These days, financial and corporate governance reform advocates have concentrated a lot of attention on corporate boards, and for good reason: board culpability played a crucial cause of our economic system’s collapse. But another category of board activity remains relatively unexamined: institutional investor boards. As with corporate boards, institutional investor boards now must form complex opinions and take potentially powerful new steps—on everything from decisions about proxy access, client directed voting (CDV), majority voting, Say on Pay, corporate sustainability reporting, to other social and political issues flowing from the regulatory regime. How will investor boards respond to these new demands and duties that fundamentally reshape their role as fiduciaries? What principles should they follow as they redefine best practices? Today we examine what lies ahead, what’s emerging in the UK and South Africa, and what needs to happen here to assure quality performance of this new fiduciary role.
The McKinsey Quarterly recently called upon institutional investors to change their focus and practices. In “How Institutional Investors Should Step Up as Owners”, Simon C.Y. Wong describes a “movement afoot in Canada, France, the Netherlands, the United Kingdom, and other markets to encourage institutional investors to become better ‘stewards’ of the companies they invest in, by adopting a more active and long-term stance.” US asset owners – sometimes referred to as “beneficial owners” – and asset intermediaries (e.g., managers, advisors, and consultants) should take this movement seriously, and “rethink their approaches to portfolio diversification, engagement with boards, and compensation.” This means, Wong said, “they could usher in a new ownership culture that would not only benefit their customers but also placate regulators, which are poised to intervene if voluntary progress is slow.”
This idea lies at the heart of the United Kingdom’s first Stewardship Code, released in July. According to the Financial Times, it is “the first of its type in the world [and] designed to sit side by side with the UK’s code on corporate governance.” The Stewardship Code comprises seven core principles – including public disclosure of stewardship policy and approach to voting proxies, active engagement with portfolio companies, and collective action with other investors – to which institutional investors would voluntarily comply – or explain why they aren’t. “Comply or explain” was first advocated by Sir Adrian Cadbury in The Cadbury Report of 1992, which helped launch the corporate governance movement. This “comply or explain” approach also was included in South Africa’s draft Code for Responsible Investing by Institutional Investors, released on September 1st of this year. Its four principles, including public disclosure of proxy voting policies and records, serve as a complement to South Africa’s corporate governance code (referred to as King 3, in honor of South African jurist and professor Mervyn King).
It sounds logical enough—good corporate governance requires good investor governance, as the two go hand-in-hand. Buy why haven’t we been able to launch a similar movement for a code here in the United States—for either corporate governance or investor governance? (The question of a U.S. corporate governance code was taken up at the Yale Governance Forum 2010, an idea strongly supported by corporate governance pioneers Ira Millstein and Anne Simpson as a way of finding common ground on core principles. The reception among participants was lukewarm.) After Dodd-Frank, wouldn’t these be the next natural steps?
Yale’s Millstein Center for Corporate Governance and Performance offers a partial answer in its upcoming study of the feasibility of a US code of corporate governance. Indeed, Millstein Center executive director Stephen Davis has long argued for shareowner stewardship, building upon Robert A.G. Monks’ memorable maxim, “Capitalism without owners will fail.” But stewardship isn’t easy, as Simon Wong posted this summer on Harvard Law School’s Forum on Corporate Governance and Financial Regulation. He cites some structural reasons: inappropriate performance metrics that reinforce trading and short-termism; a misguided interpretation of fiduciary duty that elevates quantitative data over qualitative criteria; excessive diversification that makes monitoring difficult; and flawed business and governance models that emphasize passivity. Throw in our patchwork quilt of investor oversight, involving states as well as various federal agencies, and the task gets more complicated.
Despite these stumbling blocks, as we ponder progress on corporate governance reform, we should now work to improve investor governance and accountability, too—and the re-education and training that go along with it.