The Proxy Punch-Out

By CHRISTINE GORMAN Thomas McCarroll/New York and William McWhirter/Chicago

Canny corporate raiders know there is more than one way to fell an obstinate opponent. Throughout the 1980s the knockout blow was typically delivered in a high-stakes takeover battle, with much fancy legal footwork and powerhouse debt financing. But in recent months the collapse of the junk-bond market and the passage of anti-takeover laws in more than 30 states have forced a switch in tactics. Now the savviest challengers are clambering back into the ring with an old-fashioned approach to kayoing corporate management. The new arena: the annual stockholders' meeting. The main event: the proxy fight.

In such a battle, the raider, instead of trying to buy up a majority of the company's stock, holds a smaller stake and seeks to engineer a coup by enlisting the support of other stockholders. Unlike more routine shareholder proposals, which try to persuade management to change its stance on, say, investment in South Africa, the goal of a proxy fight is to urge stock owners to throw management out altogether. They may do so by casting their votes, in the form of variously hued proxy cards, for the dissident raider and his own roster of director nominees, who promise to do a better job than the incumbents.

The power of the proxy was evident last week when the directors of UAL agreed to sell the parent company of United Airlines to its employees for $4.5 billion, or $201 a share. They had little choice. Coniston Partners of New York, which owns 11.8% of the company, had threatened a proxy campaign at the shareholders' meeting on April 26, which would have replaced the directors with another board more amenable to a buyout.

Unlike most proxy showdowns of the past, many of the current fights are being waged at Fortune 500 companies. In March, Dallas investor Harold Simmons tried to convince shareholders at Lockheed's annual meeting that he could do better than the present management to rescue the defense contractor from its financial troubles. And on May 7, shareholders of USX (formerly U.S. Steel) will vote on raider Carl Icahn's proposal to get out of the steel business once and for all. Icahn had threatened an all-out proxy fight if the matter were not put to a vote. Already 18 major proxy battles have been launched so far this year, up from only a handful last year.

Experts on corporate history point out that over the years the buyout and the more democratic proxy fight have alternated as the favored means of shaking up management, depending largely on the availability of capital. "When you can't buy, you have to persuade and compromise," observes Harry DeAngelo, director of the J. Ira Harris Center at the University of Michigan. While the proxy fight is a less certain instrument than the buyout, notes Harvard finance professor John Pound, "it is much more consistent with the American political system, in which officials should be held accountable to their constituents."

What do raiders find appealing about proxy fights? They are cheaper to run than a 1980s-style takeover battle. Investment bankers calculate that the fees and other expenses from an employee buyout add up to between 3% and 4% of the total value of a deal, while hostile takeovers are waged for about 2% of the total. Proxy fights, on the other hand, can be financed for less than 1% because the object is not to buy shares but to garner votes. Furthermore, unlike leveraged buyouts, successful proxy fights can be waged without saddling a company with takeover debt. And even if the dissident shareholders lose the battle, they often win the war. In a 1989 study of 60 major proxy contests, DeAngelo found that while managers prevailed against challengers 70% of the time, they had usually been booted out within three years of the fight.

Institutional investors, who have come to dominate the stock market, are increasingly flexing their muscle in proxy contests. Pension-fund giants find they can no longer afford to sit on the sidelines or simply sell their stock if they disagree with a firm's policies. Reason: their positions have grown so large that they would depress market prices, and their own profits, by selling out. As a result, more of these investors are becoming actively involved in determining company policies, often concentrating on long-term growth instead of short-term gains.

Shareholder democracy has become one of the biggest rallying cries for institutional investors. In 1989 they sponsored or supported shareholder proposals at 62 corporations. At last count this year, that figure was up to 112. Almost half the measures call for secret balloting -- which would make it easier for shareholders, particularly from a company's own employee stockholder groups, to vote against management. Another third of the proposals seek the repeal of so-called poison pills, financial ploys that make hostile takeovers prohibitively expensive.

While proxy battles have all the admirable, democratic qualities of a free- election campaign, they also have many of the drawbacks, including mudslinging and dirty tricks. After Lockheed discovered that Harold Simmons planned to wage a proxy battle, the aerospace company announced that it would hold its shareholders' meeting in March instead of on its traditional May date. That gave Simmons, who owns $530 million worth of shares (or 18.9%) of the California company, just a few weeks to wage his campaign.

Lockheed had posted $430 million in losses on two major defense contracts last year and had seen its share price drop from $54 3/4 to $33 5/8. Simmons said he could do better. Drawing on a war chest of $8 million, Simmons made his arguments in videotape presentations to employees, in letters and personal visits to shareholders and in full-page ads in major newspapers. Lockheed retaliated with its own ads, letters and presentations, which seemed to attack Simmons' patriotism and charged him with a "record of pension-law violations." Though the outcome of the vote will not be known for a few weeks, Lockheed management is clearly feeling the heat. Last week it promised several concessions aimed at appeasing institutional investors, including the creation of three board seats for representatives of major shareholders.

The threat of a proxy battle was also behind USX's move to appease Carl Icahn, who controls 13% of the company. For years, Icahn has been trying to get the Pittsburgh firm to spin off its steel business, which now makes up 30% of its operations. He claims that dividing USX into two separate companies would result in share prices that total $48, instead of the current $36. USX disagrees, but consented to a nonbinding shareholder vote on the matter. Most industry watchers believe that Icahn will lose.

As in politics, incumbent officials have certain advantages in proxy contests. They know how the company works and how best to get in touch with shareholders. They can spend as much as they want from the corporate treasury on their campaign. And, in contrast to political candidates, corporate officials are permitted to persuade someone who has voted against them to change his ballot. It is only the proxy with the latest date that counts.

Managers are also finding allies in state legislatures. A controversial anti-takeover measure that passed the Pennsylvania statehouse last week could make proxy fights harder to wage. The bill, which Governor Robert Casey is expected to sign later this month, would limit the voting rights of potential raiders. Furthermore, it would enable target companies to lay claim to the short-term profits earned by a successful raider. Because the bill effectively makes takeovers impossible without management's consent, Richard Breeden, the chairman of the Securities and Exchange Commission, charges that it could leave incompetent managers "free to run a company into the ground."

Such measures are clearly an overreaction to the takeover craze of the '80s, and the newly activist institutional investors are unlikely to stand for them. Some large investors are already pressuring companies incorporated in Pennsylvania to repudiate the legislation. Now that shareholders are testing their strength, they are unlikely to be pushed out of the ring anytime soon. And corporate managers may come to fear them every bit as much as they feared the hostile raider.