Foundations
Should Behave as Responsible Corporate
Shareholders and Utilize an Ignored Asset - the Proxy Vote
By Lance Lindblom
President & CEO
The Nathan Cummings Foundation
New York, NY
In Jed Emerson's article, "Horse Manure and Grantmaking" in the May / June 2002 issue of Foundation News, he advocates focusing on the 95% endowment corpus of a foundation, not the 5% grants budget. That is where he sees more impact to "manage the total assets of the foundation in order to maximize its value as a resource." However, he has missed an important asset that comes with the 95% - the shareholder proxy vote.
The real leverage for change is not in socially-responsible investing or in seeking a "blended value" of philanthropic and financial investments. The real leverage for change is in acting like responsible shareholders, like owners instead of stock traders. It is the use of the shareholder proxy and related public awareness that will result in sustainable change and so further foundation values, missions, and goals. The religious community has understood this for some time. The public pension funds are beginning to understand and exercise this power. Foundations, in contrast, do not seem to realize that they, too, have an opportunity and fiduciary responsibility as major shareholders.
Investing is supposed to provide market discipline through the rational allocation of capital. Socially-responsible investing adds the important dimension of encouraging ethical behavior while generating competitive investment returns. But is it that simple? Does socially-responsible investing "work"? And what do we mean by "work"? Better investment returns? A blended return of financial and social benefits? Socially-responsible investing probably does "work", at least at the margins, under either of these definitions. But the various arguments for it are contradictory and the return calculations range from unproven to theoretical. More importantly, by narrowing the arguments to financial calculations, we are missing the bigger picture.
The bigger picture is not "proper" financial incentives and rewards, but ethics and accountability. Financial incentives alone have backfired. The leveraged buyouts of the 1980's were meant to unlock the inherent values of corporations that comfortable managements were sitting on. The large stock option packages of the 1990's were meant to align managements’ interests with shareholders’ interests.
We
are now seeing the short-sightedness of these strategies and the impact of
unintended consequences. Managements’ interests did become aligned with one
group of shareholders - the active, short-term traders. But those get-rich-quick
interests were directly contrary to the interests of the vast majority of
investor wealth – that held in long term pension funds and endowments. They
were also often wrong, sometimes criminal as we are now seeing in the unfolding
corporate governance and accounting scandals.
The Arguments for Socially Responsible Investing -- And the Shortcomings
Socially-responsible investing screens potential investments for both negative and positive practices. The basic assumption is that management behavior impacts financial performance which determines investment performance. Everything can be directly reduced to rate of return. Proponents of SRI get to this in various ways, but each argument has its shortcomings.
There are some relatively short term studies covering a market period that rewarded "clean" industries, not because they were environmentally better or more profitable, but because they were seen as growth sectors of the "new economy." These studies are not definitive. We will not be able to document the relative returns of the funds that have been the early pioneers in SRI until they have been through more than one full economic and investment cycle.
The U.S. stock market is incredibly shortsighted and doesn’t care about financial performance more than a quarter or two out. In the recent decade of "irrational exuberance", stock prices have been driven mostly by near-term revenue growth, not by long term profitability.
This argument assumes a capital constrained market, which has not been the case for the last decade. Companies with good growth stories generally had ready access to capital.
There is a recent case that illustrates this point and counterpoint, the initial stock offering of PetroChina in 2000. China PetroChemical, the parent company, with advice from Goldman Sachs and McKinsey, restructured part of its operations as a new company to make it attractive to investors in the U.S. The offering was to raise $7-10 billion. However, an organized effort by labor, environmental and human rights groups led an active boycott of the stock offering. The result was that the offering raised less than $2.9 billion and two similar offerings were completely canceled. Market allocation of capital, yes, but caused by shareholder activism.
This
again assumes a capital constrained market, which has not been the case. Instead,
there are other consequences. Who is the real beneficiary of even small increases
in the stock price? Management with its stock options! As recent corporate
accounting and governance scandals are showing, stock options drive short
term considerations, not sound business models and ethical business practices
Shareholder Responsibility
The original role of shareholders was as owners, not stock traders. As owners the shareholders were stewards, overseeing the businesses and their managements. The financial returns were long term, determined by the performance of the businesses over time.
Today’s shareholders are often traders. Foundations may protest this, saying that with endowments they are by definition long term investors. However, investment decisions are delegated to managers whose compensation is driven by the dollar value of assets under management, i.e., by current stock prices. These managers are evaluated on the basis of investment returns, i.e., stock prices. Not surprisingly they have no concept of corporate ownership or stewardship, only buy and sell recommendations.
And yet Foundations’ proxy voting decisions are often delegated to these same managers or to voting services. Some foundations will say that they have proxy voting guidelines in place. However, these are typically limited to items such as "golden parachutes" and "poison pills". Other issues are voted in line with managements’ recommendations or are abstained. Voting is mechanical, not thoughtful. It is done from a checklist, not from consideration of merits or objectives, much less programmatic values.
There are easy arguments for not bothering to vote proxies -- and easy responses.
This confuses stock prices with businesses practices and conduct. Investment managers can be held accountable for the stocks they pick. Corporations and managements should be held accountable for operating performance and conduct, not stock prices.
Some are complicated, but many are matters of fairness, accountability, and transparency. Many shareholder initiatives on proxies are easily evaluated in the context of foundations’ missions, programmatic policies and objectives. Also, there are many research sources to help foundations evaluate proxy proposals initiated by shareholders and by management.
Actually, those votes can make more of a difference than buying or selling a few shares of stock. Trading shares is part of an anonymous, continuous market whereas proxy voting is an organized, annual event. The issues are on the table, the vote results are known and the companies’ responses can be discussed and scrutinized.
Proxy votes can send more of a signal, lead to greater change, than a few trades in the stock. Shareholder activism can have a broader impact than the invisible hand of the market -- because shareholder activism is not invisible.
The religious community has long recognized this. ICCR, the Interfaith Center on Corporate Responsibility, views proxy initiatives as a tool for getting managements to engage in dialogues about social and environmental issues. Recent examples include: Kimberly-Clark on medical products containing PVCs, which can produce dioxins when disposed of; J.C. Penny on thermometers containing mercury, which has become a municipal dump pollutant; Citigroup on predatory lending, and Home Depot on employment policies. Its success in business reforms has far exceeded the votes received on the proxy initiatives sponsored by its members.
The public and labor pension funds are more recent “converts” to the power of the proxy. They were the leaders this past year on issues such as director independence and auditor conflicts, filing resolutions with 30 companies about auditor conflicts before the Enron disclosures. Early returns from this proxy voting season indicate that corporate governance proposals received on average 35% shareholder approval. The results may not be binding, but publicizing them does raise awareness and get the attention of corporate managements.
Foundations are major investors in corporate America. We need to recognize and exercise the responsibilities of ownership. We can vote our values with our investment dollars, but the real leverage for change is an asset that most foundations ignore the proxy vote. It is an asset, a right and a fiduciary obligation to vote the proxies we hold in accordance with our foundations’ values. This power of the proxy will coordinate and integrate all of the resources of our foundations' intellectual, financial and programmatic -- to more effectively and strategically advance our missions.
