We're
Owners, Not Traders
Foundation
News and Commentary
September/October 2002
by
Lance Lindblom
Commentary: As major investors in America, foundations need to swing their
social weight. The proxy vote is an effective and often-overlooked means of
doing that.
In "Horse Manure and Grantmaking" (FN&C May/June 2002), Jed Emerson advocates focusing on the programmatic impact of the 95 percent endowment corpus of a foundation, not just the 5 percent grants budget. The endowment, he reckons, produces more impact in "manag[ing] the total assets of the foundation in order to maximize its value as a resource."
That's right, but Emerson misses an important asset that comes with the 95 percent: the shareholder proxy vote.
The real leverage for change is found in neither socially responsible investing nor seeking a "blended value" of philanthropic and financial investments. Rather, it lies in acting like responsible shareholders‹like owners instead of stock traders. Utilizing the shareholder proxy and related public awareness will bring about sustainable change and thus further foundation values, missions and goals.
The religious community has understood this for some time; public pension funds, too, are beginning to understand and exercise the "ownership" power.
But foundations don't seem to realize that they, too, have an opportunity and fiduciary responsibility as major shareholders.
Unintended Consequences
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 really pay off? And what do we mean by pay off‹better investment returns or a blended return of financial and social benefits? Investing on social principles probably does work, at least at the margins, under either of those definitions. But the various arguments for it are contradictory, and the touted returns range from unproven to theoretical.
More important, by narrowing the arguments to financial calculations, its advocates are missing the bigger picture‹which is not "proper" financial incentives and rewards, but ethics and accountability. Financial incentives alone have backfired. The leveraged buyouts of the 1980s were meant to unlock the inherent values of corporations that comfortable managements were sitting on. The large stock-option packages of the 1990s were meant to align managements' interests with those of shareholders.
We are now seeing the shortsightedness, as well as unintended consequences, of such strategies. Management interests became aligned with one group of shareholders‹the active, short-term traders. But those get-rich-quick interests conflicted directly with the interests of the vast majority of investor wealth, that is, the money held in long-term pension funds and endowments. Those interests were also often wrong‹sometimes even criminal‹as evident in the unfolding corporate-governance and accounting scandals.
Examining
The Arguments
Socially responsible investing (SRI) screens potential investments for both
negative and positive practices. The basic assumption: management behavior
impacts financial performance, which determines stock prices and investment
performance. Everything can be directly reduced to rate of return. Proponents
of SRI get to this in various ways, but each argument has shortcomings. Let's
look at some of them:
Proponents point to studies to show that SRI investing can result in equal or better investment returns. Some relatively short-term, non-definitive studies cover a market period that rewarded investing in "clean" industries, not necessarily because they were environmentally better or more profitable but because they were seen as growth sectors of the "new economy." We will not be able to assess the performance of the funds that have been SRI pioneers until they have been through more than one full economic and investment cycle.
One investment theory contends that SRI identifies the companies that will be the most profitable in the future. Those stocks are therefore undervalued and good buys now. The incredibly shortsighted U.S. stock market doesn't care about financial performance more than a quarter or two out. In the recent years of irrational exuberance, stock prices were driven mostly by short-term revenue growth rather than long-term profitability. Now the focus is on financial stability, not the expectation of future profitability.
Another theory says that allocating capital through such screens as social responsibility will impact management behavior. Management will adjust its business model to acquire the capital needed for expansion. The argument assumes a capital-constrained market, which was not the case for the last decade. Companies with good growth stories generally had ready access to capital. In the currently volatile stock market, however, socially responsible companies have no better access than others.
A recent case‹the initial stock offering of PetroChina in 2000‹illustrates this point and counterpoint. China PetroChemical sought to raise $710 billion. But the effort came up against a boycott by labor, environmental and human rights groups. As a result, less than $2.9 billion was raised, and two similar offerings were canceled. Market allocation of capital? Yes, but caused by shareholder activism.
A variation of the capital-allocation argument focuses on stock price. If positive investment screens generate additional buying interest in a stock, the contention runs, the stock price will rise. A higher price means a lower cost of capital. Managements will therefore court this market, modifying business behavior as needed. This theory again assumes a capital-constrained market, which has not been the case for the reasons mentioned above. Instead, other consequences intrude. Who is the real beneficiary of even small increases in the stock price? Management, with its stock options! As the recent corporate scandals have shown, stock options drive short-term considerations, not sound business models and ethical business practices.
Shareholder
Responsibility
Ownership, not stock trading, was the original role of shareholders. As owners,
they were stewards, overseeing the businesses and their managements. The financial
returns were long term, determined by the performance of a business over time.
Today's shareholders are often traders. Foundations may disagree, claiming that their endowments make them by definition long-term investors. In fact, 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.
Yet foundations often delegate proxy-voting decisions to those same managers or to voting services. Although some foundations will reply that they have proxy-voting guidelines in place, the guidelines are typically limited to items such as "golden parachutes" and "poison pills." Votes on other issues follow management recommendations, or voters often simply check the "abstain" box on the proxy. Voting is mechanical instead of thoughtful. It is done from a checklist, not from consideration of merits or objectives, much less programmatic values.
Proxy
Voting
There are several easy arguments for not bothering to vote proxies. Each has
an equally easy response:
The investment managers bought the stock because they like management, so we should support management. This confuses stock prices with businesses practices and conduct. Investment managers can be held accountable for the stocks they pick, but corporations and their managements should be held accountable for operating performance and conduct, not stock prices.
The issues are too complicated. Some are complicated, but lots of others involve simply fairness, accountability and transparency. Many shareholder initiatives on proxies are easily evaluated in the context of a foundation's mission, programmatic policies and objectives. In addition, foundations have access to numerous research resources that can help evaluate proxy proposals that shareholders and management initiate.
A few votes won't make a difference. 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 mechanism, 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, and 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 far from invisible.
The
ICCR Example
The Interfaith Center on Corporate Responsibility (ICCR), 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 after disposal; J.C. Penney on
thermometers containing mercury, which has become a municipal dump pollutant;
Citigroup on predatory lending; and Home Depot on employment policies. ICCR's
success in business reforms has far exceeded the votes received on the proxy
initiatives sponsored by its members.
Public and labor pension funds are more recent converts to the power of the proxy. They were the leaders this past year on such issues as director independence and auditor conflicts; indeed, before the Enron disclosures made headlines, the funds filed resolutions with 30 companies about such conflicts. Early returns from this proxy-voting season indicate that corporate-governance proposals received on average a 35 percent shareholder approval. Even if the results are not binding, publicizing them raises awareness and gets 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 a right and a fiduciary obligation to vote the proxies we hold in accordance with our foundations' values.
The power of the proxy can coordinate and integrate the intellectual, financial and programmatic resources of our foundations to advance our missions more effectively and strategically.
Lance Lindblom is president and chief executive officer of the Nathan Cummings Foundation, which is located in New York City. The foundation's program areas are Arts and Culture, Health, Environment, Jewish Life and Values, and Interprogram Initiatives for Social and Economic Justice.
