Parallel Universes Undercuts its Own Arguments

In his article The Parallel Universes of Institutional Investing and Institutional Voting, Charles M. Nathan appears to pine for the days when institutional investors took the “Wall Street Walk” if they disagreed with management on governance issues. T. Boone Pickens Jr’s response to that perspective:

That’s like the gardener telling the estate owner, “If you don’t like the way I take care of your property, sell it and move out.” That’s not the way the real world works.

Nathan’s major point is that institutional voting, for the most part, is no longer done by money managers, and is, instead, often handled by a separate internal voting function or is essentially outsourced to third-party proxy advisory firms. Because of the economies of scale, most resort to largely one-size-fits-all voting policies based on perceived corporate governance best practices, without reference to the particulars of each company’s situation. Therefore, firms should develop parallel systems to communicate with the two very different constituencies.

On the other hand, he also advises corporate governance specialists on the investor side to move to a more nuanced approach, recognizing the legitimate need for variation in corporate governance specifics in the context of more than 10,000 public companies in the US that exist in different sectors and different stages of development. That’s constructive advice. Unfortunately, Nathan also includes some very bad advice, such as the following:

The corporate governance community should recognize that it does not need and should not want to talk to the operating and financial management of a company because the voting decision makers are, by design, not involved with measuring the company’s operating and financial performance.

That advice is absurd. Many in the “parallel universe” of corporate governance are actually housed within the investment framework of their organizations. This is certainly true of CalSTRS and CalPERS. The CalPERS Corporate Governance team executes an annual process that identifies approximately 15 to 20 companies in the domestic internal equity portfolio that exhibit poor economic performance and corporate governance.

Nathan grasps the drive by shareowners to move the board from a “trustee model of a effectively self-perpetuating board” to “an assembly of annually elected representatives who are directly accountable to their electorate.” Yet, he believes “proxy access doesn’t involve investment decision makers but rather is the province of voting decision makers.”

While it may be helpful to recognize these functions governance and investment functions are often somewhat specialized, there certainly is frequent communication between the two functions on the investment side. Proxy access isn’t just “good governance.” For many, like myself, proxy access is one more mechanism to correct the “self-perpetuating board” that Nathan mentions. Many object to the ever increasing share of profits doled out to executives, up from 5% to 10% of the total.  Directors that are directly accountable to shareowners may work harder for investors than the CEO. That would be a plus.

Nathan cries that any attempt at accommodation to the demands of the corporate governance community becomes “merely a prelude to another round of demands.” Yet, he must recognize how far we are from that goal of “directly accountable” directors. Even if the SEC’s proxy access rule is finalized, it only facilitates direct accountability for 25% of the directors at companies; the other 75% can remain “self-perpetuating.”

He also loses credibility with retail investors when, in a footnote, he describes the “groundswell” to develop “client directed voting” as one that would allow a default voting pattern of “for or against management’s recommendations or to vote in proportion to all other shareowners.” Any client directed voting that doesn’t include allowing investors to build their own systems of default, based on the votes of institutional investors announced on sites like ProxyDemocracy.org or by advocates on sites like MoxyVote.com, should be flatly rejected.

Although the thrust of the article is to encourage companies to constructively engage in dialogue with what Nathan sees as separate corporate governance constituency, he frequently undermines his own arguments. That’s too bad because flexibility and dialogue are certainly needed on both sides.