The Advisors' Blog

– Broc Romanek, CompensationStandards.com

In yesterday’s WSJ, Roger Ferguson, President and CEO of TIAA-CREF, contributed an op-ed, repeated below:

In his speech last Thursday at New York City’s Cooper Union, just a few blocks from Wall Street, President Obama called for reforms to provide shareholders a stronger say in the governance of companies in which they invest.

Institutional investors should support the president’s call enthusiastically. As stewards for the savings of millions of individual investors who have little ability to influence corporate practices on their own, these institutions have every incentive to throw their weight around, especially since they bear the ultimate cost when companies perform poorly or fail.

An example: Based on discussion with TIAA-CREF and other investors, Amgen, the international biotechnology company, provided shareholders with the ability to comment on its compensation program directly to the compensation committee of Amgen’s board. When investors and companies collaborate cooperatively, we can achieve outcomes that further the long-term interests of all shareholders.

Unfortunately, many institutional investors shirk their roles. There are many reasons. Some institutional investors are reluctant to spend resources on improving corporate governance. Others face conflicts of interest, particularly some mutual fund companies–for example, firms that manage 401(k) plans for large corporations could be called upon to vote against company management, the very client responsible for lucrative 401(k) plan fees.

Finally, some investors believe that the only way to hold companies accountable is “the Wall Street walk”–if you don’t like the company, sell the stock. It’s an elegant solution but one that doesn’t always work. Portfolios that aim to replicate the performance of a benchmark index can’t sell the shares of all underperforming companies. Besides, as disclosures about Lehman Brothers’ accounting show, it may be too late to advantageously sell once problems related to poor governance become apparent. Better to engage management on governance and strategy issues before problems arise and shareholder value plummets.

Institutional investors have a lot of clout if they choose to act. Pension funds, investment 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. Specifically, they can:

• Talk with boards and management about the company’s strategy and risk management. When dialogue fails, investors need to have available the 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.

– 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.

Institutional investors also need to examine their own practices and hold themselves to high standards of governance. For example, mutual fund companies should have more independent boards of directors, who can put shareholder interests ahead of those of the investment adviser.

Greater shareholder engagement may not have averted the financial crisis. But it 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.

The stakes are high. The time to act is now.