COLUMN ONE : Pension Funds Flex Muscles : As the dispute in California over a state pension fund shows, the plans are growing more assertive. They’re now more willing to use their clout to influence corporate policies.

Last week, when Baxter International Inc. announced cancellation of plans to build a manufacturing plant in Syria, the decision represented more than a victory for Jewish groups that had charged the company with kowtowing to the Arab boycott of Israel.

Baxter’s decision also underscored the growing power of public employee pension funds to affect corporate policies on a broad range of political, economic and social issues.

The medical supply company backed out of the Syrian venture after a move by New York City Comptroller Elizabeth Holtzman on behalf of city pension funds, which own 2 million Baxter shares. Holtzman introduced a shareholder resolution requiring Baxter to disclose a report the company had commissioned on whether Baxter had illegally joined the Arab boycott by selling a plant in Israel.

Though Holtzman’s resolution drew only 7.4% of the vote, Baxter spokesman Les Jacobson acknowledged that the New York official’s involvement “no doubt played a role in the controversy” that led the company to abandon the Syrian plant.

As the Baxter case and this week’s imbroglio involving the California Public Employees Retirement System (CalPERS) illustrate, pension funds--those huge and growing pools of capital holding about $3 trillion in total assets--are no longer content to play the role of passive shareholder.

They are flexing their muscles to do combat on everything from apartheid and executive compensation to the environment and hostile takeovers. Supporters say such actions have finally given shareholders a weapon to wield against seemingly monolithic corporate management. Many critics, however, wonder whether fund managers possess the qualifications to wield such power.

Whatever the case, the growing power of the pension fund appears to be here to stay.

“Pension fund activism and government efforts to raid public pension funds are going to be the hottest subjects of the next 10 years,” said management guru Peter F. Drucker of the Claremont Graduate School.

It is precisely the two issues cited by Drucker that are at stake in the current controversy over CalPERS, which has $62.4 billion in assets and is the biggest public employees’ pension fund in the United States.

The furor flared when Gov. Pete Wilson unveiled a plan to tap CalPERS for $1.6 billion to help close the state’s yawning $14.3-billion budget shortfall. But Wilson’s plan also would muzzle CalPERS’s leading role in pension-fund activism by abolishing the fund’s current 13-member autonomous board and replacing it with a nine-member board beholden to the governor.

“This is mainly a grab for baby-boomers’ pension money,” said Sarah Teslik, executive director of the Washington-based Council of Institutional Investors. But thethreat to CalPERS’ pension-fund activism “is an important and ominous subplot,” Teslik added.

Since CalPERS banded together with a handful of other state and local pension plans in 1985 to form the Council of Institutional Investors, the fund has been at the forefront of the shareholders’ rights movement. And it has been a growing thorn in the sides of entrenched corporate managements and boards of directors.

CalPERS, for example, recently made a credible threat against business members of the California Taxpayers Assn., a research and lobbying group. Cal-Tax had commissioned a study that provided ammunition to Wilson in his effort to reduce retirement benefits.

In a letter dated June 4, six CalPERS officers warned corporate Cal-Tax members that they face “economic sanctions” if they do not back away from the fight to cut retirement benefits for public employees. Cal-Tax officials said that Occidental Petroleum Corp. left the organization because of the threat.

Pressure from public pension funds also helped force Texaco to add New York University President John Brademas to its board as an outside director and led General Motors to consult extensively on the successor to former chairman Roger B. Smith.

Public pension funds first got together to exert their growing clout at the impetus of Jesse Unruh, the late treasurer of California. What brought them together was “greenmail”--the then-common practice of takeover targets buying off would-be raiders by paying hefty premiums for their blocks of stock.

“We were concerned because companies were taking cash which belonged to all of the shareholders and paying a premium to only some of them,” recalled Harrison J. Goldin, former New York City comptroller and now the principal of Goldin Associates in New York.

By warding off raiders, greenmail payments also deprived pension-fund shareholders of the opportunity to sell their stakes at a premium.

From there, the public pension funds have acted to take on managements on a whole range of issues, including poison-pill anti-takeover defenses, the independence of board members, South African investment, environmental policies and, most recently, executive compensation.

It is a trend that “is here to stay,” said Howard D. Sherman, vice president of Institutional Shareholder Services Inc., which advises holders on corporate matters. “It is not a blip, like the takeover wave of the ‘80s.”

Sherman added that “the most important upshot” of the pension funds’ new assertiveness “is that it has forced boards of directors to undergo a very critical and healthy self-examination of their roles as guardians of shareholders’ funds.”

Success has been slow in coming. As recently as two years ago, Teslik told Business Week magazine that getting corporate managements to listen was “like trying to take a bone from a dog.”

But the pension funds began getting attention--and respect--in 1989, when they helped defeat a pair of anti-takeover measures championed by Honeywell Inc.’s management. Last year, managements around the country sat up and took notice when Wisconsin’s fund introduced resolutions limiting management’s rights to issue poison pills at K mart and Champion International--and won both votes. In a poison pill defense, a company that is a takeover target makes its stock less attractive to a potential buyer to keep the company from being acquired.

As a result, Teslik said “there is a lot more communication. Corporations watch what is going on and they say: ‘I don’t want to be next.’ If the issue is executive compensation, we’ll get quiet phone calls from companies asking: ‘Just what is it that you don’t like about compensation plans? Tell us and we’ll weed it out.’ ”

But “we are nowhere near dictating,” Teslik stressed. “We still have to say ‘please.’ ”

Still, in a Harvard Business Review article earlier this year, Drucker called the rise of pension funds “one of the most startling power shifts in economic history.”

The shift is, indeed, startling. The first pension fund in the United States was created by General Motors in 1950. As recently as 1980, public employee pension funds, which are spearheading the new shareholder activism, had just 22% of their assets in stocks. Their total stock holding of $44 billion represented just 3.9% of the total dollar value of the New York Stock Exchange.

But by 1990, total public pension fund stock holdings had soared to $293.2 billion, as many states loosened restrictions that had limited investments to bonds, and money poured into pension funds on behalf of the growing work force of baby boomers.

As a result, by 1990, stocks represented 39% of public pension fund total assets of $752 billion--and an impossible to ignore 9.6% of the Big Board’s total dollar value.

When the $691.4 billion in stocks held by private pension funds are added in, public and private pension funds together held a staggering 32.4% of the New York Stock Exchange’s total dollar value in 1990.

Indeed, the funds have become so huge that, paradoxically, their options have become severely limited. Some argue that, as a result, they have no choice but to become much more deeply involved in issues of corporate governance.

“Since there is a finite universe of investments, the old adage--sell if you are unhappy with management--has become less and less applicable,” Goldin said. “That has increasingly impelled managers to stand and fight, rather than quit and switch.”

Added Drucker in the Harvard Business Review article: “The share holdings of even a mid-size pension fund are already so large that they are not easily sold . . . . The 1% holder (of a company’s stock) cannot sell easily. And the 40% holder, that is, the pension fund community at large, cannot sell at all.”

Thus wedded to their stock holdings, wrote Drucker, today’s pension fund managers are adopting the maxim first attributed to Deutsche Bank founder Georg Siemens 100 years ago: “If one can’t sell, one must care.”

Kenneth Mertz, chief investment officer for the Pennsylvania State Employees Retirement Fund, sees the trend continuing.

“It’s true that the influence of the funds will be greater over the next 10 years,” he says, by virtue of their growing size. “But I’m not sure anyone is defining that as sheer power. How the funds exercise their influence is the issue.”

Mertz does not believe that the funds will become increasingly antagonistic toward the companies whose stocks they own. Rather, he says: “There’s going to be much more dialogue and more cooperation (between the funds and corporate managers) than there has been in the last few years.”

Asked why he believes that will happen, he said: “I just think it’s in everyone’s best interest.”

Greta Marshall, who was chief investment officer of CalPERS from 1985 to 1988, and now runs her own money management business, said that the fund’s activism is commendable.

But she added: “It has not been my experience that corporate managements are falling over themselves to change because of what CalPERS is doing . . . . I think they consider CalPERS more a paper tiger than a real tiger.”

Marshall also believes that corporate managers voice a legitimate concern in asking the most basic question about pension-fund activism. “They ask: ‘What is the competence of these people (the funds) to judge corporate management” Marshall said, especially considering that many of the public funds are run by tenured civil servants.

Holtzman, however, argued that as owners “we cannot stand idly by while corporations and their managers take actions that harm the long-term interests of our investments.”

Although some have criticized Holtzman’s campaign against Baxter’s plant in Syria as politically motivated, she said: “I don’t think there’s any question that the cloud surrounding Baxter was harmful to its image and its business.”

Another criticism of the direction the pension power movement has taken comes, ironically, from Randy Barber, co-author of a 1978 book entitled “The North Will Rise Again: Pension, Power and Politics in the 1980’s” that predicted the rise of pension power.

“Many of the so-called shareholder democracy proposals are merely ploys to make it easy to put companies into play,” said Barber, referring to a strategy to make companies susceptible to takeovers.

For pension funds to truly act in the best long-term interests of their beneficiaries, he said, they would have to channel their investments toward preserving jobs and the economic vibrancy of struggling communities.

Barber, who is a consultant to the AFL-CIO, would like to see pension plans use their clout to encourage companies in their stock portfolios to stop exporting jobs overseas or to Sun Belt states where unions are weak.

Other forms of “social investing” have been attempted on a small scale by New York City’s funds, which have put $50 million into Small Business Administration loans and $350 million into local housing for new construction and rehabilitation.

Management guru Drucker views the new focus on pension power as healthy and predicts that pension funds may eventually play analogous roles to those played by the German hausbanks and the Japanese keiretsus, which supervise and closely judge the managements of member companies.

German hausbanks have ownership stakes in a wide variety of industries, but derive most of their income from commercial relationships with the companies in their portfolios, rather than from dividends and share appreciation. Keiretsus-- groups of companies which own interests in one another--also place power over suppliers, subcontractors and ministries above profits, wrote Drucker.

Pension funds, Drucker concluded, “have more than mere power. They have the responsibility to ensure performance and results in America’s largest and most important companies.”

Columnist Tom Petruno in Los Angeles contributed to this story.

STATE PENSION FUND: Columnist Tom Petruno notes that, despite controversy, CalPERS’ returns lately have been well above average. D1