Annual Meeting, Corporate Governance – Yawn – So What

In celebration of the opening day of Annual Meeting Season we consider an article from the Harvard Law School Forum on Corporate Governance and Financial Regulation, The Parallel Universes of Institutional Investing and Institutional Voting, posted on April 6, 2010 by Charles Nathan.  Normally our trusty panel discusses weighty subjects like this, but Homer Simpson ran for cover.  It wasn't “Harvard” that scared him, it was “Law School” -  he was afraid he would be called on in class even when his hand wasn't up, and he wasn't too happy about the fact that the footnotes in Parallel Universes ran longer than the main text.  Parallel Universes notes the history of voting by institutional investors (loosely, organizations like pension funds or asset managers that own shares for the benefit of others) – the institutions voted with management unless there was a problem, in which event they would dump the stock – the Wall Street Walk.

In the 80's the “vote with management approach” changed in response to regulatory rulings extending institutional fiduciary duties to include voting.  To deal efficiently with a large quantity of data, the institutions generally turned to a formulaic assessment, often conducted by a third party such as Glass Lewis or ISS (now part of Risk Metrics) in making voting decisions.    The formulas grew to include more factors over time, but the result was still automatic. If for example, the Comp Committee is not independent or the stock option plan reserves too many shares, then ISS says to vote “withhold” on the directors and the institutions obey.  Parallel Universes notes  the  disconnect between the people making the decisions on when to buy and sell a stock (call them the Alpha Crowd for short, although we are clearly a lot less formal than Mr. Nathan, don't waste time looking for footnotes here) and the people deciding how to vote the same stock (the Governance Crowd).

In assessing the gap between the Alpha and Governance Crowds, Parallel Universes states “The point of this commentary is not to pass judgment on the merits of our current institutional voting system but to understand it and continue to plumb its applications.”  Really, Mr. Nathan?  In your one example, the Governance Crowd would vote withhold on Warren Buffet because he is both Chairman and CEO of Berkshire Hathaway and the Governance Crowd formula calls for independent chairmen.  In your discussion of alternatives to the Alpha-Governance disconnect, you mention a second “solution”.   Why refer to “solution” if you haven't judged that a problem exists, and why use an example that would lead to the ludicrous decision to dismiss Warren Buffet unless you are tickling a subliminal urge  to demonstrate problems with the status quo.

Despite the protestation of neutrality, Parallel Universes notes repeatedly that the formulaic approach cannot take special circumstances into account.  Based on personal experience trying to turn around an ISS recommendation in an unusual situation, then attempting to persuade institutions to vote against the ISS recommendation, I could not agree more with Mr. Nathan's view (or at least his view as I see it).  I only wish he would put it in a headline rather than cloaking it in non-judgmentality (it's good to invent a word every once in a while – keeps spell check on its toes).

In my view, the rigidity of the formulaic approach to voting is not the biggest problem arising from the Alpha/Governance disconnect.  Some people care about corporate governance for its own sake, but everyone (including the ultimate beneficiaries of pension funds and managed assets) wants to make money.   The disconnect suggest that corporate governance is unrelated to financial performance.  Many “owners” currently feel this way, but the leaders of  the Alpha Crowd are starting to assess governance as performance related, and it won't be long before this drives more expansive participation by the Alpha Crowd in voting, even if it means taking some new types of information into consideration to meet fiduciary duties.  Sure it requires analyzing lots of data and making judgments, but, really, isn't that what the Alpha Crowd does?

Photo Credit:  robertpalmer