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Council of Institutional Investors


A senior administration official recently asked me for a two page summary of corporate governance. Well, I thought, if my father can summarize Christian ethics in five words (always do what love requires), surely I can do corporate governance in one short blast of iambic pentameter (or, on one overhead, if defense department officials are involved).

Corporate governance is what you do with something after you acquire it. It's really that simple. Most mammals do it. (Care for their property.) Unless they own stock.

But forget the stock market for a minute. Think about any other type of private property. Before you acquire this property, however trivial, you probably expect to spend some time deciding whether to acquire it, and on what terms. (Shall it be a J. Peterman duster or a James Robinson dessert spoon? A laptop or a notebook? A professional football team or a McDonald's franchise?) But you also expect to spend time--probably a lot more time--taking care of the property once you own it. Indeed you would think it odd to spend a hefty sum for a car and then not pay any attention to maintaining it or checking to see if your mechanic is maintaining it.

Why is it, then, that when you become just as real an owner of property, but do it by buying stock, you expect to ask the first set of questions (What to buy? At what price? When?), but not the second (What to do after you own the property?)? Why is it that, if you buy a restaurant outright you are expected to watch the maitre d' and the chef, and are expected to take action if the tables don't fill, but if you buy the same restaurant by buying stock and, with other owners, take the same actions, you are (1) labelled an "activist" engaged in "confrontational" behavior, (2) told by your chef that you don't have the requisite cooking skills to oversee him, (3) effectively prevented by government regulators from taking all but ineffectual ownership actions, and (4) likely to be sued on the grounds that you didn't fully reveal to the government your innermost thoughts about what you might do with your menus.

I thought about this recently when reflecting on the nine years I have spent in the curious world of pension funds. Over this period I have attended countless pension board meetings of major public funds. Typically, a significant portion of the board's time is spent listening to experts explain what the fund ought to buy (generically, categorically, or specifically) or, why, after-the-fact, they bought what they did. (Listening to these explanations when the buying produces bad results is about as painful an experience as listening at close range to my eldest son practice the tenor sax.) But, with the exception of some funds that are Council members, I can never remember a pension fund board getting a presentation from a money manager or consultant on what they ought to do with the stuff they buy after they buy it.

Does this strike anyone else as not the way to run a portfolio, let alone a competitive private sector? If you have an active group of expert horse trainers training race horses, it probably does no harm for spectators to bet on races. But if all the trainers become bettors, can anyone be surprised if the caliber of the horses begins to slip compared to horses at other race tracks where there are still trainers at work?

Pension funds are, with other institutional investors, the owners of more than half of all publicly traded equity. If virtually none of them spend any time training horses, and spend all of their time betting on existing ones, who can doubt that something powerful must be preventing them from doing the training, since in every other known context owners of property take care of it on an on-going basis, not just after major problems develop.

Of course, selling shares exerts weak corporate governance effects and hostile takeovers exert costly ones. But they are not the answers: does anyone think that the way to produce top race horses is for owners to threaten some horses that they will be turned into cat food or hope that other horses that get sold a lot will feel hurt and decide to run faster?

Slow horses and empty restaurant tables are often symptoms of poor horse training and ineffective restaurant oversight. Vice President Quayle and Governor Clinton have rightly identified excessive CEO pay as a symptom of the relative absence of effective owners in the stock market. The SEC has done more: it has come up with limited, conservative solutions through its proposed proxy reforms.

Of course, those who oppose proxy reform like to suggest (1) that there is no problem, and thus no need for reform, and (2) that these reforms are radical, premature forays into complex territory.

It is difficult to come up with two sillier arguments. First, there couldn't be more massive evidence that there is not only a problem, but a major problem: in every other setting in which owners own property they actively engage in ownership activity. But when owners own stock there is so little ownership activity in large publicly traded companies that it is possible to name off the top of one's head most of the individuals or entities who have taken such actions over the past ten years! And this is despite the fact that the U.S. equity markets are huge. It is hard, indeed, to picture a more stunning aberration from the norm, or a more disturbing one for anyone who believes in the value of a private sector.

Similarly, it is almost comical to suggest that corporate governance is a new or complex or scary idea. When people own property they care for it: corporate governance simply means caring for property in the corporate setting. It is difficult to picture a more fundamental premise in a private market economy. It is even more difficult to figure out how a Republican administration can come up with principled objections to such an idea: if you don't want owners to be the ones who make decisions concerning their property, who do you wish to substitute?

To avoid the obfuscating rhetoric that is often associated with policy discussions about corporate governance, and to gauge the correctness of a corporate governance suggestion, remove it from the context of the stock market and ask what the right answer is in the context of other types of property ownership. While this substitution is not perfect (adjustments do have to be made to reflect the shared ownership of publicly traded companies), in general the answer you get in less politically charged ownership settings is the right one. Let car owners make sure the oil gets changed: don't make them sell the car or ask for government permission to have basic servicing done.

Sarah A. B. Teslik
Executive Director
December 1991

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