Saturday, June 21, 2014

Increased director independence as a substitute for regulatory intervention

Professor Urska Velikonja has just published a new article arguing that the trend toward corporate boards with a "supermajority" - not merely a majority - of independent directors is part of a strategy by large institutional investors and corporate managers to fend off more substantive forms of corporate regulation that would reduce shareholder wealth.  Her thesis is that when corporations engage in risky and illegal behavior, they - and their shareholders - capture gains while externalizing losses; thus, large shareholders and managers have an interest in staving off real regulation.  The easiest way to do that is by advocating for greater board independence - it's functionally a call for self-regulation. 

I think the thesis has an intuitive appeal - similar to, for example, The Failure of Mandated Disclosure, which, as Steven Bradford pointed out, argues that we too often default to additional and wasteful disclosures as a substitute for substantive regulation (see also Joan Heminway's post on disclosure creep).

In the case of Professor Velikonja's argument, though, I think the picture is slightly more complicated.  Many institutional investors are employee or union pension funds - in other words, their beneficiaries are exactly the third parties to whom corporate misbehavior is externalized.  It's not obvious that they, or the funds who represent them, would prefer less substantive regulation, even if it resulted in lower corporate profits; however, the fund fiduciaries - in their capacity as fund fiduciaries - only have limited tools available to protect their beneficiaries.   They can advocate for better corporate governance, but it's not obvious that they can, consistent with their fiduciary obligations, advocate for greater corporate regulation.  (David Webber discusses some of the limits of fiduciary pension plan discretion in The Use and Abuse of Labor's Capital).  Anyway, given these constraints, I am not certain that it is fair to say that institutional investors as a group prefer to advocate for corporate governance reforms over more meaningful regulation - for at least some of them, their options may be somewhat limited.

Ann Lipton | Permalink


Thank you for featuring my paper, Ann! I’ll be the first to concede that I paint with a somewhat broad brush. It may be that pension and union funds truly are in a different class in terms of their goals than other institutional investors, and it is the fiduciary duties of fund administrators that stand in the way.

It is true that pension and union funds sometimes advocate for proposals that do not clearly and exclusively advance shareholder value. But for the most part, it is accurate to say that in their corporate governance policies, their public comments (to the SEC, for example) or shareholder proposals, pension and union fund administrators seem quite comfortable to advance a shareholder-centric corporate governance agenda. But perhaps this metric is unfair because the perceived and/or actual political and legal constraints on advocacy are very real for pension and union funds. [At least the D.C. Circuit in Business Roundtable v. SEC seemed to think pension and union funds were suspect, and referred to them derogatorily as “shareholders with special interests.”] I read your post to suggest that pension and union funds cannot do what they really want to, and that it’s a fair critique.

At the same time, pension and union funds manage a relatively small share of equity holdings. According to the most recent Flow of Funds report, all private and public pension funds combined hold 14.5% of corporate equities; other institutional investors (funds and insurance) hold more than twice that amount. While your critique that I attribute motive where there is none is on point, I think that my broader point still holds.

In any event, thank you so much for your thoughtful post.

Posted by: Urska | Jun 21, 2014 8:21:09 PM

Ah, see, it doesn't surprise me that they aren't as big a holder as other kinds of institutions! And I do think you're right, fundamentally - i.e., that governance reform looks easy to do and doesn't end up rocking the boat too much, and that's why it becomes an easy solution.

Posted by: Ann Lipton | Jun 22, 2014 12:29:18 AM

Thanks for the post, Ann, and the paper, Urska. I will look forward to reading the paper, although I admit to the overall view that independent directors may not, in any number, affect governance significantly. The empirical literature is mixed on these kinds of effects (although more study is needed, for sure), and I think we all can agree that structural independence is not always the equivalent of perspective/thought independence. Perhaps, then, if Urska is right, the move to boards with supermajorities of independent directors may hold false promise for institutional investors . . . . But I suppose I should read the paper and learn more! :>)

Posted by: Joan Heminway | Jun 22, 2014 10:00:56 AM

Hi Joan - yeah, Urska acknowledges that point in the paper. I.e., she highlights research about how supermajorities of independent directors are counterproductive, and then sets out to discover why anyone structures a board that way, given the givens. She concludes that it's a mechanism for fending off more substantive regulation.

Posted by: Ann Lipton | Jun 22, 2014 6:35:29 PM

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