Governance disclosure needs nutrition label

Pension funds should disclose their governance arrangements using a methodology similar to a nutrition label, with members easily able to compare the transparency and accountability of fund standards, a leading corporate-governance expert from Yale says.

Dr Stephen Davis, the executive director of Yale School of Management’s Millstein Centre for Corporate Governance and Performance, has called for greater governance disclosure from both defined-benefit and defined-contribution plans.

Beneficiaries should be able to access and compare governance information through apps, in a similar way to the how consumers compare restaurants and other service providers, Davis told

“It would be tempting for some advocates to be very prescriptive of the types of governance arrangements funds ought to have,” he says.

“But the trap there is that there are so many different types of funds and so many types of markets that it would be very hard to come up with a one-size-fits-all model. It makes some sense to have a bedrock of disclosure for funds. It is kind of a nutrition-label approach, where they would have to describe what governance arrangements are, and how they are designed to align with the interests of beneficiaries. If they don’t disclose this, they have to explain why.”

This approach to fund disclosure is detailed in Davis’ latest paper, Mobilising Ownership and an Agenda for Corporate Renewal, due to be published this month by the Brookings Institution.

Disclosure would also cover such things as the remuneration of internal investment staff and the fees extracted from funds by external managers. Davis advocates funds showing how this remuneration is aligned to the long-term interests of fund members.

“We now have apps on phones and tablets that can help individuals compare restaurants or doctors and all manner of services. There is no reason why we should not expect of our retirement systems disclose information that would allow a similarly easy comparison,” Davis says.

“I am not necessarily suggesting funds release information that is proprietary, but about their governance arrangements, about their accountability and transparency because that is a bedrock question. If you are a citizen saver, you really should have the right to know if a fund that wants your money has the capacity to align with your interests.”


 Global governance database
A recent paper co-authored with Ben Heineman, senior fellow at Harvard University Law School and Kennedy School of Government, Davis calls for a global database on the governance of institutional investors.

After a subsequent roundtable in New York earlier in the year, Columbia Law School’s associate professor of law Robert Jackson Jr has taken the lead in developing such a database.

Davis says the the call for a database came out of the lack of information about fund governance and the increasingly important role ownership is given in the regulatory framework of markets.

Recent regulatory reforms such as the Dodd-Frank Act in the US and the Stewardship Code in the United Kingdom give shareholders increasing power relating to engagement with companies and the disclosure they can demand.

Davis says regulators have taken a chance that institutional investors, as large owners in the market, can take a key role in policing the market effectively.

In Are Institutional Investors Part of the Problem or Part of the Solution?, Davis and Heineman ask whether institutional investors are using these powers properly.

The authors also note that the level of disclosure required by corporations and demanded by institutional investors is much more onerous than those required for these same investors.

“We have made boards accountable, but accountable to whom? It looks like we have made them accountable to institutions. Even if their beneficiaries have long-term objectives, they act short-term. So the work of corporate governance needs to be matched with work on fund governance,” he says.

“The alternative to that is that corporations should actually reverse the process of making boards more accountable to investors and conclude that is a mistake because investors are inherently short-term. My view is that is not right, but the problem is that we have institutional investors that are out of alignment with their beneficiaries. If we bring them back into alignment, we can actually try ownership, we haven’t really tried it yet.”

Davis notes that institutional investors may require companies to provide extensive background information on directors, while beneficiaries may have little or no readily available information on who their fiduciaries are.


Equality of disclosure information
In the paper with Heineman, Davis notes that institutional investors – pension funds, insurance companies, endowments and their asset managers – now own more than 75 per cent of the largest 1000 companies in the US.

Despite this, little is known about these investors, with wide differences in the disclosure of governance arrangements at the institutions.

“Funds that are associated with asking corporations for generous disclosure are themselves rather opaque and would be hard pressed to meet the same kinds of disclosure requests they are asking from portfolio companies,” he says.

While Davis says some public pension funds like CalPERS have “looked in the mirror” and undertaken wide-ranging governance reforms, others still have a governance structure with a sole fiduciary

He singles out corporate pension plans as having particularly opaque governance arrangements, with beneficiaries commonly having little idea about the fiduciary of the fund.

“The information may be available but it is not easy to find. In most companies it is very difficult to get extensive background on the fiduciary and usually it is one fiduciary,” he says.

Warning that the definition of fiduciary duty is antiquated, Davis says it is better suited to an old defined-benefit-dominated retirement system.

The prevailing definition of fiduciary duty in many jurisdictions also curbs the capacity of investors to consider intangible factors such as environmental, social and corporate governance (ESG) considerations, Davis notes.

Along with questions around what fiduciary duty is, Davis says that it does not currently extend to a range of intermediaries.

Noting that there can be as many as 16 intermediaries between a beneficiary and an end investment, Davis says that in the US the Department of Labour and the Securities Exchange Commission are working though the question of whether fiduciary duty should cover intermediaries.

In the US the regulation of defined-contribution schemes, which accounts for an increasingly large slice of the funds in the retirement system, is also a vexed question for regulators.

Currently, the US Securities and Exchange Commission regulates 401K plans with a focus on protecting investors in the market generally, according to Davis. He questions if special protection should be given to investors in retirement schemes as they are effectively forced investors, and notes that there is little discussion around the governance issues specific to defined-contribution plans.

“With a defined-contribution scheme the issue is really the selection of funds. Which funds do you make available to scheme members, and how do you go about making that decision and who monitors those funds, and what are the contracts that define the relationship?” he says.

“Those are the main jobs for a board of a defined-contribution scheme. For a defined-benefit scheme it is different, there is more of a direct relationship and a more direct set of investment decisions.”

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