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Pension funds around the globe must be tuned into Canadian news as never before. With one of Canada's largest blue-chip corporations, BCE, now facing potential privatization bids from consortiums led by Canadian pension funds, a new chapter is being written in the book on institutional investor activism.

We've seen this rising power coming for some time. More than 30 years ago Peter Drucker predicted that U.S. pension funds would eventually dominate equity markets. In The Unseen Revolution he said it all started with the creation of the General Motors pension plan in 1950.

Until then, pension plans had invested mostly in bonds and other interest-bearing instruments. The GM plan invested primarily in a basket of publicly traded equities, giving downside protection through portfolio diversification.

And although it was initially a tough sell to the United Auto Workers union, the plan's creation triggered an unprecedented boom, as more than 8,000 similarly structured pension plans were established within just one year.

Almost overnight, equity-based pension plans became important players in the market and by the end of 1974, these funds controlled an estimated 30 per cent of the equity market and would eventually control American corporations.

But did Mr. Drucker envision the growth in power of the private equity arms of pension plans, as we are now seeing in Canada? It's forgivable to miss such a development when looking ahead 35 years. But if you had said 15 years ago that a Canadian pension plan would lead to the privatization of BCE, I think experts would have dismissed you as delusional.

So why are pension funds opting for privatization instead of a more intensive activism campaign to fix an underperforming portfolio company? For one, it's cheaper. Institutional investors who mount campaigns for change, for example a fight to replace the board of directors of a company, find it expensive in terms of money and time. They must convince, at their expense, other shareholders of the merits of their dissident board slate. The incumbent board of directors is in a position to defend itself using corporate funds. So the shareholder fighting for change (or dissident shareholder), pays not only all costs related to the campaign to oust the target board, but also, because they own shares, the dissident shareholder effectively pays their pro-rata share of the costs incurred by the incumbent board in defending their position. In the end, the campaigning shareholder may lose the battle.

If the activist shareholder is successful, and the new board generates value by improving corporate performance, all shareholders benefit, but the costs of effecting the change will have been borne disproportionately by the dissident shareholder. This "free ride" problem acts as a disincentive to this kind of activism. In the case of a privatization, the fund or consortium of funds share the costs and the benefits proportionately. In addition, once privatized, costs associated with being a public company disappear.

Is private equity another "unseen revolution" manifesting itself? It is highly doubtful that we will see a wave as significant as the one triggered in 1950 by GM, because the funds, in time, will sell into the market the shares of the companies they privatize. The Ontario Teachers Pension Plan demonstrated just how profitable a privatization strategy can be. It was directly involved in a group that purchased the Yellow Pages business from BCE, repackaged it as an income trust and sold it to purchasers in the public market at about triple the purchase price. Other large pension plans are seeing the light.

Unfortunately, BCE shareholders could not be free riders and also reap the benefits of the transformation of Yellow Pages into an income trust. From this perspective, the growth of private equity investment does not serve to galvanize the interests of small and large shareholders.

It may be comforting to invest alongside a savvy fund like Teachers, but less so if there is a perception that the savvy fund may also be looking to privatize the investment at the lowest possible price. For example, Teachers, through its private equity division, took publicly traded fireplace and barbeque manufacturer CFM Majestic private for $60-million, outmaneuvering other potential suitors in the process. Facing a cash squeeze, CFM was acquired at a price that many considered a steal, but because Teachers also held a majority of CFM's debt, it held the upper hand in any contest for control.

These individual situations aside, there should be a broader good to the addition of private equity capability to the toolkit available to a pension fund to "fix" an underperforming portfolio company. The ability to initiate a privatization plan gives a fund a very big stick when it comes to ensuring shareholder accountability, at least with widely owned companies. Controlled companies, many of which have two classes of shares with unequal voting rights, will be the ones sold by these savvy funds when performance issues go unresolved.

In the end, it is the power of the vote that gives pension funds the control. As long as the stewardship of pension money continues to be entrusted to strong and accountable leaders like Claude Lamoureux, chief executive officer of Teachers, the entry of pension funds as private equity investors should be beneficial to our capital markets.

William MacKenzie is an independent consultant, and since October, 2006, Director of Special Projects with the Canadian Coalition for Good Governance.