Executive Director, IRRC Institute
Managing Partner, Sinclair Capital
Website: IRRC Institute
IRRCi Twitter: @IRRCResearch
1. Along with many other projects relating to corporate governance, you are presently serving as the executive director of the IRRC Institute. Could you provide a brief explanation of what it is that your institution does? What services do you provide and what are the institution’s main objectives?
The Investor Responsibility Research Center Institute (IRRCi) originates, funds, quality-controls and disseminates objective research designed to help investors, policymakers, and other stakeholders make sound decisions. While the research focuses on the U.S., we are acutely aware that capital markets are global.
We are unique for a number of reasons:
i. We start from a unique perspective: What do investors need to know and how can the insights from the research help investors make better decisions. So our reports have impact.
ii. We are passionate that our research be objective and unbiased. As a result, we have established a reputation as a thoughtful NGO which examines complex issues with nuance. As a result, our research is well-regarded and has been referred to Congress and the SEC. In fact, the same research is sometimes used by advocates on both sides of an issue. We don’t mind that; in fact we like that we can elevate the level of discussion so that the arguments are based on facts. Of course, sometimes the conclusions are overwhelming. In that case, we don’t shy away from controversy, such as the recent examination of executive compensation which concluded that “alignment” and “total shareholder return” has run wild to the point where value creation is not a priority in corporate incentive plan design, nor in how institutions cast their “say on pay” votes.
iii. We rely on experts to do our research. No one firm or NGO has expertise in all the issues of interest to investors, from capital markets to sustainability to corporate governance. For example, we have issued reports as varied as high frequency trading, fracking, and executive compensation and board responsibilities. Therefore, we find the subject matter experts to research each report. One result is that we publish both practitioner and academic research. I am surprised, but apparently we are one of the rare institutions that reach across the practitioner/academic divide.
iv. We understand that our mission is greater than we are: The IRRCI Board decided that we do no fundraising. That effectively means we will go out of business when our money runs out. However, it also means we have no obligations to funders and can focus exclusively on research and impact. It also means we can be exceptionally efficient; More than 85% of our expenditures go to furthering our research program.
v. Finally, consistent with our desire to elevate the discussions and to have maximum impact, all our research is available free of charge on our website, www.irrcinstitute.org.
2. As a promoter of data-driven decisions and one of the most influential thought leaders in corporate governance issues, do you find that there is a link between the two concepts? Would you say that making data-driven decisions leads to better corporate governance?
I could answer that in a number of ways, but let me focus on two. The first is obvious: Of course having more facts is better when you are making decisions. But that statement needs context: Data is interpreted by human beings who bring their own experiences, values and prejudices to how they interpret them. That’s fine, people have different opinions. But that’s one reason we try so hard to provide objective data: In effect, we try to give the users of our research a single variable equation where the variable is their own subjectivity, rather than a double variable equation where the supposed “facts” or analyses are also skewed by a prior opinion.
Second, is that we often examine broadly accepted, but unexamined aspects of corporate governance. So, for example, we benchmarked corporate “engagement” with investors. Everyone talks about engagement, but there was no understanding of exactly what that means. It turns out that corporate officials and investors use the same word, but mean very different things. From the amount of time an engagement takes to what constitutes success to who should be in the room, there are some real differences in how various constituencies understand engagement. Such robust examinations sometimes uncover what Al Gore might call inconvenient truths. So, for example, while there has been reams of executive compensation research, when we decided to look at executive compensation, we asked formulated a simple research question: How does the way corporations and investors look at long term incentive compensation plans relate to economic value creation? We found that, by and large, it doesn’t. Rather, the dominant impetus is for alignment. Everyone knew that total shareholder return was an ex-post alignment metric, not an ex-ante value creation metric, but the implications had never been examined. That’s caused quite a stir.
3. You have mentioned on several occasions the issues that arise from shareholders’ short-term mentality; how does this mentality negatively affect management? How does it affect corporate governance as a whole? What can be done to alter this short-term thinking?
Wow, that’s a question I could write a book about. Let’s start where I ended the last question, with executive compensation. If we judge compensation by alignment with stock price movement over a one-year period, what does that tell management about investing long-term in the business? Fewer than 15%of large American companies use any metrics regarding to innovation or creation of future value in their long-term compensation plans. Some 25% of companies don’t even have long-term metrics. And 90% don’t have any performance period beyond three years. And this is despite the fact that Board members and senior executives themselves think that a planning period of four years or more would improve financial results.
Layer on that the fact that the Bank of England has found that we investors (and presumably Boards and managements) overly discount future cash flows. That means we undervalue long-term investments – like infrastructure and new product development. Those are exactly the investments that, over time, can create the most value. Yet when we do invest for the future the payoffs can be remarkable. As an example, I believe it took Apple more than five years to bring the Ipad to market. Yet the vast majority of companies have planning horizons shorter than that.
There is hope, however. Some companies get it right. They align their strategic planning with their compensation, both for the metrics and for the performance period. So, that’s the first thing that companies can do.
Also, companies can better understand their shareowner base and then communicate with it. Companies need to understand that the statistics about shareowners becoming more short-term are skewed badly by the rise of high frequency trading. In reality, shareowners (other than HFT) hold for just as long as they always did. There’s a simple, common-sense test to prove that. Ask a CEO who the top 20 shareowners are; chances are he or she can name them. And they don’t change much from quarter to quarter. So if a CEO and Board undertakes to explain a multi-year strategic plan to them, and gives them a sense of how to judge whether the plan is on trace, most shareowners will give them the time to realize that plan. Of course, the company has to deliver on progress towards the specified goals and give progress reports in the interim.
So, to recap, start by creating a great strategic plan. Then align your performance and incentive compensation metrics to it. Finally, explain it to your shareowner base. In other words, create trust with your shareowner base through accountability within a multiyear framework.
4. In The New Capitalists, the award-winning book which you co-authored, you focus on citizen investors and how they are shaping the corporate agenda. How does the influence of citizen investors presently affect corporate governance? Do you see this changing in the near future? Do you have any recommendations for balancing the negative effects of citizen investors?
First, thanks for the nice compliment on the book. The follow up should be out late in 2015.
I don’t know that I agree that there are negative effects of citizen investors. In fact, I think it’s quite the opposite. Regarding investors and citizens as materially overlapping constituencies is a very healthy construct for economies and societies; it’s when we think of them as separate that we get into trouble.
Let’s take the environment as an example. A theoretical construct that says investors should go ahead and pollute all we want and externalize those costs onto society so that investors can benefit is a horrible idea. It’s horrible for the obvious reason – we get climate change, polluted air, despoiled land and water – but also for purely economic reasons. First, investors are members of society, so they pay through either taxes to remediate the pollution or through poorer health as a result of it. Paying out of the bank account labeled “taxes” rather than “investments” doesn’t change the fact that you have to pay. Second, and not so obviously, it’s often more economic and more effective to manage and mitigate the problem than to deal with it after the fact. In other words, paying out of the pocket labeled “investments” is actually less expensive than trying to externalize the costs. So polluting is not an economic solution.
Despite that, much of the fiduciary law around the world does create an artificial barrier surrounding the “investor” part of citizen-investors. That has to change, and, I’m exceptionally happy to report, it is changing (though perhaps more slowly in my home country of the United States than elsewhere). Still, there is an increasing recognition that considering environmental, social and governance aspects of investing is valid. We see that through the recent work of the Law Commission in the United Kingdom, through the work of the United Nations Principles for Responsible Investment, and through the self-definition of fiduciary duty to include sustainability by major investors such as the California Public Employees Retirement System.
Still, old style interpretations of fiduciary obligation linger in regulation and in the court system. They create unnecessary hurdles to holistic thinking. So I’d like to see those laws change.
5. How do you see Corporate Governance developing in the next few years? Are there any specific hurdles boards must overcome to reach this prospective target?
I came to corporate governance through investing. In the early 1990s, when I was running New York City’s pension funds, I came to realize that the central mission was finding someplace to invest $80 billion that would earn a return above the rate of inflation, forever. That’s when I became interested in corporate governance, because it had the potential to both improve the efficiency of corporations and to make sure the economic benefits were allocated appropriately.
So, I would like corporate governance to become even more focused on sustainable value creation. That means allowing corporations to take multi-year risks, even while holding managements and boards accountable. To do that, we need to deepen the trust between boards, managements and shareowners. That, in turn, suggests increased transparency and communication amongst all the players.
The good news is that is happening. Some of it is driven by regulation, such as the enhanced auditor reports in the UK and the proposed new auditor reports in the US. But it’s also happening organically, as corporations and investors understand that they must work together to optimize outcomes. So, for example, earlier I said corporations and shareowners defined engagement differently. But both agreed on two things: Engagement is increasing and is at an all-time high and that engagements are usually successful.
Of course, there are always hurdles. One of the biggest is that we sometimes forget that — for all the research and data and theories and policies and procedures and regulations — corporate governance is implemented by human beings. And we’re all fallible. So, perhaps that’s the biggest hurdle. Let’s recognize our imperfections. Then we can work to overcome them.
Thank you Jon!