Institutional investors, including pension funds, and the corporate boards they elect have much in common. They have fiduciary responsibilities. They have a strong sense of stewardship. And they are both continuously being urged to take a long-term view, despite compensation structures that sometimes incentivize short-term results.
For all the commonalities, non-executive corporate board directors have only recently started to engage directly with long-term institutional investors. Yet in our meetings with institutional investors and pension funds, it is clear that a willingness by board directors to meet with them, when requested, is often taken as a proxy for the presumed quality of the board.
Institutional investors assess the willingness of boards to engage with shareholders as a signal of board effectiveness and a strong board culture. Investors want boards to be open to building a relationship that allows for appropriate dialogue with the right pace and timing.
Investors want to know how the board is involved in developing strategy and the chief executive officer succession process. Investors view succession as a significant risk factor; strong long-term and emergency-succession planning processes are therefore important risk mitigation responsibilities of the board. They also expect the board to defend their decisions on executive compensation, not the executives themselves.
Investors are clear in their desire to better understand how boards evaluate and improve their own effectiveness. Many see a robust evaluation process as a good indicator of strong corporate governance.
The Commonsense Principles of Corporate Governance, unveiled in July, support those findings. The principles were developed by a group of executives from leading prominent public corporations, including James Dimon, chairman and CEO, J.P. Morgan Chase & Co., and Warren E. Buffett, chairman and CEO, Berkshire Hathaway Inc. Others in the group include major institutional investors mainly based in the U.S., including Laurence D. Fink, chairman and CEO, BlackRock Inc.; Ronald P. O'Hanley, president and CEO, State Street Global Advisors; Brian C. Rogers, chairman, T. Rowe Price Group; and F. William McNabb III, chairman and CEO, Vanguard Group.
The principles contain an entire section on “asset managers' role in corporate governance,” which states that asset managers, on behalf of their clients, should evaluate the performance of boards of directors, including thorough consideration of the following:
- To the extent directors are speaking directly with shareholders, the directors' (i) knowledge of their company's corporate governance and policies and (ii) interest in understanding the key concerns of the company's shareholders, and
- The board's focus on a thoughtful, long-term strategic plan and on performance against that plan.
As investor expectations and preferences continue to evolve, it is becoming increasingly important for boards to be able to both get inside the minds of their shareholders and, in some cases, engage directly with them. In essence, they must become more “investor-savvy.”
Boards need to consider a number of steps to become investor-savvy. These steps involve making sure the board knows where institutional investors stand on key issues, thinking like investors when it comes to reviewing strategy (including how an activist might view capital allocation decisions), developing a policy on when and with what type of investors the board will engage directly (and preferably disclosing that in the proxy), and deciding which directors have the skills and experience to engage with investors when required.
The final steps include ensuring there are directors on the board with experience dealing with investors who are available to engage and considering adding one or two savvy investors to the board, as General Electric Co. did in 2012 when it added John J. Brennan, chairman emeritus and senior adviser of Vanguard.
Yet many investors need to look at their own stewardship arrangements and the number and quality of staff they can deploy to undertake constructive engagement with directors. The Commonsense Principles note: “Asset managers should actively engage, as appropriate, based on the issues, with the management and/or board of the company, both to convey the asset manager's point of view and to understand the company's perspective.”
It would be counterproductive to field poorly trained staff, disconnected from the institution's portfolio managers, and who might take a confrontational approach to dialogue with board leaders.
The Commonsense Principles also state: “Asset managers should … have clear engagement protocols and procedures.” More investors could choose to disclose their approach to engagement on their websites. They could also set up systems to respond quickly to requests to engage by boards (even if it's a negative response). As boards become more investor-savvy, investors need to become more board-savvy.
A successful long-term approach by a public company requires a supportive long-term institutional investor base. Working together, institutional investors and board directors can be more effective stewards of the future wealth of society.