supervisory Board and Management Board) should allow the Chief Executive Officer to devote himself exclusively to the management of the company's affairs, by releasing him from certain tasks.
• allows an easier reading of the compensation packages of the top executives, including the granting of stock options. The information on individual compensation introduced as a result of the wording of the text is consistent with the framework of the corporate governance charter adopted by the International Corporate Governance Network in 1999. The Commission des Opérations de Bourse, acting in its capacity as a regulatory body, has decided to require such a breakdown in each of the documents which it must review and approve, as from September 1, 2001;
• submits, in the framework of the prevention of conflicts of interest, all agreements between a company and any of its shareholders holding a percentage of voting rights in excess of 5%, to prior authorization by the Board of Directors.
• sets a limit on the number of directorships an individual may hold, and at the same time reduces the number of directors. In the logic of the Funds, this measure should allow directors who will be less "diluted" in the exercise of their functions to act more effectively in Boards of Directors which are more focused;
• provides that, under conditions which remain to be defined by decree, information regarding the company's approach to dealing with the social and environmental consequences of its activities must be provided to the shareholders; and
• moves to 5% the threshold of shareholding as regards the possibility for one shareholder, or several shareholders acting as a group, to submit written questions to the Board of Directors or to request the dismissal of a statutory auditor.

The NRE Law may, from the standpoint of the Funds, be considered as a reaffirmation of a concept of corporate governance, the globalization of which would naturally relate to the interrelationship among the different financial markets. Nevertheless, a certain number of provisions which continue to be sought by the Funds are today outside the purview of French laws or regulations. The frustration of the Funds is primarily focused on the following points:

• the limitation to 2 (or 3, in certain circumstances) directorships to be held by any one director (source: CalPERS);
• the limitation on length of the term of a director;
• the limitation on the term of the statutory auditors;
• the affirmation of the "one share, one vote" principle and the removal of any clause establishing a double voting right, a limitation on voting rights, or a differentiated rule regulating the allotment of dividends;
• the elimination of all clauses rendering a possible takeover by a third party more difficult;
• implementation of means of participation in the meetings for the benefit of the shareholders, such means being identical to those now granted to the members of the Board of Directors by the NRE Law;
• the public access to the proceedings of the boards, audit committees and general meetings of shareholders; and
• the adoption of "international" accounting standards.

A comparative analysis of the various charters of corporate governance adopted by the Funds and the current state of French law and practice reveals a certain number of points of divergence. A reconciliation, in the event it should be sought could be envisaged by means of the evolution of market practices at the initiative of the various players, i.e. the regulatory bodies, the issuers, the shareholders, or (when necessary for their implementation) by legislative action