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Article Excerpt
Pension fund capitalism is a new, albeit evolving, stage of Anglo-American capital market development. It is marked by the ability of pension funds to aggregate the widely disbursed ownership of beneficiaries and therefore act as single entities with a unified voice. Pension funds within their investment portfolios are increasingly using this voice to engage companies. Such corporate engagement in its broadest definition is the use of one's ownership position to influence company management decision making. Corporate engagement brings together four distinct underlying currents: first, the increased use of passive index funds; second, the corporate governance movement; third, the growing impact of socially responsible investing; and, finally, the impact of new global standards. At its best corporate engagement offers a long-term view of value that both promotes higher corporate, social and environmental standards and adds share value, thus providing long-term benefits to future pension beneficiaries.
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This article interrogates pension funds' use of corporate engagement to challenge the corporate, social and environmental standards of the firms in which they invest. It seeks to understand the underlying drivers of this phenomenon in order to gain a deeper understanding of the potential impact of corporate engagement on firms' decision-making and long-term performance.
The influence of today's massive pension funds is being felt in every capital market in the world. The result is not the pension fund 'socialism' envisioned by Peter Drucker, but rather a reconfigured capitalism (Clark 2000; Monks 2001). Far from timidity (Drucker 1976), pension funds are using their influence to engage and, in some cases, aggressively challenge the management of corporations in which they invest. They do so in order to ensure long-term shareholder value for future beneficiaries. Corporate engagement of this kind reflects a power shift within the firm away from managers and toward shareholders and the pension funds who represent them.
The struggle for corporate control between owners and managers has a long history in the legal and economic literatures (Roe 1994). The rise of public corporations that dominated the 20th century meant a dispersal of ownership rights across large segments of the population. While the advent of public corporations spread the benefits of capitalism more broadly, owners surrendered control of firm-level decision making to a cadre of professional managers who administrated the firm on their behalf (Berle and Means 1933). Much academic work focuses on firm-level decision making, examining the components of the production function, the impact of location, sunk costs, and path dependence on such decisions. Within this framework, managers are assumed to be the dominant actors in the decision-making process with the owners' role reduced to that of capital providers awaiting the pay-off of managers' decisions.
But today's pension funds are shifting decision-making roles within the corporation. This article examines that power shift and the four central drivers that are the catalysts of pension fund corporate engagement. Pension funds re-aggregate previously dispersed shareholders with concentrations of ownership unseen since the great industrialists of the 19th century (Clark 2000; Davis and Steil 2001; Hawley and Williams 2000; Monks 2001). We assert that pension funds are using this concentration of shareholder power, and the resulting lowered transaction costs, to actively engage company management in order to raise firm-level standards of behaviour across a range of issues, including, accountability, transparency, and social and environmental standards. The term employed herein to describe this new phenomenon is corporate engagement and this article will describe its development in more detail.
We use qualitative methods to develop our argument. We combine an extensive literature review with in-depth interviews of both U.K. and U.S. pension fund trustees and managers as well as other knowledgeable industry players. Given the senior positions held by our interviewees we draw on the elite interviewing techniques developed by Gordon L. Clark (see Clark 1998 for an in-depth review of elite interviewing styles). These interviews are further augmented by extensive internal document reviews in order to develop a grounded theory of pension fund corporate engagement (for detailed description of grounded theory, see Strauss and Corbin 1998).
Corporate engagement in its broadest definition is the use of ownership position to influence company management's decision making. It brings together four distinct underlying currents in global pension fund investing. Each of the drivers of corporate engagement will be interrogated in this article. We examine pension funds' growing use of passive index funds. We find that passive indexing results in pension funds' inability to exit firms with which they are dissatisfied. This lock-in creates a tension between those money managers who advocate a hands off approach to investment decisions and those who want to see the market power of their retirement capital used in a more socially-motivated manner, one that shapes market outcomes. For this latter group of pension fund investors, the result of indexing is an increased awareness on their part of the standards, accountability and transparency of the firms in which they invest.
The fourth section of this article deals with the corporate governance movement that acts as the second driver of corporate engagement. This phenomenon, growing rapidly since the early 1980s, initially focused on issues of boards of directors' and the governance structures of the firm such as the role of independent directors', senior management compensation, and the use of poison pills. Today corporate governance tackles much broader areas of firm-level transparency and accountability.
The fifth section of the article looks at the growing impact of socially responsible investing (SRI) on pension fund corporate engagement with a focus on the social and environmental standards of firm-level behaviour. This driver developed both as a result of the newly introduced British SRI disclosure legislation and out of pension funds' concerns for the long-term share value of their investments. (1)
The sixth section of the article examines the role globalization of financial markets combined with the rise of international social, environmental and accounting standards are beginning to have on pension fund corporate engagement. This section asks whether such globalization of finance dictates the scope of action available to both nation-states and individual firms. Finally we find that the terminology of corporate engagement is ill-defined and would benefit from greater clarity of its goals and understanding of its experiences to date. Currently such corporate engagement can range from quiet discussions with management and the voting of proxies, to more contentious approaches such as mounting dissident shareholder resolution campaigns and public removal of firms and even whole countries from the pension fund investment portfolio (a recent and contentious CalPERS' decision).
While corporate engagement shares these approaches with socially responsible investors, a primary concern of the pension fund investor is the long-term share value of the company. (2) Therefore corporate engagement does not ask the firm to sacrifice long-term profitability but rather to raise its standards in order to reduce risk over time. It uses tools already available to owners within the corporate structure and represents a claim of the rights of owners to establish standards of firm behaviour. This article addresses both the drivers of corporate engagement and its targets in an effort to better understand corporate engagement and its potential to anchor capital in certain communities, civilize human resource practices within firms, and encourage compliance with labour and environmental standards domestically and internationally.
THE FIFTH STAGE OF CAPITALISM
While current financial markets continue to exist within a nexus of nation-state regulatory controls, they operate with global reach and global impact. In essence the financial system is in transition to a truly global market. While there appears to be tacit agreement among policymakers and the public more generally about the benefits of a global financial system, part of this understanding is predicated on a growing demand that international rules and standards of behaviour be established to serve a broader societal interest beyond simply those of financial elites (Stiglitz 2002). What differentiates these global demands from the national frameworks of the past is the inclusion of environmental and labour standards in addition to financial regulatory regimes. The impact of this transformation from a national to a supra-national configuration is a contested status for the proper arrangement of the financial system, simultaneously national and global in scope and scale.
Not only are we grappling with spatial change in financial markets, but we are also witnessing a change in the dominant actors within the system. We suggest this shift represents a new stage of capitalism, one in which institutional investors, more generally, and pension funds, more specifically, play the key role. Pension funds and other institutional investors aggregate shareholders' interests within a broadly dispersed capitalist system, thus reversing the Berle and Means (1933) pattern of widely held ownership with declining shareholder power. (3) In addition to their ability to re-aggregate ownership patterns and their growing assets, pension funds increase their leverage within the financial system through a newfound willingness to act as owners both individually and in coalition with others. As a result, pension funds lower the transaction costs of intervening in the market that previously prohibited such action by owners. The result is pension funds and other institutional investors beginning to use their position to exert control over the corporations they hold in their portfolios.
Robert Clark (1981) in his paper "The Four Stages of Capitalism" offers an interesting model to examine how capitalism has changed over time (see Figure 1 for our version of Clark's stages of capitalist change). Clark's four distinct phases of capitalism can be neatly traced through the last two hundred years of history. In the first stage the entrepreneur was the primary actor and the object of his activity was the private corporation. The second stage saw the professional business manager usurping the role of entrepreneur. The object of his attention was the publicly held corporation, ideas central to the Berle and Means analysis of the 1930s managerial economy.
[FIGURE 1 OMITTED]
The third stage of capitalism witnessed the ascendancy of the portfolio manager with the rise of financial intermediation in the capital supply chain. The fourth stage of capitalism, which emerged in the 1970s and 1980s, heralded the beneficiary as the principal actor and the professionalizing of the savings function as the object. Peter Drucker (1976) went so far as to call this stage the Unseen Revolution, positing such power in the hands of beneficiaries that he attached the term socialism to the new role they were to play. Each of these distinct stages...
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