The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic Review

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The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic ReviewMany have chronicled the shift from owner-founders to managerial capitalism and on to fiduciary capitalism but Hawley and Williams are among the first to spend the majority of a book on the implications of fiduciary capitalism and where this recent development might lead. In 1945 corporate equity was valued at slightly less than $120 billion; more than 90% was owned by individuals and about 4% by institutions. The value of corporate equity has grown enormously to $7.8 trillion in 1998. While the share of individuals has fallen to 44%, the proportion owned by institutions has risen to 48%. State and local pension funds owned about 1% of outstanding corporate equity in 1969; by 1998 they owned more than 10%.
Ironically, although the Employment Retirement Income Security Act has been interpreted by the Department of Labor to require proxy voting by ERISA funds on behalf of beneficiaries, the authors point out that the Employment Retirement System Act (FERSA), established for federal employees, provides that voting rights are delegated to the administrator, appointed by the trustees. We don't trust our federal trustees to vote the shares of what is likely to become the world's largest institutional investor. Fortunately, other funds, such as the California Public Employees Retirement System (CalPERS), are not under the same restrictions and have become effective owners whose monitoring has added value.
Hawley and Williams review the record of corporate governance interventions. A few of their observations are as follows:
Board independence does matter for some tasks such as replacing poorly performing CEOs and not overpaying for acquisitions.
Visible and aggressive activism results in substantial increases to shareholder wealth but quieter activism doesn't yield the same results.
Binding bylaw amendments are potentially one of the most important new tools for institutional investors.
Tying director compensation closely to firm performance may have the unintended consequence of making the board more risk adverse and deferential to the CEO because, unlike the typical diversified shareholder, board members will be subject to the fortunes of one firm.
Hawley and Williams argue that many large funds have become "universal owners," since 1/3 of the assets of the 200 largest defined benefit funds are invested in indexed portfolios. As such, they should not only be concerned with monitoring individual firms but also with portfolio-wide effects. Universal owners will still need to pay attention to the alignment of manager and shareholder incentives but that won't be enough.
For example, the authors argue that universal owners have a responsibility, derived from the duty of care, to oppose policies that create negative externalities, like pollution, and support policies that produce positive externalities, such as corporate education and training programs. In contrast to single firms who may find it advantageous to throw off the costs of pollution to society, universal owners will suffer the costs of cleanup through deteriorating infrastructures, higher taxes and other costs to their other holdings.
At the same time, universal owners are able to capture nearly the full benefit of positive externalities, like corporate training programs, because even if trained employees subsequently leave the firm where training occurred, they are likely to find new employment with another universally owned firm. Since the size and breadth of universal owner portfolios expose them to economy-wide risks and rewards, their programs must increasingly be concerned with the long-term growth and economic efficiency of national and world economies.
Universal owners who want to maximize shareholder value will need to develop "public policy" positions to ensure a well-trained labor force, effective infrastructure, legal and regulatory environment, as well as monetary and fiscal policy. They want to ensure the corporate environment encourages efficiency and doesn't externalize costs.
The authors provide several examples of such public policy activities, most of which appear to be drawn from CalPERS. These include:
policy guidelines on issues such as the environment;
surveys of firms on particular policies, such as high-performance workplace issues;
monitoring the lobbying efforts to ensure one firm doesn't put others at a competitive disadvantage;
grading portfolios on particular issues, such as adherence to corporate governance guidelines;
targeting firms on specific issues, such as the controversy surrounding logging ancient forests or producing defective products.
They envision that institutional investors will develop areas of expertise and "coat tail" off each other to create a more efficient division of labor.
Of course any volume on the cutting edge is bound to raise as many questions as it resolves and The Rise of Fiduciary Capitalism is no exception. Their troubling conclusion discusses the problem of who will watch the watchers. While a growing professionalism at corporate boards and institutional investors may prevent the most egregious abuses, the authors believe that trustees holding tremendous power and wealth may soon face a tremendous backlash from the public if such power is perceived as being abused.
They end with a series of unanswered questions concerning the growing concentration of wealth in the hands of a relative few professional owners. Who will monitor the monitors? Government? The market? How do we protect beneficiaries from institutional abuse? Is fiduciary duty enough to assure appropriate behavior?
These are important issues that we are likely to grapple with for the foreseeable future. While government certainly has a role in monitoring the monitors, it is too often a captive of the very interests it is monitoring. As for the market, it doesn't respect ecological and other needs ignored by current pricing structures.
While some, like myself, believe the impetus to act as universal owners will probably come from the ultimate beneficiaries, Hawley and Williams have their doubts. They see beneficiaries rising up and demanding more input as unlikely, since beneficiaries are "even more diffuse, disinterested, and disenfranchised" than the traditional Berle-Means shareholder. "Thus it is unlikely that beneficiaries as a group will ever be able to effectively `watch' the fiduciary institutions." Our "best hope for effective monitoring is transparency coupled with competition between the institutions."
Visionaries, such as Robert Monks and Mark Latham, have proposed a heightened role for proxy monitoring firms to monitor and provide guidance to the management of portfolio firms. Maybe the rise of such institutions will provide the competitive core that Hawley and Williams see as the best hope for effective monitoring.
My own assessment is that such new institutions will play an important role but that we also need to rebuild our fiduciary institutions so they are more democratic.
CalPERS provides an excellent model of an institution that legitimates the enormous power of its fiduciaries by holding them accountable to members and stakeholders. Six of its 13 board members are nominated and elected directly by its members and beneficiaries. Four others serve as ex officio members based on their position as State Treasurer, Controller, Director of the Department of Personnel Administration and a designee of the State Personnel Board (SPB). Two members are appointed by the Governor, an elected official of a contracting public agency and an official of a life insurer. One is appointed jointly by the Speaker of the Assembly and the Senate Rules Committee.
CalPERS is far from perfect in providing mechanisms to let its members hold the board accountable - incumbents have several advantages over challengers, such as use of CalPERS funds for traveling to meet constituents while campaigning, and members have no initiative or referendum process. However, it is far more democratic and participatory than most institutional investors...and more successful. While many large institutional investors have become universal owners, CalPERS is one of the few to begin to look at the larger policy issues that Hawley and Williams argue will make corporations more democratic.
The Rise of Fiduciary Capitalism provides the best synopsis to date of how fiduciary capitalism developed but less of a guide concerning the difficult subject of "how institutional investors can make corporate America more democratic" than its title might imply. Still, the book is important as one of the first to recognize that fiduciaries, acting on behalf of universal owners, have a duty of care that extends to influencing public policies in order to generate both wealth and a healthy environment. Wide circulation of The Rise of Fiduciary Capitalism could accelerate that recognition and the ultimate shift towards more democratic corporations.The Rise of Fiduciary Capitalism: How Institutional Investors Can Make Corporate America More Democratic Overview
At the beginning of the twenty-first century, the structure of corporate ownership is undergoing major change. The Rise of Fiduciary Capitalism chronicles the rise of fiduciary institutions—primarily public and private pension funds—which now own almost 50 percent of the equity of American corporations. In turn, approximately 50 percent of Americans either own stock individually or, more typically, have an ownership or retirement interest in these fiduciary institutions. James P. Hawley and Andrew T. Williams argue that, because of their extensive diversification of ownership, fiduciary institutions have become "universal owners" with a significant stake in a broad cross-section of the largest publicly traded firms in the economy. Forced to evaluate portfolio-wide effects of individual firm actions, these institutions have a quasipublic policy interest in the long-term health and wellbeing of the whole society. As universal owners, fiduciary institutions are in a unique position to develop and pursue policies of virtuous efficiency, minimizing negative externalities and encouraging positive outcomes by the firms in their portfolios. In this way, they have the potential to make the firms in which they own stock more responsive to the needs of the Americans to whom they are responsible and thereby make those firms more democratic.The Rise of Fiduciary Capitalism investigates the nature of property and ownership in the modern corporate setting, the effects of the decline of traditional, personally held property in equity form, and the governance implications of the developing new form of corporate ownership.


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