Restoring Trust: Proposals for Shareowner Stewardship
By Stephen M. Davis, senior fellow, Millstein Center
"Capitalism without owners will fail," Robert A.G. Monks has famously written. Today, as we sort through the wreckage of the financial crisis, it is time to re-frame this insight for policymakers charged with crafting a new architecture for global financial markets. Think of it this way: Owners that fail to exercise stewardship responsibilities must be understood as constituting a systemic risk, right up there with lax regulation and substandard board oversight. That is the essence of findings from an international roundtable the Millstein Center conducted on February 13 in New York City.
In the run-up to the collapse, a select cadre of funds demonstrated vigilance and sought to overhaul governance at companies such as AIG. But too many others did not. Instead, uncritically, they poured the collective savings of tens of millions of employees into banks, corporations and Wall Street ventures that over-compensated CEOs, engineered artificial short-term gains and gambled fatally with risk. It was not just a US blunder. In a March 12 speech, City Minister Lord Paul Myners scolded UK pension funds that "disengaged investors lead to ownerless corporations and the risk of unaccountable executives and boards running amok." But the US has harbored a unique public policy challenge. The federal Department of Labor, charged with overseeing pensions covered by the Employee Retirement Income Security Act of 1974 (ERISA), was loath to exercise oversight powers to ensure that retirement fund behavior was aligned with long-term member interests. In particular, participants in the Center roundtable on shareowner stewardship concluded that:
A bedrock structural feature may be affecting the ability of many U.S. retirement plans to serve as optimal stewards of employee savings. Almost no plan sponsored by corporations gives members a voice in how it operates. By contrast, in Britain, Australia and other countries pension schemes are overseen by trustee boards selected from the sponsoring company as well as retirees and workers. This is important because the way a retirement system is governed appears to affect the performance of pension savings. Studies by the Rotman International Centre for Pension Management show that over time, when an employee pension plan is transparent and accountable, it generates at least one to two percent of additional return per year. Over a 20 year savings period, that amounts to a big boost for the average worker. But if a retirement plan is opaque and unaccountable to members, the drain can be equally large.
Despite its mandate to protect retirement savings, serial US administrations have allowed the Department of Labor's watchdog role as a check on retirement fund governance to wane. Enforcement has been episodic at best, particularly when it comes to overseeing how regulated funds undertake their duties as stewards. A scathing 2004 General Accountability Office probe into DOL practices detailed just how safeguards had disappeared.
The Center's roundtable found consensus on a recovery agenda for fund governance; we will soon release this as part of an omnibus white paper on reforms to the capital market. In the meantime, consider the following four public sector steps to restoring robust ownership to capitalism.
Critics will charge that such an agenda, imposed in economic crisis, will add financial burdens and red tape when what companies really need is relief to survive. But with savvy tax changes and smart oversight, the switch to accountable savings could reduce value leakage while preserving the ability of retirees to purchase products our corporations sell. That's a win-win we desperately need.
 Research conducted by Graham, Harvey and Rajgopal ("Value Destruction and Financial Reporting Decisions"). See similar conclusions in The CFA Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics (Breaking the Short-Term Cycle, July 2006).
 Steward, F. and J. Yermo (2008), "Pension Fund Governance: Challenges and Potential Solutions," OECD Working Papers on Insurance and Private Pensions, No. 18.
 Available at www.gao.gov/new.items/d04749.pdf.