STUMP » Articles » Public Pension Assets: It's Not Your Money to Play With, Pension Trustees » 2 August 2017, 19:09

Where Stu & MP spout off about everything.

Public Pension Assets: It's Not Your Money to Play With, Pension Trustees  


2 August 2017, 19:09

…and more importantly, the politicians who want to play with pension assets.


So here is somebody who advocates for ESG (that’s Environment/Social/Governance) investing, arguing that one should expect these social-justice-warring funds should actually not yield as much. At least in the short run.

Negative screening is a common application of Environmental/Social/Governance (ESG) investing. It avoids “sin stocks” and divests from industries or firms deemed immoral or having poor or undesirable standards along one of the three E, S or G dimensions. It’s promoted largely on the fact that it’s virtuous. While we may all define virtue differently, advocating for it in this way is fair and appropriate. However, employing these constraints is also often promoted as enhancing expected returns. That is, if you avoid certain companies, industries, and even countries, that are deemed non-virtuous, you should expect to make more money over time. Do good and make the same return or more! This is mostly wrong and, more the point here, actually at odds with the very point of ESG investing. Pursuing virtue should hurt expected returns.

Put simply, if two investors approach an asset manager, one who says “just maximize my return for the risk taken” and the other who says “do that but subject to the following constraints,” it is simply false and irresponsible for the asset manager to assert that the second investor should expect to do as well as the first, except in the case where those constraints are non-binding (and therefore not relevant). Even in that case, it’s still irresponsible to say that the second investor should expect to do better (again, if this is just a trade it’s a consistent view but the ESG negative screening program has zero to do with it as you’re doing what you’d do otherwise out of greed!).
What happens when one group of investors, call them the virtuous, simply won’t own a segment of the market (the sin stocks)? Well, in economist terms the market still has to “clear.” In English, everything still gets owned by someone. So, clearly the group without such qualms, call them the sinners, have to own more than they otherwise would of the sin stocks. How does a market get anyone, perhaps particularly a sinner, to own more of something? Well it pays them! In this case through a higher expected return on the segment in question. This may be unpleasant but it is just math (like math could ever be unpleasant). In the absence of extra expected return the sinners would own X of the market segment in question. The only way to get them to own X+Y is to pay them something more. Now, assuming nothing else changed, how does the market assign this sinful segment a higher expected return? Well by according it a lower price. That is, if the virtuous decide they won’t own something, the sinners then have to, and they have to be induced to through getting a higher expected return than otherwise. This in turn is achieved through a lower than otherwise price.
Put simply, if the virtuous are not raising the cost of capital to sinful projects, what are they doing? How are they actually affecting the world as they wish to? If the cost of capital isn’t also an expected return, what is it? This might be a painful reality to swallow for the virtuous. To get precisely what they want, which is less of the bad stuff occurring, they have to pay the sinful investors in the form of a higher expected return. Importantly, this isn’t an accidental byproduct of ESG investing. It’s the only way all this really matters one drop to the central issue – how much bad stuff happens. If the discount rate used by sinful companies isn’t higher as a result of constraints on holding sinful stocks than there was no impact. And, if the discount rate on sin is now higher, the sinful investors make more going forward than otherwise.

The author of this piece, Cliff Asness, seems to have an interesting history re: investment philosophy.

I don’t totally agree with him, though, re: the effect of all the screeners. While investors may expect higher returns from inherently riskier/unpalatable ventures, that doesn’t mean they’ll get them. Yes, they can bid down the stock price. But, of course, some of the “vice” companies can fail, and can be hit hard by changing regulatory conditions.

While I have nothing much to say re: social/environmental screeners, I think good governance screeners are pertinent, and I don’t mean by making sure you’ve got 50% women on the board. I mean what it says — good corporate governance, so that you don’t run the risk of a runaway CEO.

But here is the final paragraph:

Frankly, it sucks that the virtuous have to accept a lower expected return to do good, and perhaps sucks even more that they have to accept the sinful getting a higher one.16,17 Well, embrace the suck as without it there is no effect on the world, no good deed done at all. Perhaps this necessary sacrifice is why it’s called “virtue.”

Asness, I believe, is speaking to individual investors, and that they should not fool themselves that they’ll be doing well by doing good, at least in the short run.

Perhaps, sub rosa, he is warning fiduciaries that they will get lower returns from this divestment push…that they can’t cover up that they are deliberately going to get lower returns in order for some politicians and bureaucrats to feel good about themselves.

By playing with other people’s pension money.

This is one of the reasons I’m hesitant to encourage public pension trustees and asset managers to expand their vision beyond a fiduciary duty to the pension fund beneficiaries. Yes, maybe it would be nice if they thought about taxpayers, but once you let that in, they get to use the assets for so many more things, like their own idea of what is “moral” in terms of investments.

There are multiple ways that asset managers and pension trustees have “played” with the assets they are managing or overseeing on behalf of these beneficiaries. I’m not going to look at divestment today (that’s for tomorrow!), but I’m going to look at “activism” pursued by the trustees, specifically, shareholder activism.


Stockholder activism had been a thorn in the side for many CEOs (more on that in the section below this one), and with the new Congress and President, we see a new bill going through Congress to put a lide on some of this activity.

From June: NY State & City Comptrollers, State Treasurers:
Federal Bill Attempts to Silence Investors

A broad coalition of state fiduciaries today joined New York State Comptroller Thomas P. DiNapoli and New York City Comptroller Scott Stringer in issuing a “Joint Statement on Defending Fundamental Shareowner Rights” in strong support of the use of shareholder proposals as an essential tool in maintaining corporate transparency and accountability. The Statement is in response to provisions of the Financial CHOICE Act, legislation pending in the U.S. House of Representatives, which would effectively prohibit most investors from filing shareholder proposals.
Currently, the Securities and Exchange Commission permits investors holding $2,000 of company stock for at least one year to file a shareholder proposal. The Act would raise the bar for filing a proposal and require shareholders own 1% of company stock for three years before putting a proposal forward for a vote. If approved, for example, the Act would require an investor to own more than $2.6 billion in the stock of a top 10 U.S. company, more than $1.5 billion in the stock of a top 25 U.S. company, and more than $850 million in the stock of a top 50 U.S. company before being able to seek to bring a proposal to their fellow shareholders for a nonbinding vote.

Many current U.S. corporate governance practices and certain regulations reflect advancements over the last 10 to 20 years that were achieved through the shareholder proposal process. Comptrollers DiNapoli and Stringer have made use of shareholder proposals as a particularly effective tool for voicing concerns and improving corporate governance on numerous issues, including excessive executive compensation and corporate accountability and transparency.

Joint Statement on Defending Fundamental Shareowner Rights:

The robust shareholder proposal process, as currently structured and administered under SEC
Rule 14a-8, works well for investors, public companies and capital markets.

It is fair, efficient and effective:

- The rule permits shareowners who have owned $2,000 worth of company stock for at
least one year to file a proposal;

- A shareowner may refile a proposal only if it has received at least 3 percent of the vote on
its first submission, 6 percent on the second and 10 percent on the third; and

- The SEC has a well-earned reputation for fairness in overseeing an administrative process
that allows companies to exclude proposals from their proxy cards that do not meet the
procedural and/or substantive hurdles contained in Rule 14a-8.

Shareholder proposals provide an orderly means to mediate differences between a company’s
management, board of directors and shareowners. The proposals allow shareowners to signal
issues of concern in the interest of enhancing long-term company value and provide a
framework for the company to respond with information about its strategy, governance and
risk management approaches to the issues raised.
U.S. corporate governance must continue to evolve and advance. Filing shareholder proposals
is one particularly effective tool – provided to investors at the federal level – to voice concerns
and to propose reforms, in order to protect our long-term investments and encourage
sustainable, robust corporate practices at publicly-traded companies. On an ongoing basis,
shareholder proposals address current and emerging issues that have the potential to impact
our investments.

We believe that shareholder proposals are an essential tool to maintain corporate
transparency and accountability and that their administrative rules must be protected in their
current form.

Thomas P. DiNapoli
New York State Comptroller

Scott M. Stringer
New York City Comptroller

Kenneth Bertsch
Executive Director
Council of Institutional Investors

Betty T. Yee
California State Controller

John Chiang
California State Treasurer

Denise L. Nappier
Connecticut State Treasurer
Connecticut Retirement Plans and Trust Funds

Susana A. Mendoza
Illinois State Comptroller

Michael Frerichs
Illinois State Treasurer

Peter Franchot
Comptroller of Maryland

Nancy K. Kopp
Maryland State Treasurer

Deborah B. Goldberg
Massachusetts State Treasurer
& Receiver General

Tobias J. Read
Oregon State Treasurer

Joe Torsella
Pennsylvania Treasurer

Seth Magaziner
Rhode Island General Treasurer

Looking to propose a shareholder vote? It may get tougher

WASHINGTON — If you’re a shareholder in a major corporation, having your voice heard may soon become harder.

Tucked into a Republican bill to defang the Dodd-Frank financial rules is a provision to make it more difficult to bring proposals to a shareholder vote. It would mean fewer investors could force votes on issues important to them — from executive pay to political spending to gender discrimination.

The House is to vote on the legislation this week.

On its surface, the provision to weaken small-shareholder influence has nothing to do with the overall bill’s goal of reversing the stricter rules that took effect after the 2008 financial crisis. But Republicans have used the opportunity to embrace a plan favored by corporations to reduce the number and reach of shareholder proposals.

Critics warn that the restriction would diminish the ability of individuals, public pension funds and social investment funds to influence corporate behavior.

“It would have a chilling effect on small shareholders’ ability to effect change,” says John Roe, head of ISS Analytics at Institutional Shareholder Services, which advises investors on shareholder ballots.

Companies counter that the provision would lighten the nuisance costs they bear to keep unneeded proposals off shareholder ballots. Corporations routinely spend time and money to mount cases against such proposals to regulators and sometimes to fight them in court.
Under the shareholder provision, individuals or groups of investors who wish to put proposals to a vote would have to hold more of a company’s stock — and to have held it longer — than they now do. About one-third of proposals wouldn’t make the cut, Roe estimates.

Public companies hold a significant edge in the balance of power with shareholders — by, for example, controlling access to the annual proxy ballots that guide voting. In recent years, groups of shareholders have fought, with rising success, to get names of alternative candidates for board seats on ballots.

The swaggering billionaire investors who fight big companies, like Carl Icahn and Bill Ackman, can sometimes force strategic changes. But the new requirements would reduce the influence of individual investors, public pension funds and social investment funds that hold smaller portions of company stock.

Consider John Chevedden. A self-described activist investor with slim holdings in about 80 companies, Chevedden files more proposals, by far, than any individual, public pension or social investment fund: 858 from 2010 through 2017 so far. (The next-biggest was the New York State Common Retirement Fund, a pension fund, with 323.) Chevedden tends to focus on access to proxy ballots, votes for corporate directors and shareholder rights.

“I ask pointed questions,” he said by phone from his home office near Los Angeles. “I want to improve governance.”

Chevedden pushed successfully this year at Marathon Petroleum to adopt a simple majority vote for directors instead of a supermajority of 80 percent now required. Marathon had asked the Securities and Exchange Commission to keep the proposal off the proxy statement. But the SEC staff ruled against the company. The proposal drew 72 percent of the vote at Marathon’s April meeting.

Under the Republican legislation, shareholders would have to own at least 1 percent of a company’s stock for at least three years to put a proposal on the ballot. That compares with the current requirement of $2,000 worth of stock for one year.

At Apple’s current share price of $154, for example, you’d have to hold about $8 billion in stock — 52 million shares.

Such hurdles “would shut down shareholder proposals” even for many pension funds, said Amy Borrus of the Council of Institutional Investors, which represents pension funds and other big investors.

The CHOICE Act has passed the House, and as of today, has been sent to the Senate for review.

I have no idea if it will get anywhere in the Senate.


I want to be clear — I don’t think shareholder is necessarily a bad (or a good) thing. All sorts of “activist” shareholders have different goals, and those with the goals of improving the company performance…and know what they’re doing… can really help all the investors in that company.

When Activists Enter the Kitchen, the CFOs Feel the Heat

Investors cheered last month when Whole Foods Market Inc. named a chairwoman and five independent directors. After losing more than 40% since late 2013, shares rose 2.2%.

Charles Kantor was less impressed with a different change. The portfolio manager at Neuberger Berman Group LLC, was concerned that the finance chief the company named the same day, Keith Manbeck, lacked experience, as the company is being targeted by activist investor Jana Partners LLC. Neuberger Berman owned a 2.7% stake in the upscale grocery chain as of March 31, according to FactSet.

“He has a very steep learning curve,” said Mr. Kantor, who signed a letter last year calling for a new CFO with a background in real estate, cost-cutting and store economics.

When activist investors call for changes at a company or on its board, their campaigns often start at the top, with the CEO in the crosshairs. Public activist pressure played a prominent role in ousting the chief executives of three S&P 500 companies this year: insurer American International Group Inc., railroad CSX Corp. and aerospace-parts maker Arconic Inc.

But pressure is mounting on CFOs, too, as they are more often tasked with cutting waste, increasing efficiency and boosting margins.

The number of companies targeted publicly by either dedicated activists or those for whom it is a strategic focus rose 24.6% to 456 world-wide in 2016 from 366 from the previous year, according to Activist Insight.

His experience dealing with pressure from activists dates back to the mid-2000s while CFO at Warner Chilcott PLC, he said. Mr. Herendeen was two months into a new CFO role at Zoetis Inc. in 2014 when he learned Pershing Square Capital Management LP had a stake of more than 8% in the animal-health company and was agitating for board seats and expense reductions.

Mr. Herendeen helped lead a drive that included cutting Zoetis’s head count by more than 20% over about 24 months, refocusing research and development, and reducing the variety of packages and dosages it sold. The efforts are expected to save $300 million in annual costs in 2017, according to a company spokesman.
Demand for activist-seasoned CFOs is rising. “A lot of our more recent requests are that a candidate has had experience with an activist,” said Peter Crist, chairman of Crist|Kolder Associates, an executive recruiter. “We’ve had more CFOs say, ‘You know, so-and-so at ValueAct really likes me,’” he added, referring to ValueAct Capital Management LP.

The thing is that it can be very difficult to get rid of a CEO or other C-suite execs (unless the CEO and/or chair of the board want them gone.) Activist shareholders can help get rid of bad management.

But sometimes, they have goals other than improving company results for the long term.

CalSTRS, Shareowners Call for Changes in Netflix Board Policies

The California State Teachers’ Retirement System (CalSTRS) and other Netflix investors let their voices be heard at the entertainment company’s annual meeting Tuesday, voting against the companies wishes on several proposals.

The proposals in question were in favor of reforming Netflix’s corporate governance policies, including proxy access, annual director elections, and the elimination of supermajority, two-thirds voting requirements. Although Netflix’s board recommended voting against these proposals, shareowners put their proverbial feet down and the majority voted in support of these changes.

That sort of thing makes sense — it’s corporate governance, and the public pension fund managers do have a duty to be active in this way. I’ve seen insurance company CIOs (chief investment officers) do this, too.

Here is a another recent shareholder activism involving public pension funds: Pension Funds Oppose Mylan Board, Compensation Plan, Investors Call on Mylan Chairman, Director to Step Down, NY Comptrollers, CalSTRS Retaliate Against Mylan Board — again, there were some really iffy moves going on in this company, which could be seen as the board members enriching themselves at the expense of the greater shareholders.

But I’m skeptical that this is the only kind of activism that pension fund managers and trustees engage in.


This is from 2012, but it seems just as pertinent now: Union Pension Activism: In Whose Best Interests?

Union pension funds manage more retirement assets in the United States than public pensions—$3.5 trillion to $2.8 trillion.

Union pensions may be using the financial clout that comes with these assets to inappropriate ends, according to two researchers from Stanford’s Rock Center for Corporate Governance.

David Larcker and Brian Tayan’s recently published paper, “Union Activism: Do Union Pension Funds Act Solely in the Interest of Beneficiaries?” looks into shareholder activism by union retirement systems.

“Shareholder activism is an important mechanism for imposing market discipline on the decisions of corporate executives and directors, and union pension funds take an active role in this process,” the authors state. “Are union-sponsored proposals made solely in the interest of their pension beneficiaries? Or are they used to further social and political priorities that are important to union leadership?”

The study is here.

While it keeps saying “union pension funds”, they’re including public pension funds in here (!)

I will excerpt a little:

Recent history demonstrates the active role that CalPERS and other union pension funds take in the governance process. According to Proxy Monitor, union pension funds are the second most active sponsors of shareholder proposals, introducing 33 percent of shareholder proposals between 2006 and 2012. By comparison, individual investors sponsored 41 percent of proposals during this period, religious and socially responsible investment funds 25 percent, and other institutional investors (such as Fidelity and Vanguard) only 1 percent. Union-sponsored shareholder proposals are typically initiated using general funds accumulated through union dues and other sources rather than pension assets.

In a related analysis of proxy voting, a 2011 report by the Department of Labor Office of Inspector General finds that these standards are generally not being upheld. It cites numerous examples of proxy voting among pension funds where “the economic benefits… are not apparent and neither the investment managers nor fiduciaries could provide documented economic rationale for the proxy-voting decisions.” It concludes that, “it is questionable whether the fiduciary or investment manager making the proxy-voting decision complied with EBSA requirements to consider only the economic benefits to the plan when making proxy-voting decisions.” It recommends that the labor department have the authority to assess monetary penalties against fiduciaries for failing to comply with the proxy-voting requirements of ERISA.

In 2012, that was not about to happen. A lot of Inspector General reports have been ignored over time, and I assume this one was put in the circular file.

Another 2012 story: The Power of Pensions: Global Scheme Activism at CalPERS, Japan’s GPIF, Noway, Others

— Public pensions, with assets worth over US$4 trillion globally, have the power to exercise considerable influence over equity markets — an influence that can extend to shareholder activism, and can be at odds with other corporate owners.

This strong claim comes from a newly released academic paper that characterizes public pension funds as some of the world’s largest, most powerful institutional investors, commanding substantial ownership and influence over corporate governance and strategy.

The paper — titled “Global Pension Fund Activism: A Review of the Largest Government Pension Systems” by Siona Robin Listokin of George Mason University’s School of Public Policy, compares formal fund guidelines for socially responsible investing and ownership, along with shareholder actions such as proxy proposals, class action lawsuits, and communication with corporate management in North America, Western Europe and Asia.

According to Listokin’s research, state and local government pension funds in the United States, for example, own between 10% and 20% of the US equity market. By comparison, “as early as two decades ago, very few public funds were actively investing in foreign equity markets. As investment in and engagement with equity markets has increased, public pension plans, like other institutional investors, are in positions to wield considerable leverage over corporate managers,” the whitepaper asserts.
According to the paper, CalPERS — with assets totaling $207 billion and around 65.7% of the assets invested in global equities as of July 2010, is generally considered a leader in public pension fund engagement and activism. “A look at the fund’s investment policy can be confusing, however. The policy is aimed at maximizing long‐term investments to cover obligations efficiently and effectively, and the fund insists that corporate governance activisms help maximize investment return,” the paper says, noting that while CalPERS is a signatory to the Global Sullivan Principles — designed to increase the active participation of corporations in the advancement of human rights and social justice — the fund limits its corporate governance activities to those that will impact financial returns. Meanwhile, CalPERS does have exclusion lists, which generally involve investments in unstable countries which violate the fund’s human rights standards. The fund also takes an active engagement with companies that may violate human rights in dealings with Sudan.

Again, that was 2012. What’s going on with Calpers now?


It’s not just shareholder activism that makes me wary.

Back in June, I saw the @Calpers account tweeting a link to the following:

CalPERS California Initiative 2016

CalPERS California Initiative 2016
Creating Opportunities in
California’s Underserved Markets

What is this?

The CalPERS California Initiative

The California Initiative has committed over $1 billion to companies located in traditionally underserved markets, primarily, but not exclusively, located in California. The initiative has sought to discover and invest in opportunities that may have been bypassed or not reviewed by other sources of investment capital. The California Initiative’s primary objective is to generate attractive financial returns, meeting, or exceeding private equity benchmarks. As an ancillary benefit, the California Initiative was designed to focus investment in California’s underserved markets and invest in portfolio companies that:

• Have historically had limited access to institutional equity capital

• Employ workers who reside in economically disadvantaged areas

• Provide employment opportunities to women and minority entrepreneurs and managers

Okay, they mention the primary goal is to achieve returns similar to private equity … hmmmmm and the ancillary benefits are all this feel-good stuff. That’s not the business of the pension fund, really.

It’s not a long report — only 32 pages of pdf, and a lot of that is just filler to make it look pretty.

So I perused the data therein, and looked for info on the expected returns, how investments are selected, etc.

The objective of the California Initiative is to generate attractive financial returns. The performance of the California Initiative is reported regularly by CalPERS Private Equity and is reported annually with the presentation of this Initiative.
Since the inception of the California Initiative, CalPERS has invested approximately $1 billion in 539 companies.

Okay, let’s see what the summary tells us with regards to the results.

The California Initiative represents a significant capital investment in California’s economy with 55 percent of capital allocated to “California Companies”, defined as those headquartered in California, or with a plurality of employees or facilities in the state.

• The California Initiative has created and sustained jobs within California and the nation through continued economic uncertainty, supporting 176,559 workers at all companies since inception.

• Companies receiving investment through the California Initiative have provided quality jobs to employees, with benefit levels for health and retirement outpacing statewide and national levels.

• The California Initiative has invested in areas of the state that have historically not received institutional equity capital, with 20 percent of all dollars deployed in California allocated to companies located in these underserved markets.

• Economically disadvantaged communities benefit from the California Initiative and its portfolio companies. The California Initiative employs a significant number of economically disadvantaged persons, with 44 percent of GSIF portfolio company employees classified as low- to moderate-income.

• California Initiative portfolio companies have leadership that includes women and minorities at levels that outpace national and state and local levels.

Squiiiint. Do you see anything about the benefits to the pension fund in those summary findings?

It’s all about the benefits to the companies and people being invested in. NOT THE PENSION FUND PARTICIPANTS.

So, when I originally read the report, I tweeted:

This is not the pension fund’s job, dammit.

It’s to generate returns for the pensioners.

All the metrics in the report were about job growth, geography, and demographic groups.

Nothing about what these investments have actually gotten the pension funds.

But it said the results are reported with Calpers Private Equity. Let’s see what we can find there.

In the report, there were two private equity funds mentioned, plus a “Phase I”, which I can’t find at all — maybe that is just 9 funds among the many, but I can’t tell which ones they are.

California Community Venture Fund, whose results don’t look that great.

Golden State Investment Fund looks better, so that’s good.

They don’t make it easy for one to see how well the California Initiative actually fulfills its supposed primary role, do they?


These are the kinds of things that annoy me:

Investors want more women, minorities on corporate boards:

What do Amazon, Facebook, and Netflix have in common? Not a single person of color sits on their corporate boards.

For that reason alone, the Massachusetts pension fund refused this year to support the slate of board nominees recommended by each company.

When it comes to diversity in the boardroom, Treasurer Deb Goldberg, who also serves as chair of the state pension board, is taking a hard line. The state’s $66 billion pension fund is a shareholder in about 9,000 companies, and its new proxy voting guideline related to diversity means it voted against or withheld its vote in 69 percent of director elections this year. That’s up from 17 percent in 2012. Goldberg’s message to corporate America is simple: Massachusetts doesn’t tolerate a board whose makeup is less than 30 percent women and people of color. Diversity matters, and study after study shows that different viewpoints are good for the bottom line.

About 1,690 companies failed to meet the state’s new criteria on diversity, and many of them are household names: JP Morgan Chase, Hershey Co., Nordstrom, Under Armour, TripAdvisor, and Wal-Mart.

Most public companies have at least one woman or minority on their boards. But in 2017, tokenism is no longer acceptable.

Goldberg is building on what her predecessor, Steve Grossman, started in 2011. He called it “zero tolerance for zero diversity,” and Goldberg ratcheted it up a notch by setting specific requirements. Calling for 30 percent diversity on a board isn’t an arbitrary figure; that’s critical mass.

It used to be if you wanted to take a stand, you would unload your holdings. Goldberg doesn’t think that works anymore.

“These companies can sell stock to someone else. They don’t care if you have divested,” said Goldberg, adding that having a “voice is much more influential than walking away.”

I will admit, there is a veneer of research that bolsters their claims that great sex & ethnic/racial diversity increases board (and then company) performance. But only if you pick which research you want to believe.


Why Diverse Teams Are Smarter – from Harvard Business Review. Let’s see the results:

A 2015 McKinsey report on 366 public companies found that those in the top quartile for ethnic and racial diversity in management were 35% more likely to have financial returns above their industry mean, and those in the top quartile for gender diversity were 15% more likely to have returns above the industry mean.

Let’s check McKinsey’s 2015 report: Why Diversity Matters

In the United States, there is a linear relationship between racial and ethnic diversity and better financial performance: for every 10 percent increase in racial and ethnic diversity on the senior-executive team, earnings before interest and taxes (EBIT) rise 0.8 percent.

Racial and ethnic diversity has a stronger impact on financial performance in the United States than gender diversity, perhaps because earlier efforts to increase women’s representation in the top levels of business have already yielded positive results.

July 2013: Catalyst – Why Diversity Matters

Catalyst found that companies with the most women board directors, especially those with three or more women board directors, had better financial performance than those with the fewest women board directors.
In a study of more than 150 German firms over five years, researchers confirmed that boards need a critical mass of about 30 percent women to outperform (as measured by return on equity) all-male boards. This translates into a “magic number” of about three women, based on average board size.

Let’s follow that footnote!

Gender Diversity in the Boardroom and Firm Performance: What Exactly Constitutes a ‘Critical Mass’?

The under-representation of women on boards is a heavily discussed topic – not only in Germany. Based on critical mass theory and with the help of a hand-collected panel data set of 151 listed German firms for the years 2000-2005, we explore whether the link between gender diversity and firm performance follows a U-shape. Controlling for reversed causality, we find evidence for gender diversity to at first negatively affect firm performance and – only after a “critical mass” of about 30 percent women has been reached – to be associated with higher firm performance than completely male boards. Given our sample firms, the critical mass of 30 percent women translates into an absolute number of about three women on the board and hence supports recent studies on a corresponding “magic number” of women in the boardroom.

I do not find five years of performance all that indicative… because it’s not clear to me that data were cherry-picked ahead of time.

They do have a nice table in the paper, and they report the ones that show positive links, negative links, and no link whatsoever.

I will just use the researchers’ common phrase: more research is needed. Maybe they were on the up-and-up with the specific companies and the specific time frame used. This review of research also basically shows that if there is a correlation, it doesn’t seem to be particularly strong.


I don’t think requiring various sex & race bean-counting will necessarily hurt board performance, and it may be helpful to breaking up chummy insider dynamics (which tends to be bad for corporate governance), but it seems to me a lot of these asset managers are doing this for moral preening purposes.

I have no doubt they’re true believers, but I really doubt they’ve done much due diligence with respect to how strong the research is to back up the “critical mass = better results” argument they make. And in many cases, they don’t even make the “better results” argument.

As for pressured companies, maybe they’ll end up picking insider women and minorities to get the numbers right, without any real diversity added to the boards.

Because, you know — the correlation in past studies were based on time periods and companies that were not being forced by investors to get that “critical mass”. So that critical mass was achieved probably due to some qualities about the specific people you’re counting in your “positive” pile.

It’s the old cargo cult way — you see that the better-performing companies for a specific time period had specific qualities… and you mimic the bits that are most easily observed. You can observe how many women are on the board, thus – that must be the magic! Woo!

But it could be any number of other things going on, such as which sectors were doing well, who the specific women and/or ethnic minorities were (maybe this was during a push for more outside directors, and that was the key), the expertise of the board members, and all sorts of things. Heck, it could come from how few companies were involved in the study. Even for the ones with large numbers of coumpanies in the sample — was it weighted by market capitalization?

I’m just saying that these pension fund trustees need to do a bit of due diligence on this supposed magic sauce that will improve corporate performance. It may be true, and it may simply be cherry-picking.

I did a quick search for results — and one aspect that annoyed me were no links to their data. PUBLISH YOUR DAMN DATA WHEN YOU PUBLISH YOUR PAPER! Then one could backtest the hypothesis on prior study groupings, so there would be no particular suspicion that you were cherry-picking which country, which companies, and which time period.


I recently listened to an excellent audiobook called The Wisdom of Finance, which just came out this year. My Goodreads review is here.

Appealing to a wide variety of audiences — it makes core financial concepts comprehensible for non-finance people, and it connects finance people with a broader view from the humanities. Desai takes a denigrated subject, even by some of its own practitioners, and makes it more human (with all the bad and good that entails.) He uses examples from history, literature, art, poetry, movies, TV, and even song lyrics (She take my money when I’m in need…)

One of the core issues he deals with is the principal-agent problem, when one has to hire someone else (the agent) to represent your (the principal’s) interests. The problem arises because you can’t guarantee that the agent’s interests will align with yours.

In this case, pension fund beneficiaries have the pension fund trustees who are supposed to represent the beneficiaries’ interest… and who hire fund managers who are supposed to represent that interest….

Here is Desai explaining the problem:

Josh Barro: So wait, let’s walk through the principal-agent problem and the producers. So why – what’s the principle-agent problem?

Mihir Desai: So the underlying principal-agent problem in today’s society is we have shareholders who are separate from the managers. 120 years ago, most of us worked for ourselves or had the privilege of working for ourselves. Today, we have ownership in one place and management in another. That is the kind of central problem today because the managers don’t necessarily operate on behalf of the owners. That’s pretty well-embodied in the story of The Producers where Bialystok and Bloom basically raise 25,000% of what they need and then they try to create a movie – sorry, they try to create a play that will surely fail so they don’t have to repay their investors. Of course, it’s “Springtime for Hitler,” it becomes a great hit and they go to jail.

But that underlying problem of investors, in their case, these old ladies who they raised money from, it is the problem of investing in companies today which is how do you create incentives and how do you monitor managers so they do the right thing. I think that’s – I really believe that’s arguably the most important problem in capitalism today. That principal-agent problem and how we solve it.

He is specifically talking about shareholders and the CEO in that interview, but in the book, he does get into that there’s a problem of there being a chain of principal-agents, where one agent hires another.

In this case, the pension fund beneficiaries don’t really have a choice of agent — let’s say Calpers. I mean, they may vote for certain politicians who will hire/appoint Calpers folks. The unions may vote for some of the pension trustees – but it’s unlikely to be all the pension fund trustees. That’s the first layer.

The trustees hire asset managers (who may be people who are managing other people… turtles upon turtles…).

The asset managers may be voting the proxies, or raising shareholder proposals….

And the companies they have shares in have to have a board of directors… which hires the CEO (and vice-versa…)

You can see this entire chain, and for some of the players, there is something of an alignment of interests, but it’s not perfect. The beneficiaries don’t much care about return optimization — they just want their benefits.

The pension fund trustees may be politicians (who want higher office, better connections, a cushy lobbying job) or other people who may want to leverage this position for other things.

The asset managers, if they’re in house, may want a good bonus or job security; outside asset managers may want to optimize their fees.

Then there are the politicians in the governor’s seat or in the legislature who may want to play with the funds for their own ends.

But I will get to divestment tomorrow.

All along that chain, value can be lost due to people who are deliberately seeking other goals (and it can be lost due to randomness or incompetence as well). Someone wants to send some seed money to somebody who supported your campaign; a company that hires specific union workers; making sure a bit of the money is spread all around the state so that taxpayers may not grumble as much because taxes go up to cover pension losses….

….so you see why I want the trustees to focus only on managing the pension fund, and not all this other crap. Sure, it’s nice to think about all these other things, but you may be hurting the principals because you are seeking personal glory.

Related posts:

Priorities for Pension Funds: Climate Change or Solvency?

Setting the Stage for 2017: Questionable Pension Asset Management Practices

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