Making the Grade in Sound Investing
First Quarter 2013
Corporate Board Member
by Deborah Scally
CalSTRS is the largest teachers’ pension fund in the United States, providing for the retirement needs of California’s K-12 and community college teachers with roughly 856,000 beneficiaries currently, both active and retired. Since 2008, Anne Sheehan has served as the director of corporate governance within the investment office, which is responsible for overseeing the $155 billion of assets under management. We recently interviewed Sheehan to discuss the major issues critical to CalSTRS in 2013 and her role in helping to achieve those goals.
So let’s begin by giving an overview on CalSTRS’ mission.
As you can appreciate, we are invested for the long term because we’re going to be paying teachers’ pensions for a lot of years to come here in California. We are vested all across the markets: the private markets, the public markets, fixed income, public equity, private equity, and real estate. We have a new hedge fund program, a commodities infrastructure, and we are on a global benchmark.We are invested across the globe, not just in the United States, although on the public equities side and with fixed income, we still have a tilt toward the United States. At last count, we were invested in 48 markets across the world. We use the corporate governance program to manage risk within the portfolio and to make sure our companies are acting in the long-term interests of our beneficiaries, and we use engagement with them to carry out our corporate governance responsibilities.
Here in my shop, we vote the proxies and also manage about $3 billion placed with activist managers whom we team up with and partner with on governance activities.
What are the top-of-mind corporate governance issues that CalSTRS will be spending its time and energy on this year?
Obviously, all of us here in the investment office, like everyone around the country, are watching what is going to happen with the fiscal cliff because the markets are fearful of uncertainty, as you know. Some companies made the decision to move up the payment of dividends or other types of compensation that they’ve made in this calendar year versus next, so they’re all waiting to see what happens on the tax rates.
But from a corporate governance perspective, we really have three to four major priorities, one of which is majority voting. A majority vote standard in uncontested elections for corporate boards is really the right governance standard to have, in that the directors should get the majority support of their shareholders in order to stay in the boardroom. We think that majority vote should be done every year, which means we don’t like classified boards; we think this is a standard that companies should adopt. Right now, almost four-fifths of the Fortune 500 and S&P 500 have a majority vote standard. Many of our colleagues at other funds are trying to push those remaining large-cap companies to a majority vote standard. We at CalSTRS have focused on mid-cap companies over the last couple of years, and last year we wrote to about 85 companies asking them to adopt a majority vote standard. Out of those, 81 actually adopted. This year we are writing to 100 companies encouraging them to adopt this [standard].
How do you approach them in that communication?
We’ll write them and lay out why we think majority vote is good, why we think they should adopt it, and that we would be happy to file a shareholder proposal if they don’t see the wisdom of adopting this on their own. For many, we reach resolution, and sometimes they say it’s already been discussed in the boardroom because many of their other shareholders are asking for the same thing. Sometimes we have filed resolutions [already] if we’re up against a deadline for their annual meeting, but if they agree to adopt it, we’ll withdraw the resolution, which we view as a victory.
What is the typical resistance that you hear from companies on this issue?
Well, often the resistance is, “Our directors get overwhelming support now, so we don’t think a majority vote would make a difference.” Sometimes, though, we have agreed to postpone the resolution, if they’re in a proxy fight or something [of that nature], so we’ll agree to introduce it next year.
In essence, generally if they’ve gone through their discussions, there is no real substantive reason why they shouldn’t [adopt it], and they recognize that. Sometimes it’s just their legacy rules that they’ve had under a plurality standard. They’ve had plurality voting and it’s worked, and they say, “We always get the support anyway.” We just continue to chip away at those companies.
What other areas are you focusing on in 2013?
The other issue that we continue to focus on here is greater diversity on corporate boards, an issue CalSTRS has long been devoted to. Being a teacher fund, we have a diverse beneficiary member base, and California is a very diverse state. And while we’re not exclusively invested here, we do acknowledge the benefits of diversity in our state, and we have seen, through academic studies, the benefits of diversity on corporate boards. So we continue to push that front. We also collaborate with others in educating public company board members about the benefits of diversity and how to get more diversity into their boardrooms.
Definitely increasing women in the boardroom is a big focus. Women have about 17% of the S&P 500 board seats now. But we haven’t really moved the needle much—hence the need for events like the one that Corporate Board Member held at the New York Stock Exchange last summer to try to educate people on this.
Credit Suisse did a study this summer that talked about the economic benefits of having greater board diversity and how those companies [with at least one woman on the board] performed better than those [without gender diversity]. We also watch what’s going on overseas with regard to quotas, and while I don’t think that’s going to happen in this country, it is a consistent drumbeat. So we file shareholder resolutions at companies that have no diversity asking them to amend their charter or bylaws of their nominating committee to include diversity as one of their criteria as they go search for new board members. So that continues to be an issue for us.
One thing we learned out of the financial crisis is the impact of groupthink, so trying to get different types of thinking in the boardroom is important, because men and women look at things differently; they operate differently; they function differently—and the same holds for ethnic diversity within the boardroom.
Anything else on CALSTRS’ front burner?
We file a number of resolutions and also engage with companies on sustainability reports—issues that really are key and to their performance—trying to make sure that investors get that information from the company. So we will file resolutions asking companies about how they are handling water resource issues if they’re a [heavy] water user, or about energy efficiency if they use a lot of energy in manufacturing, processing, for instance, because those are costs that land on the bottom line, eventually. So sustainability continues to be an issue for us regarding more transparency in reporting and how [companies] manage these resources.
One issue that hasn’t gone away is executive compensation. How does CalSTRS view the progress with transparency made in this arena?
The advent of say on pay a couple years ago sort of thrust companies, issuers, and shareholders into a dialogue on compensation, which continues to be a priority of ours. We issued executive comp guidelines about three years ago as to what we’d like to see in comp packages. We have always “voted” on pay, but instead of voting on say on pay, we used to withhold on comp committee members as a way to communicate our position. So the say-on-pay vote really just formalized our mechanism for expressing our views on compensation packages.
In addition, say on pay has led to more engagement. After the first year we issued a report that is on our website, “Lessons Learned: The Inaugural Year of Say-on-Pay,” which shows we voted against about 23% of the pay packages the first year of all of our voting; [in 2012] it was about 18%. We really try to prioritize and focus on what we call the worst offenders—you know, the ones who don’t really have pay-for-performance alignment in their compensation package. We also want to make sure that the compensation package is structured for the long run, because we’re inherently long-term investors. As we tell companies, we’re going to be in their companies as long as there are teachers who have a retirement we need to pay. So we want comp structures that are focused on the long term, and have longer-term performance metrics that really align pay with performance.
When you have a company that tries to justify higher compensation plans by saying, “We need the higher-priced talent to manage us out of our current situation,” how do you respond to that? There can’t be a one-size-fits-all solution, and you have thousands of companies you are looking at.
I guess a couple of ways I’d respond to that is to say we are all for good pay for good work. We are not for excessive pay for average work. And it’s that balance and alignment that we need. If they want to pay someone with performance stock units so that they get paid if they’re there for the long run and perform well, then that is a consideration. It can sometimes be too easy [for a company] to make adjustments and make the numbers in one year, but we want to see sustained performance in a compensation structure, not just one-year metrics.
So speaking a bit more broadly about the pressure to satisfy investors today, can you comment on how a board ought to respond to the pressure of making quarterly earnings numbers even though you and many institutional investors philosophically stand for long-term performance?
Well, those quarterly earnings reports are sort of road signs along the way on a long journey. We are seeing fewer companies giving guidance than we used to, which helps to not set up those types of [short-term] expectations. And we remind them that, since we are heavily indexed, we don’t trade on day-to-day news like many of the day traders. We’re in this for the long-term. If you look at some of the statistics, 50% of the holdings in most of the big companies are institutional investors like us who are going to be in for a long time. And I think one thing we learned out of the financial crisis is that managing for the short term doesn’t get us very far. It skews the incentives and skews the risk. So, we remind companies they need to manage for the long term, and with sustainability. As I said, I need the money there to pay the pension of the teacher in 50 or 75 years—the teacher who’s just being born now.
Tell us a little bit about how you engage with companies. Do you ask for a direct meeting with the board? Do you ever get turned down? Are board members ever uncomfortable with those situations?
We use various levels of engagement depending on what the issue is. Sometimes it’s fine to speak to the corporate secretary or investor relations person about an issue to help us understand why [their company is] doing something.[But other times] a company [may be] taking an action that we find very objectionable, such as when Disney recombined its chair/CEO position after quite a lot of hoopla a number of years ago when they said they would consult with shareholders beforehand (after separating the position when George Mitchell was chair during all the publicized issues with CEO Michael Eisner). Then this last year, they recombined it in Bob Iger’s employment contract. And their view of “discussing it” with shareholders was telling them after they did it! That was not exactly what most shareholders had in mind. So in a situation like that, we’ll write to the companies or sit down with them, and yes, there are times you do need to talk to the directors. It’s going to be helpful to talk to the corporate secretary, or someone in investor relations, but there are certain issues where you’ve got to talk to the directors.
Compensation is a perfect example of where we have a real issue. Sometimes, for example, it’s hard to talk to the head of HR, because he or she is trying to defend the boss’s pay or the action that the board took. So, it’s helpful to talk to the comp committee chair or the members who put that structure together and approved that package for that company and ask why they did it. In those cases, we think board members should make themselves available to shareholders—not every day, not all of the time, because we’re all very busy. But I think there are instances where it’s important for them to talk to their shareholders.
It seems shareholder/director engagement has become a much bigger issue in the last few years, even though the level of transparency in disclosures has never been as high as it is today.
Yes. But meeting with directors in person is very helpful. And what I have learned over the years is, as I talk to various board members and develop relationships, they can become touchstones for me on issues. I have a couple of friends who chair audit committees, and so when an issue comes up, I can get insight about it. We should be able to have a dialogue with the board when necessary. There are still some companies that will not make their board members available to shareholders unless it’s at the annual meeting when you have to take a number and get in line. I just don’t think that is appropriate.