David Webber on Employee-Funded Capitalism
In the subtitle of his highly recommended new book, The Rise of the Working-Class Shareholder, David Webber calls employee pension funds “Labor’s Last Best Weapon.” He says that working-class employees could be a powerful force for sustainable economic growth through their pension funds. In an interview, Webber talked about the opportunities and challenges in making the best use of that weapon.
How much money is still managed for public pension fund and labor union retirement funds?
Somewhere in the neighborhood of $3-$6 trillion is invested in U.S. public pension funds. By some measures, that’s around 10% of the market. The range is largely a question of whether one counts what they have on hand, or if you include what they are owed.
How much information do public pension funds and labor union fund participants get about the money being managed for them — about the portfolio? About how ownership rights like proxy voting and shareholder lawsuits are being managed? When they do get information, how much control do they have in providing feedback or direction?
Pension funds generate certified annual financial reports. These reports are not unlike what you might see in a 10-K. They contain certified financial information about the fund’s investment allocation and performance, descriptions of the board members, and some discussion by board members or the executive director about the fund itself. That’s also where you will find references to shareholder lawsuits. The funds tend to be pretty proud of their role in shareholder lawsuits, and often tout that role in additional materials sent to fund participants like newsletters. Some funds may disclose information more frequently. There can be variation on the public fund side because states and cities have different rules that apply to these disclosures. Some funds may also make select federal filings.
Many funds disclose both their proxy voting policies and a record of their actual proxy votes. For example, you can find both on the CalPERS website: proxy voting policy, and its global proxy voting decisions. CalPERS’s proxy voting policy spells out the fund’s highly-detailed views on investor rights, for example, and the proxy voting decisions show it voted. I don’t know how many funds offer this much disclosure. I do know that CalPERS is viewed as a gold standard on such issues by other funds that try to emulate it, and I believe that almost all of the large state and city funds are similarly accessible on these points. There are more than 4,000 public pension funds in the United States, but 90%+ of the assets are in the top fifty funds.
As to the point about worker control and direction, that is primarily a function of worker representation on boards. For most public funds, workers and retirees elect some percentage of the board from peer workers and retirees. Sometimes it’s majority worker control, other times minority or 50/50. (In the Taft-Hartley context, its 50/50). Typically, the remainder of the board in the public context is comprised of elected officials, sometimes several directly, such as the governor, state treasurer, or mayor, other times comprised of political appointees. To stay with the CalPERS example, it has a 13 member board, six of whom are elected by workers and retirees, three are political appointees (two by the governor, one jointly by the senate and the assembly) and the remaining four are ex officio: the state treasurer, the state controller, the director of the state’s department of human resources, and a representative of the state personnel board. Interestingly, there are a couple of empirical studies that show that worker representation on pension funds boards correlates with better fund performance. The basic argument is that these workers are themselves fund participants, as are their co-workers, friends, and family members, and may pay closer attention to fund outcomes.
Some shareholder activism by union funds has been criticized as being directed toward topics that should be addressed by collective bargaining instead of topics more properly reserved for shareholders. How do you respond?
Union and pension fund shareholders are often depicted as special interest shareholders whose interests deviate from the rest of the market. In fact, the same argument can be applied to all shareholders, though it is selectively applied only to public pension funds and labor union funds. The most egregious example of that selective application is the D.C. Circuit Court’s opinion in Business Roundtable v. SEC, in which the D.C. Circuit struck down the SEC’s proxy access rule largely on the argument that the rule would disproportionately empower these so-called special interest shareholders: public pension funds and labor union funds, to the purported detriment of other shareholders. But if you’re looking for special interests, you will find them everywhere.
Mutual funds earn much of their profits from managing the 401(k)s of large, publicly-held U.S. companies. That also creates a conflict that has a potential to defang their activism. One study by the 50/50 Climate Project found that Vanguard never voted against management at companies where Vanguard was on the company’s 401(k) platform. Sovereign wealth funds invest on behalf of nation states, and may well make investments with political criteria in mind. Foundations have political or social agendas alongside their portfolio interests. Insurance companies may sell products to the companies they invest in. None of this means that the solution to these conflicts means turn all power over to corporate boards and managers, who also have interests that may deviate from maximizing returns. The point is that many market players have economic and other interests in their institutional DNA that may deviate from investment performance in any and all circumstances. So what?
I think this “special interest” issue is blown out of proportion. And I think that the best evidence for my argument is to see what happened to proxy access after the D.C. Circuit struck it down. New York City’s pension funds, overseen by NYC Comptroller Scott Stringer, launched the Board Accountability Project, in which they picked up the same rule the D.C. Circuit struck down — 3 years, 3% ownership, 25% of the board — and took it directly to the shareholders, one company at a time. We all know what happened. Shareholders voted overwhelmingly in favor of these proposals. Notice that the NYC funds — public pension funds — are precisely the special interest shareholders that the D.C. Circuit freaked out about in Business Roundtable. The D.C. Circuit paternalistically stepped into liberate shareholders from the supposed special interests of the NYC Funds, only to find that shareholders overwhelmingly opted to empower precisely these same shareholders by voting for proxy access. Why did they do that?
First, because the special interests can often be constrained by the need to appeal to a broad swathe of the market. And second, because overall, even with this special interest concern, the market concluded that it was better off empowering public pension funds or labor union funds rather than leaving boards almost entirely insulated from meaningful electoral opposition. Investors are big girls and boys. They can recognize that their own interests may be advanced by other shareholders, even those whose interests might not perfectly align with their own in all circumstances.
You raise the issue of union pension funds investing in non-union companies, including those, like Walmart, that have been accused of not treating their workers well. Should pension fiduciaries make trade-offs based on policy rather than strict investment risk and return?
This question boils down to the scope of pension trustee fiduciary duties. In answering it, I think it’s important to bear in mind two distinct questions: first, what are the legal obligations of trustees, and second, what’s the best policy choice. In general, I do not think that there is a legal obligation to maximize returns in all circumstances, and there are some cases that have reached that conclusion. As a policy matter, returns are always important and almost always paramount, though it’s worth contemplating situations in which departures might be justified. For the most part, funds pursue policies of maximizing returns while simultaneously considering their other interests, and I think that’s usually the right answer.
In addressing this very knotty issue, I think it’s important to recall that pension funds have three main sources of revenue: employer contributions, employee contributions, and investment returns. People often point to the fact that investment returns constitute the largest source of revenue, though that’s a bit misleading, given that much of these returns may be attributed to the time-value of money. I’ll return to this point about the three pillars of fund revenue.
As noted, working class shareholders today pursue a policy of maximizing returns to the portfolio, tied to risk characteristics, though there are some noteworthy departures from this. An important addition to the maximize returns point is the “investments of equal value rule”. That rule allows fund fiduciaries to choose one investment over another for any reason, as long as the two investments have the same risk-reward profile. That leaves a lot of low-hanging fruit for funds to pick, namely to choose profitable investments that also advance their other interests and goals. Not long ago, trustees hardly paid any attention to these issues and deferred almost entirely to whatever investments their fund managers presented to them. Fortunately, that has changed.
One way to frame some of the trickier aspects of this issue is to discuss it in light of another challenge to these funds: the threat of privatization. What happens when one pillar of fund revenue undermines another? There are some public pension funds that have invested in companies that privatize public sector jobs, quite literally funding the job losses of their own fund contributors. I provide examples of this in my book: a public school custodian whose pension fund get invested in Aramark, Aramark then shows up in his town, underbids the union for the school contract, and offers him his job back for more than 50% paycut. An orthodox “maximize returns” view would say: that’s fine, as long as the return on investment was worth it. I disagree. The law does not require maximizing returns to the fund. It requires that trustees invest, “solely in the interests of participants and beneficiaries and for the exclusive purpose of providing benefits.” I have argued at great length in my book and also in this law review article that those two things are not the same. Financing your contributors’ job losses with their own retirement funds directly undercuts their benefits and can even harm the fund itself through the double loss of both employer and employee contributions to it. Even if all we care about is the fund, that can harm the fund. And the language of the rule itself says “participants and beneficiaries” not “fund”. For the record, there have been multiple court cases that have found no breach of fiduciary duty when a fund deviated from maximizing returns or considered participant jobs. I’m not saying that everyone accepts that view, but it’s not just some purely academic argument either. And I will add that most of the time, funds seek to maximize returns and pursue their other interests under the “investment of equal value rule”. If anyone is really interested in getting into the legal weeds on this issue, I published a law review article about it here.
Many funds have dealt with privatization either by saying that they simply won’t invest in it, or that they will invest in it under certain circumstances. I applaud those efforts and think they are consistent with fiduciary duty. I will also note that these efforts are often framed consistent with the maximize returns view under the “investment of equal value rule” by simply arguing that there are other investments the fund can make instead of privatization. Policies that shape or avoid privatization efforts may be justified on these grounds, or also on the argument that the segment of the portfolio devoted to such investments is simply too immaterial to implicate fiduciary duties in any meaningful way.
That brings us to the Wal-Mart part of your question. I would analyze this a bit differently, because Wal-Mart is part of the index, and I think that pension funds should basically be indexed, and then be active and engaged shareholders across the portfolio. It’s also a step removed from the privatization example, since Wal-Mart isn’t actually competing for public sector jobs. Still, worker pension investments remain troubling. Wal-Mart is undermining workers, wages, and unions around the country. Their business model is based on the ruthless exploitation of labor. And one may particularly question it in light of the success of other similar retailers, like Costco, that pay workers comparatively high wages and benefits. If one can find alternative investments of equal value, one might consider getting out. And that leads to yet another consideration. Swedish and Danish pension funds recently divested from Wal-Mart over its treatment of workers. They didn’t put a fig leaf over that choice and supply an investment rationale. Their view was, we’re appalled by their labor practices, we won’t invest in Wal-Mart. They did the same for Ryan Air. That raises questions about how we think about these issues. Should U.S. pensions do the same? Why or why not? Our conception of fiduciary duty is not a law of physics. It is a legal, political, and cultural choice. Others have made different choices than we have. Their choices might be better.
As you know better than anyone, much of the shareholder activist movement today was born out of the move to divest from South Africa over Apartheid. The argument there wasn’t “South Africa is a bad investment because of Apartheid.” It was, “we’re morally appalled by Apartheid, and we don’t want to be invested in companies that have a role in upholding it.” Once you make that choice, it opens the door to asking when you can make it again. We still make such choices today. Some pensions favor investments in green energy or minority-owned businesses, boycott Iran or Sudan or counter-boycott Israel boycotters. Often, but not always, these choices are given legislative or other political cover, removing them from the fiduciary duty analysis. Maybe the answer for public funds will always be that political cover. We still do not have a satisfying theory of when an issue becomes important enough to be labelled a moral issue trumping economic considerations and removed from the economic calculus. I have always thought that there is some implicit majoritarianism in it, a strong sense that if investors were acting directly they would divest over Apartheid, so we can make that choice for them. I have often pondered the idea of ratification in these contexts, that is, putting some of these issues to a vote of your fund participants and beneficiaries.
In general, I think funds should pick the low hanging fruit by maximizing returns, using the “investments of equal value rule” to choose investments that also advance their other interests. I think they should think very carefully about whether and how to engage in investments like privatization that threaten one of the other pillars of fund revenue. And I would like them all to consider labor issues, especially those that directly affect the worker-contributors to their funds.
Can pension funds have an impact on issues like climate change and corporate political contributions? What tactics are most effective?
Pension funds have had an impact on these issues, primarily through shareholder proposals. For example, just last week shareholders voted in favor of environmental and sustainability proposals at Kinder Morgan, the massive energy infrastructure company. The $200 billion New York State Common Retirement Fund filed the sustainability proposal, and was backed by CalPERS, CalSTRS, The Texas Teacher Retirement System, and the Florida State Board of Administration, and the Ontario Teachers’ Pension Plan. This effort follows the first successful environmental proposals at Occidental Petroleum and Exxon last year, in which the New York State Common Retirement Fund was also a lead filer, and which received substantial backing from public pension funds. The reality is that energy companies like those targeted by these proposals know more, or are at least in a position to know more, about the effects of global warming than almost anyone else. Yes, these proposals are about disclosure, but they are about more than that: forcing companies to assess their exposure to known climate risks. One can readily understand why companies might not do so on their own. They could rationally fear the answer, and might incur securities law disclosure obligations should they come to learn some bad news. It’s not a surprise that they have been forced to undertake such studies by their investors. And while this information matters greatly to investors managing their portfolios, it is also attracting wider notice in the scientific community. For example, I just spoke to Scientific American about this last week, not a publication that typically covers shareholder proposals. These proposals are not the solution to global warming on their own but I do believe they are a step in the right direction.
Shareholder proposals regarding corporate political activity have fared less well. It’s possible that they won’t find the same audience that the environmental proposals have found, but it may just take time. It took years for environmental proposals to start cracking the 50% threshold with any regularity, and it’s possible that recent scandals like the one involving AT&T’s alleged payments to Michael Cohen, Donald Trump’s lawyer, may reanimate concerns about corporate political activity.
I recognize that one can always argue that these issues should be dealt with by government. And perhaps, ideally, they should be. It is hardly surprising, given the current dysfunctionality of government, and given who currently runs the EPA, that investors would turn to alternative approaches to make progress on these issues.
How will the new pay ratio disclosures affect investor oversight?
I think that disclosure of the CEO-worker pay ratio is a nice example of how working class shareholder institutions can simultaneously pursue their interests as investors and their broader interests. The investor rationale is multifaceted. First, I think it fits into a larger set of concerns regarding how best to cope with out-of-control CEO pay. Say on pay does some of that. But I think the ability to compare the ratio, particularly within industries, can shine a light on CEO pay too. Secondly, those who pushed for the rule, like the AFL-CIO’s Office of Investment, argued that it would shed light on human capital management, that is, on the question of not just how you’re paying the highest compensated employee in the company, but everyone else. The pressures leading to increases in CEO pay are well known. Say on pay and the CEO-worker pay ratio offer some welcome counter-pressure. No one wants to come in first place for highest ratio.
The second argument, about examining how companies pay the rest of their workforce, has taken on a fascinating turn ever since the ratio began being disclosed this proxy season. For example, the Wall Street Journal recently published an article, “Are You Underpaid? In A First, U.S. Firms Reveal How Much They Pay Workers,” discussing how workers were discovering how much they were getting paid relative to workers at their competitors. All of this fits into a broader conversation in this country about economic inequality, one that I think is helpful for labor. So I think CEO-worker pay ratio disclosure work for these investors both on investment grounds, and in support of their other goals.
One of the toughest problems you identify is “the risk of capture.” What does that mean and how do we prevent it?
In 2004, Florida’s teachers unions aggressively opposed the reelection of Jeb Bush as governor. After he won, Bush resumed his duties as a trustee of the Florida State Board of Administration, for which the Florida governor also appoints two members. That board oversees Florida’s Retirement System, about half of which consists of teacher pension money. Shortly thereafter, the Florida Retirement System made a $182 million investment in Edison Schools, a private company that replaced public school employees. In short, teacher retirement money was used to undermine public school workers. That’s an example of what I mean by capture: a pension fund being used against the interests of the very people who contribute to it.
How do we avoid this fate for pension funds? Worker representation on boards can help. So can worker vigilance about these issues. The development of policies by public pension funds about privatization, about labor issues. We see this already happening. There is no reason to reinvent the wheel. Pension funds can look to others to see how they have handled these issues, and innovate where required.