In the Nation's Interest
Remarks by Roger W. Ferguson, Jr. President and CEO, TIAA-CREF
I’m honored to be here to begin today’s discussion about the effects of regulatory reform on institutional investing.
The company I lead, TIAA-CREF, is one of the largest pension funds in the nation. Founded in 1918 to provide retirement security to university faculty, we now serve 3.6 million participants at 15,000 institutions. While the higher education business is still at our core, we have a growing presence in other not-for-profit sectors, including health care, cultural organizations, and the public sector.
With 410 billion dollars in assets under management as of the last quarter, we carry substantial weight as an institutional investor. People will return our calls, which is a benefit not available to most average investors.
When we make our opinion known, boards listen and engage. They provide information, insight, analysis, and access to their views. This allows us to make more informed decisions on behalf of our participants.
We believe that having this clout brings responsibilities. We have a responsibility to be an active investor, especially since we and our participants bear the ultimate cost when companies perform poorly or fail. When investors and companies cooperate, we can achieve outcomes that further the long-term interests of all shareholders – not just our participants.
Of course, we are not alone. Pension funds and endowments and insurance companies are the largest group of investors in U.S. companies, holding more than 40% of the outstanding equity of publicly traded firms. These institutions can and should do more to protect investors’ long-term interests.
Today, I’ll make a case for how institutional investors should use the power that comes from our size and scope to actively promote good management … and how our ability to act will be shaped by changes in the financial regulatory landscape.
Recent reforms include Dodd-Frank, as well as SEC actions that have helped to resolve longstanding debates about the role of shareholders in corporate governance. These reforms give shareholders influence in the market that may help to mitigate business and market risks if they choose to use it.
Historically, there have been three primary measures to align the interests of those that own corporations and those that run them, and ensure that companies develop strategies intended to create long-term value:
- a board of directors overseeing management on behalf of shareholders;
- executive pay that gives managers a stake in the success of the firm;
- and, more recently, a growing expectation of transparency regarding the firm’s social responsibility.
Each of these areas is, in turn, a response to ineffective business practices, including board entrenchment, misalignment of executive pay, and a lack of incentives for social responsibility.
Until recently, these three problems did not attract much attention. As long as the market was performing well – and as a result shareholders and society generally benefitted from corporate activity – it seemed reasonable to let companies continue to do business the way they saw fit.
Attitudes began to change over the past decade as the market stopped delivering strong returns and high profile corporate failures eroded public confidence in corporate leadership.
- Several failed companies had boards that were either complicit or unaware of the facts, and upon closer inspection had ties to management that compromised their independence.
- Companies – particularly financial companies – had compensation policies that provided rewards for short-term results that ultimately compromised performance. Shareholders, too, tended to applaud short-term results while disregarding the need to have management properly incentivized to return long-term, sustainable profits.
- And we recently saw with the BP disaster how a lack of transparency on environmental issues can have a strongly negative impact on shareholders and other market participants.
The Role of Universal Owners
As scrutiny of business practices has increased, certain investors, especially pension funds, have begun to develop a shared identity as “universal owners.” These funds, by virtue of their missions, are long-term oriented. And by virtue of their size, they usually own every company in the market.
The growing role of universal owners has had implications. First, the ability of pension funds to fulfill their missions depends less on short-term company performance than on the long-term performance of the market as a whole. This makes concerns about externalities and social responsibility much more significant.
It also means that – while asset managers are central to institutional investors’ success – there is a limitation on the ability of universal owners to create value by trading in and out of stocks. Because they are owners rather than renters, they have begun to see a responsibility to actively hold companies accountable for performance.
Active ownership is not a coercive approach to accountability. Rather, it is about engaging with management to ensure that companies are acting in the interests of shareholders – before problems arise.
The Effects of Regulatory Reform
Recent financial regulatory reforms are intended to help shareholders be more active owners and make it easier for them to exercise their rights – particularly in relation to the three key areas – board accountability to shareholders, executive compensation, and social responsibility.
Under the heading of board accountability, one of the most significant reforms is that proxy access will allow shareholders to nominate directors to boards under limited circumstances.
- Shareholders or groups of shareholders with 3% ownership of companies for three years are eligible.
- Shareholders can nominate up to 25% of the board seats, but it’s more likely that the typical number of nominees will be one.
Furthermore, it used to be the case that shareholders – especially retail shareholders – who did not cast votes would have their votes cast by brokers on routine items. Ostensibly, this was to help achieve a quorum, but in reality these became automatic votes for management.
Brokers will no longer be able to cast such votes, removing a built-in bias in favor of management and increasing the ability of dissident shareholders to achieve majority votes. (Though legislation did not mandate majority votes.)
Additionally, SEC rules that were put into practice last spring ramped up disclosure requirements, giving shareholders access to more information on important matters such as:
- the relationship of a company’s compensation policies and practices to risk management;
- background and qualifications of director nominees;
- information surrounding the company’s board leadership structure and the board’s role in risk management;
- and potential conflicts of interest of compensation consultants.
On the compensation front, the centerpiece of recent reforms is a non-binding vote on executive compensation – better known as “say on pay.”
Advocates, including TIAA-CREF, have sought such a voice on compensation for many years. In fact, four years ago, we practiced what we preached by becoming one of the first US companies to voluntarily provide an advisory vote to our participants – even though we are not a publicly-traded company. Since then, several companies have followed suit. Now, it’s no longer optional; the new legislation will require this for all public companies.
Shareholders also will have a vote on “change of control” events, such as golden parachutes.
The SEC will be required to issue rules regarding clawbacks of executive compensation due to material non-compliance in accounting statements. And the SEC is directed to require listing standards that include greater independence of compensation committees, consultants, and advisers.
In our third area – social responsibility – we see valuable efforts to improve transparency. Shareholders will not have a vote on social responsibility, but they may file proposals asking for policies or disclosures on social and environmental issues.
Many markets require corporate social responsibility reports from companies. The U.S. does not, but it is increasingly requiring disclosures on specific issues related to CSR, including:
- Board diversity
- Climate change
- Mine safety
- Payments to foreign governments
- And conflict minerals
With some exceptions (like clawbacks), the governance provisions of Dodd-Frank and other reforms do not ask companies to change internal governance policies. Instead, the provisions are intended to create a layer of accountability by providing shareholders with more information and more power to vote on this information.
Objections to Reform
These reforms have been the subject of debate for some time and a number of objections have been raised.
The first is that activist shareholders with short-term or political agendas will hijack these rights to force boards to adopt policies that are not in the interests of all shareholders.
However, none of the proposed reforms transfer that kind of power. Proxy access is only available to owners or groups of owners who control at least 3% of shares and have held their stake for three years. And no shareholder nomination will succeed unless it is supported by a majority of shareholders. Most other reforms simply enhance transparency and the advisory role of shareholders.
Another concern is that we are moving from “director centric” governance to “shareholder centric governance.” Perhaps we’re investing too much power in shareholders who don’t have the expertise to make these kinds of decisions.
For instance, with “say on pay,” will shareholders take the time to examine Compensation Discussion and Analysis documents, or will they simply object to the size of a pay package on the face of it? Will the votes really be votes on compensation or votes on confidence in management?
More generally, there is a fear of “check the box” governance that does not take into account each company’s specific situation. There is a reasonable concern here, and it will be important for investors to avoid overreach.
What Pension Funds Can Do
Let me offer a vision for active ownership that uses these new tools in a way that addresses these objections.
If boards are committed to a long-term strategy, universal owners are their natural allies against whatever short-term pressures they are under. For example, positive votes on “say on pay” resolutions can help to blunt criticism of CEO pay.
The danger is that we forget that even though companies share some common characteristics, they are all, in fact, different. We should not demand the same prescriptive governance structures for everyone.
- For instance, a major clothing retailer has two compensation cycles per year, which is generally not considered a best practice. But the fashion industry has two seasons – fall and spring – and performance in one does not necessarily reflect performance in the other. In this instance, it makes sense to pay people separately for success in each season.
- Rather than a coercive or prescriptive approach to corporate governance, we advocate a “soft accountability.” “Say on pay” and shareholder proposals are advisory only; proxy access results at most in a change in one director, who cannot change corporate policy without the support of other directors.
Active owners welcome these rights while hoping not to use them. The assumption is that most companies are reasonably well governed and that access, “say on pay,” and shareholder proposals should only be a last resort. Our hope is that these rights will lead to an ongoing dialogue between shareholders and companies that will render the use of these rights unnecessary in most cases.
Among specific actions active investors can take are the following:
- Talk with boards and management about the company’s strategy and risk management. When dialogue fails, investors should use appropriate tools to bring companies to the table, including the right to nominate and remove board members.
- Exercise voting rights on matters such as director elections, executive compensation, and other governance matters.
- Ensure that compensation policies fit the unique situation of each company, integrate with business strategy, and align managers’ incentives with shareholders’ long-term interests.
- Don’t define what corporate social responsibility means for a company, but ensure that it is being handled as a matter of strategic importance. Does the company understand this as a matter of business priority, or is it a public relations exercise? Do shareholders have enough information to judge whether the company is managing its risks?
- Actively defend the integrity of accounting standards, because the quality of reported information is critical to investors’ ability to judge risk and allocate capital appropriately.
Greater shareholder engagement can help to ensure efficient allocation of capital, connect company owners and managers in an ongoing dialogue about their common purpose, and reduce the risk of future failures.
And, perhaps most importantly after a decade filled with examples of corporate malfeasance, shareholder engagement can help to rebuild trust between businesses and the broader public.
I started my remarks by telling you that as a financial services company with more than 400 billion dollars of assets under management, companies return our call. Yes, our heft makes our portfolio companies responsive. But it is because of our reasonable, rational, and responsible approach to active investing that portfolio companies continue to return our calls. In fact, they privately seek out our opinions on critical matters of governance and social responsibility.
TIAA-CREF has always been a reasonable, rational, and responsible active investor. The new shareholder powers granted by Congress and the SEC will not change our approach – but we hope that the new rules will encourage other institutional investors and companies to join us in efforts to ensure long-term sustainable wealth maximization for the millions of Americans who invest for their future through us.
Commentaries are the views of the authors and do not necessarily represent policies of the Committee for Economic Development.