Stewardship and Governance Principles Gain Broad Backing

Institutional investors have historically made their collective voices heard through organizations such as the Council of Institutional Investors and International Corporate Governance Network. Now the Investor Stewardship Group (ISG) is amplifying a set of governance principles on behalf more than 60 U.S. and international institutions - among them BlackRock, California State Teachers' Retirement System (CalSTRS), TIAA and Vanguard - with a combined $31 trillion of assets in U.S. equity markets.

Officially launched in January 2018, and stressing communication between its constituents and corporate issuers, ISG describes itself as “a sustained initiative to establish a framework of basic investment stewardship and corporate governance standards for U.S. institutional investor and boardroom conduct. The result is . . . a set of stewardship principles for institutional investors and corporate governance principles for U.S.-listed companies.”

“A couple of years ago, several of us - the core founders of ISG - felt that at times in the U.S., companies were unwilling to meet with groups of shareholders” to answer questions and address concerns about corporate governance activities - that is, “about managing all risk and being accountable,” says Aeisha Mastagni, portfolio manager, sustainable investment and stewardship strategies, CalSTRS.

One of ISG's co-founders, Mastagni has publicly expressed concern on behalf of CalSTRS about the growing number of companies with dual-class share structures that give unequal voting rights to some owners, typically founders. Google, Facebook and Lyft have taken this approach.

Mastagni has also represented CalSTRS in discussions of corporations' executive compensation and sustainability practices. Other issues commonly raised by institutional investors relate to climate change, over-emphasis on short-term results versus long-term profitability, board and executive-suite diversity, and board members' independence.

“If we were asking [companies] for basic governance reform, we would often get comments like, 'You are the only ones asking for that,' or, 'You are the only ones who want that particular provision,'” Mastagni explains. That led a group of institutional investors - 16 to start - to decide to band together to push for improved corporate responsiveness.

ISG has produced a Stewardship Framework for Institutional Investors and Corporate Governance Framework for U.S.-Listed Companies. The ISG supporters are listed as either signatories (for example, Elliott Management, Goldman Sachs Asset Management, J.P. Morgan Asset Management, T. Rowe Price) or endorsers (Aberdeen, Hermes Investment Management, Investec, Schroders).

Principles-Based Flexibility

According to an overview by corporate governance consulting firm Georgeson, posted in May 2018 for the Harvard Law School Forum on Corporate Governance and Financial Regulation, the ISG framework is “an unprecedented attempt to establish a set of elementary corporate governance principles for U.S.-listed companies as well as parallel stewardship principles for U.S. institutional investors.”

The paper noted that U.S. corporate governance practices “have historically been informed by multiple regulatory and rules-based regimes,” including Securities and Exchange Commission regulations, stock exchange listing requirements and state laws.

The ISG principles, by contrast, “are based substantially on U.K., Continental European and other non-U.S. frameworks that establish principles-based corporate governance standards and tend to rely on 'comply-or-explain' accountability,” Georgeson said. “Advocates for this type of principles-based approach stress the flexibility that it gives for companies to adopt a tailored response to important tenets such as boardroom transparency, as opposed to responding more narrowly to prescriptive rules.

“As institutional investors continue to focus more attention on environmental and social matters, including related governance concerns, the framework's principles-based approach will be a tool, for both institutions and companies, to promote mutually agreeable objectives, particularly given the lack of rulemaking or legislation mandating more specific disclosure on trending topics such as board diversity and environmental concerns.”

Shareholders and Other Stakeholders

One corporate governance expert, who requested anonymity, sees ISG in a different light: “as a group of investors, not a formal organization,” who came together with a variety of motivations.

“Some have gotten involved for marketing purposes, others to minimize the power of other institutional investor groups, some to bang the drum for their clients' concerns, and others because they want to change the world,” this observer said. “Ultimately, they will have to deal with the question of whether a corporation's business is solely to make a profit for its shareholders or whether or not corporations are in business to do far more, like addressing societal problems.”

That question of “purpose” became mainstream news in August when the Business Roundtable issued a new Statement on the Purpose of a Corporation. It was “signed by 181 CEOs who commit to lead their companies for the benefit of all stakeholders - customers, employees, suppliers, communities and shareholders” - and therefore not shareholders alone, the Roundtable said.

“These modernized principles reflect the business community's unwavering commitment to continue to push for an economy that serves all Americans,” said Jamie Dimon, chairman and CEO of JPMorgan Chase & Co. and chairman of the Business Roundtable.

The Council of Institutional Investors criticized the Roundtable statement, saying that it “undercuts notions of managerial accountability to shareholders” and has the effect of “placing shareholders last, and referencing shareholders simply as providers of capital rather than as owners.”

Linking Purpose and Profit

When asked about the Roundtable announcement, Mastagni of CalSTRS and ISG said she believes that “companies have to take into account all of their stakeholders in order to succeed and be a long-term performer in the marketplace.”

In January, Larry Fink, chairman of ISG signatory BlackRock, wrote in Purpose and Profit, his annual letter to CEOs, that society is increasingly looking to companies, both public and private, to address pressing social and economic issues, and this means serving the needs of stakeholders, broadly defined.

“Profits are in no way inconsistent with purpose - in fact, profits and purpose are inextricably linked,” Fink wrote. “Profits are essential if a company is to effectively serve all of its stakeholders over time . . . Companies that fulfill their purpose and responsibilities to stakeholders reap the rewards over the long term. Companies that ignore them stumble and fall.”

Quoted on a Business Roundtable “welcoming the debate” web page, Martin Lipton, founding partner of Wachtell, Lipton, Rosen & Katz - and keynote speaker at the inaugural ISG/Corporate Issuers Conference on September 13 - defended the stakeholder statement:

“The BRT did not dismiss shareholders as 'simply' providers of capital. To the contrary, the BRT principles recognize the fundamental importance of shareholders to the company and commit the company to transparency and engagement with its shareholders to obtain their views of the company's strategy, operations, and prospects.”

Lipton added that corporate boards' “ability to consider other stakeholder interests is not only uncontroversial - it is a matter of basic common sense and a fundamental component of both risk management and strategic planning.”

“Constructive Dialogue”

ISG outlines six principles for U.S.-listed companies' corporate governance, including an emphasis on boards' independence, on their accountability and responsiveness to shareholders, and that shareholders' voting rights be “in proportion to their economic interest.”

Says Mastagni, “It is important for the business community to understand that there is a huge collective body - the ISG - that agrees on these standards, and that without them, it is hard for a corporate governance structure to work properly.”

Donna Anderson, vice president and head of global corporate governance at T. Rowe Price, said in a December 2018 ISG press release, “At a time when some corporate interest groups are questioning the value of shareholder engagement and advocating ways to diminish the voice of investors, the members of ISG strongly support the principles upon which ISG was founded: a long-term investment orientation with constructive dialogue between corporations and their investors, responsible stewardship by investors, and support for the basic standards of good corporate governance.”

“We were thrilled,” Mastagni added, “when the first companies - Prudential Financial, State Street Corp. and Regions Financial Corp. - chose to disclose this information and set great examples for all companies to consider.”

Committee Structure

As for its own governance, ISG is managed in collaborative fashion - there is no president or chairman - by three committees: a steering committee, chaired by Matthew DiGuiseppe, vice president and head of Americas on the asset stewardship team, State Street Global Advisors; governance committee, headed by Anderson of T. Rowe Price; and marketing and communications committee, led by CalSTRS' Mastagni.

Mastagni, who sits on all three committees, says that ISG communicates with members through regular conference calls, and many will convene at the September 13 conference on the University of Delaware campus, co-hosted by the John L. Weinberg Center for Corporate Governance, which has a partnership relationship with the ISG. Weinberg Center director and corporate governance authority Charles Elson and Wall Street lawyer Martin Lipton will have a “fireside chat.”

Lipton will be discussing his strategy for effective corporate governance, which he calls “The New Paradigm,” as laid out in 2016 for the International Business Council of the World Economic Forum and revisited in an August 2018 Harvard Law School Forum posting and a February 2019 follow-up.

Lipton supports stakeholder, as opposed to shareholder, primacy, and contends that managing corporations in the public interest will diminish short-termism along with attacks by activist hedge funds on the long-term goals of companies. In the 2019 paper, corporate governance is conceived as a voluntary, private-sector collaboration among corporations, shareholders, and other stakeholders to achieve sustainable long-term value and resist short-termism.

“The New Paradigm” does not favor corporate-governance legislation, thus rejecting proposals like Senator Elizabeth Warren's Accountable Capitalism Act, which would require that for corporations with $1 billion or more in annual revenue, at least 40% of the directors be elected by employees.

Collaboration on Governance and Risk

“The New Paradigm” principles fall into “three buckets”:

- Governance is about the relationship between a company and its shareholders and between company management and the board of directors. Through good governance and candid relationships with shareholders, companies “will be in a position to demonstrate that they have engaged, thoughtful boards overseeing reasonable, long-term business strategies.”

- Engagement is exchange of information - dialogue - between a company and its shareholders, rather than dictates from either side. “Companies commit to being responsive to the issues and concerns of shareholders, while shareholders will proactively communicate their preferences and expectations.”

- Stewardship, the relationship between shareholders and a company, “reflects a commitment on the part of asset managers and investors to be accountable to the beneficial owners whose money they invest, and to use their power as shareholders to foster sustainable, long-term value creation.”

“The New Paradigm” assigns to boards and senior managements joint responsibility to determine a reasonable risk appetite, oversee implementation of standards for managing risk and foster a culture of risk-aware decision-making.

“In fulfilling its risk management function, the board's role is one of informed oversight rather than direct management of risk,” according to Lipton's framework. “The board of directors should consider significant risks to the company, including technological disruption, cybersecurity and reputational risks. The board should not be reflexively risk-averse; the board should seek appropriate calibration of risk to benefit the long-term interests of the company.”

Katherine Heires is a freelance business and technology journalist and founder of MediaKat llc.