Stephen Davis on the future of corporate governance, shareholder activism, and proxy voting

Growthpolicy.org interview with Dr. Stephen Davis, Associate Director and Senior Fellow, Harvard Law School Programs on Corporate Governance and Institutional Investors. In November 2017, Growthpolicy.org spoke with Dr. Stephen Davis on the future of corporate governance, shareholder activism, and proxy voting. To contact Dr. Davis: 1. Harvard Law School bio: https://pcg.law.harvard.edu/stephen-m-davis/ 2. Twitter @SMDavisCorpGov: https://twitter.com/SMDavisCorpGov 3. LinkedIn: https://www.linkedin.com/in/stephen-davis-6282424/ 4. Video of London Business School “Leading Minds” session to launch What They Do With Your Money: How the Financial System Fails Us, and How to Fit It: https://www.youtube.com/watch?v=FurdWskNPN0 5. Book: Stephen Davis, Jon Lukomnik, David Pitt-Watson, What They Do With Your Money: How the Financial System Fails Us and How to Fix It (Yale University Press, 2016): https://www.amazon.com/What-They-Your-Money-Financial/dp/0300194412 Interviewed by: Devjani Roy, Project Advisor, Growthpolicy.org; https://www.linkedin.com/today/author/devjaniroy?trk=pprof-feed

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Growthpolicy.org: In July 2016, a small cohort of America’s best-known business leaders signed their name on a set of voluntary guidelines titled “Commonsense Corporate Governance Principles.” What, in your opinion, are the most pressing topics that affect corporate governance today, outside of SEC regulations and stock exchange listing rules? Davis: The Commonsense Principles were a helpful step. But they were framed as a one-off statement and were authored principally by corporate executives. That’s not what the U.S. capital market best needs right now. Instead, what would be most helpful would be the approach tested elsewhere of principles framed by all major parties in the market, and with an ongoing process to encourage take up and revisions of guidelines over time.  That way principles could become a living, influential asset to the market. An important partial step in this direction is the Investor Stewardship Principles (ISG), the first effort by an investor collective—now more than 40 funds strong—to set out best practices principles. It comes into effect in January 2018. This too has one-sided authorship—in this case investors rather than corporates. But the ISG is conceived as a long-term initiative with a secretariat, periodic assessments, and a commitment among signatories to advance objectives through engagement with portfolio companies. This approach is closer to the stewardship principles model used in other markets, and should help move communications between companies and investors to a new level where long-term value is a central focus. Among the key issues investors need to address to achieve sustainable value creation is whether a board is diversified enough so that it has eyes on markets of tomorrow; whether it has independent leadership such as an outside chair with independent information to perform effective oversight of management; and whether it has a credible framework for understanding and managing the many cyber and intangible risks facing business. Growthpolicy.org: The agency problem and investment managers: Investment managers, hedge fund managers, investment management companies—the large pension funds, the Blackrocks and the Vanguards of the capital markets—work at the intersection of the agency problem in economics. How can corporate governance evolve to make sure such financial agents put investors’ interests first, subvert the problem of moral hazard, and act as reliable financial stewards of the capital they are entrusted with? Davis: We are at a historic tipping point in capital markets. The big three institutions—Blackrock, Vanguard, and State Street Global Advisors (SSGA)—have in only the past two years moved from treating corporate governance as chiefly a compliance exercise designed to keep regulators and lawyers happy to handling it as a stewardship responsibility with relevance to value and risk. We can see the implications of that profound transformation internally with a doubling of staffs in each of these shops and the lifting of status of stewardship professionals within each. Externally, we can track the change with, for instance, the milestone vote in 2017 by all three against management on climate change at ExxonMobil; the statements by CEOs of all three on the need for corporate attention to board diversity and climate risk; and the embrace of the high-profile ‘Fearless Girl’ campaign on diversity by SSGA. None of this would have been conceivable a handful of years ago. Reasons for the shift are not yet well explored, but they are likely to include signals from sales staffs at these funds that millennial investors, who are emerging as the chief suppliers of capital to markets, are increasingly interested in aligning their savings with their values. However, evidence shows that the evolution from compliance to stewardship is happening at two speeds. The big three may be moving quickly, but other mutual funds are stuck in sluggish gear. What will bring the investor world as a whole to more attentive ownership—after all, a bedrock doctrine of effective capitalism—is the involvement of grassroots savers, who have been largely left out of corporate governance law, regulation, and codes. One group representing such individuals is ShareAction (disclosure: I am a trustee), based in London. We need a similar body—what I call a ‘MoveOn.org for the investor class’—in North America. Its mission would be to advocate that institutional investors behave as accountable stewards of capital to advance sustainable, responsible, and well-performing listed companies. Growthpolicy.org: Shareholder activism and corporate governance: 2017 has seen some high-profile instances of shareholder activism. What, according to you, lies ahead for shareholder activism, particularly as a force that can change corporate governance? Davis: Activist investors come in many stripes; some with ideas that can gut a target company’s capacity for long-term success, others with sound analysis and ideas that build long-term performance. Markets tend to sort them out fairly quickly. That’s because activists typically hold only a sliver of a company and depend for success on persuading the big funds to join them. Big funds won’t do that if they distrust the motives and track records of the activists. But unlike, say, five years ago, those same big funds will now absolutely join activists they believe in when a target company is troubled. The trend line is clear that big funds will often rely on activists to identify targets, do the research, and propose solutions. Curiously, many activists have shown themselves awkward at building long-term relationships with the big funds, showing a preference for insularity and opacity. I would forecast that in the near to medium term activists will likely shift toward more transparency and relationship building just as big funds have shifted toward acceptance of activists’ legitimacy. Growthpolicy.org: What is your opinion on the current proxy voting process? What needs to change for better practices in corporate governance? Given some recent highly divisive proxy fights, do you believe we need more unified practices, or a standard code, for proxy contests? Davis: No one would voluntarily build the complex proxy ballot system we have now. But we inherited it from a time when proxies were generally conducted for compliance purposes, not to decide real power struggles within listed companies. That companies such as Broadridge and regulators have been able to keep the framework alive is a tribute to their ingenuity. But the truth is that a ground-up overhaul would be a painful but welcome development. The problem is that entrenched interests would work to block it; and the high levels of distrust in markets could derail it. The main principles would be simplicity, integrity (that is, credible independent parties responsible for distributing, counting, and certifying the vote), maximum accessibility, and low cost.