Remarks on Shareholder
Posted by Jay Clayton, U.S. Securities and
Exchange Commission, on Saturday, January 20, 2018
Jay Clayton is Chairman of the U.S. Securities and Exchange
Commission. This post is based on Chairman Clayton’s recent
remarks at the SEC-NYU Dialogue on Securities Markets . The
views expressed in this post are those of Mr. Clayton and do not
necessarily reflect those of the Securities and Exchange
Commission or its staff. Related research from the Program on
Corporate Governance includes The
Agency Problems of Institutional Investors by Lucian Bebchuk,
Alma Cohen, and Scott Hirst.
This is now the fourth in the series of SEC-NYU
dialogues, and I am pleased with the four topics that have been covered, as well
as the quality of the discussions thus far. It is important that the SEC be able
to take a forward-looking approach with respect to our securities markets—to
keep up to date with key developments, and be alert to issues where regulation
may be appropriate in the future. Hearing about new developments or
theories—whether they require us to take specific action or not—is an important
part of that process. At the end of the day, our ability to spot growing issues
and head them off with thoughtful, informed, incremental regulation, or
deregulation, will always be preferable to addressing problems retrospectively,
including through enforcement.
I also appreciate these SEC-NYU dialogues
for their cross-disciplinary focus. Bringing together practitioners,
stakeholders, regulators, and academics of various stripes to exchange
ideas means that our views can be subject to debate and analysis by
those with a perspective different from our own. Iron sharpens iron;
we are all the better for it.
Today’s SEC-NYU dialogue will focus on the current state of shareholder
engagement, including the roles of institutional and activist investors—and how
those roles have changed over time. I’ll try to set the table.
governance structure of public companies reflects the reality of capital
allocation in a well-functioning free market economy: capital is allocated
predominantly on a collective but widely distributed basis; in practice,
companies have many shareholders who have no connection to one another. Various
factors drive this approach to collective capital allocation, including that,
first, in a global economy, firms have necessarily become large (and therefore
very few can be funded by a single investor or small group of investors).
Second, from an investor’s perspective, diversification across investment
opportunities has proven to be a prudent and attractive strategy. As a result,
firm ownership is diffused and ever-changing. This is fertile ground for the age
old problems of collective action. How do we address collective action problems?
There are several proven approaches but, for companies, we have long settled on
the approach of selecting dedicated individuals to oversee the company’s affairs
and imposing on them a fiduciary duty. These fiduciaries generally own no more
than a small portion of the company.
the U.S. approach to capital allocation and firm governance is a proven
approach—and I firmly believe the best approach—it is not a perfect one. The
separation of ownership and control raises alignment of interests questions—or
as my fellow economists say (I’m upgrading my status here), principal-agent
problems. How can the principals (the stockholders) be sure their agents (the
managers) are acting in the best interests of the stockholders? These are not
new issues. I studied them in earnest 30 years ago and my professors at the time
had been studying them for 30 years before that. We have, however, in practice
made significant strides in the past 30 years. These strides have been driven by
many factors, including our experiences—both good and (unfortunately) bad—new or
changing regulation, and, importantly, as a result of substantial reductions in
the costs of monitoring and shareholder communications. The information
asymmetries and absences that plague principal-agent relationships have been
narrowed. As regulators, we have mandated or suggested rule sets—including
disclosure requirements and incentive driving requirements and prohibitions—that
have reduced the opportunities for misalignment between shareholders and
managers. Based on my observations and, more significantly, my interactions with
various market participants, I believe it is clear that governance has improved
as a result.
work is far from over. Why? Not because more rules are better, but because our
work has not been perfect, and because markets are ever-changing. We need to ask
if our rule set has kept pace. For example, increasingly, a second layer of
separation between ownership and control has opened between the ultimate owners
of capital and corporate management. Shareholders invest in investment
vehicles—mutual funds, ETFs, etc.—which in turn own the shares of operating
companies. In theory, a daisy chain of fiduciary duties keeps these interactions
focused on the interests of the ultimate beneficial owner, but it also means
that the principal-agent issues are multi-layered.
addition to principal-agent alignment issues, there also are shareholder
alignment issues within the body of shareholders of the same firm. The key issue
to understand how best to serve the interests of the ultimate owners of capital
is to understand what they want. This issue, while facially straightforward,
also is vexing—particularly when you dip below the level of broad principles.
Shareholders often have different and sometimes divergent views on objectives
and how best to achieve the selected objectives. This is not a surprise.
Shareholders can have vastly different investment time horizons. As a well-known
specific example, we have seen many cases where some shareholders believe
capital should be reinvested while others believe it should be returned to
shareholders through buy backs or dividends.
take a slightly more complex example, let’s assume an index fund that owns, as a
part of that index, a company that may be poorly managed. What might an investor
in that index fund expect the fund’s investment manager to do? Perhaps the fund
should do absolutely nothing: investors may simply want the lowest-cost exposure
to the market, warts and all. Perhaps the fund should do nothing affirmative,
but if an activist engages with the mismanaged company, the fund could support
the activist—which would ideally drive up the stock price with the index fund
along for the ride. Perhaps the fund should intervene directly—if the index fund
can’t exit the investment, then being an activist passive fund may be the best
path toward increasing the value of the fund. How should an index fund select
from among these options? Should index funds seek guidance from investors in the
fund, or clearly disclose their engagement policies such that potential
investors could self-select into their desired category?
what if the company is not being actively mismanaged, but simply lacks some of
the governance features that governance professionals have deemed to be “best
practice”? Should the passive index fund actively pre-empt? Should the index
criteria themselves take on this issue? Recently, particularly at larger public
companies, active shareholders have sought to establish or modify specific
aspects of governance rule sets, as well as company policies on an array of
environmental and social topics. How should companies respond to those
overtures? How should other investment funds react?
are all complicated issues, with no easy answers, in large part because
engagement, while it is valuable in many cases, is not free. It costs
shareholders time and money to engage and, for some shareholders—or in some
cases, a substantial majority of shareholders—the marginal benefit of engaging
on a particular topic may not be worth the effort. Let’s not forget that the
director-officer fiduciary duty model itself was designed to, and does
effectively, if not perfectly, address the fundamental problem of fair and
efficient collective action.
more point on structure. Even proxy voting is costly to shareholders: analyzing
the issue up for a vote, the potentially varying points of view on that issue,
formulating an opinion, and casting the ballot is a series of actions that
requires nuanced determinations that may be beyond individual shareholders. Even
investment companies struggle. Because they frequently compete on fees, are
funds tempted to understaff proxy voting, or to outsource it to a proxy advisory
firm? Have we added a third layer of principal-agent issues? Has it helped?
are all questions that we need to be examining, and I hope today’s discussion
can shed some light on at least some of them.
Turning from structure to market realities of the day: Few companies are immune
to activist pressures—as two of our distinguished panelists here today will no
doubt discuss, activist owners can substantively influence the governance of the
largest of companies. And, increasingly, they are doing so. Activism may be
evolving, but it is not going away. So it is more important than ever for
shareholders to understand and evaluate activists’ long-term impact on companies
and shareholder value. In particular, to what extent do shareholder campaigns
launched by activist investors create value for all shareholders? What is the
effect of these campaigns on long-term value? To what extent does passive
institutional ownership—and the involvement of proxy advisors—facilitate the
growth in activist campaigns? And activists themselves are not monolithic; they
may themselves have different tactics or different time horizons that may lead
to differential outcomes with respect to this range of questions. Do activists
take advantage of the imperfections in our system or do they smooth them? I’ll
give an answer—it’s probably both.
explore these issues, I want us to keep in mind a group of shareholders whose
voices rarely have a place at the table: the Main Street Investor. The engine of
economic growth in this country depends significantly on the willingness of Main
Street investors to put their hard-earned capital at risk in our markets over
the long term. If our system of corporate governance is not ensuring that the
views and fundamental interests of these long-term retail investors are being
protected, then we have a lot of work to do to make it so.
look forward to hearing the discussions, analyses, and recommendations that will
come out of today’s event. Thank you all for agreeing to spend your time with us
so that we can benefit from your insights. I wish you a day full of enjoyable
and fruitful discussions.
Harvard Law School Forum
on Corporate Governance and Financial Regulation
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