Monitoring the Monitor

Abstract

Many public pension funds engage in institutional activism. These funds use the power of their spooled ownership of publicly traded stocks to effect changes in the corporations they own. This article reviews the theory and empirical evidence underlying the motivation for institutional activism. In theory, the merits of institutional activism hinge critically on two agency costs: 1) the conflicts of interest between corporate managers and shareholders, and 2) the conflicts of interest between portfolio managers and investors. This leads to two types of institutional activism: shareholder activism and social activism. While portfolio managers can use their position to monitor conflicts that might arise between managers and shareholders (shareholder activism), they can also abuse their position by pursuing actions that advance their own moral values or political interests at the expense of investors (social activism). Which of these effects dominates the actions of portfolio managers will determine the value of activism and is an empirical issue. Perhaps the most high-profile activism has been pursued by CalPERS with their annual focus list. The article documents that CalPERS has pursued reforms at focus list firms that would increase shareholder rights and (imprecisely) estimate the total wealth creation from this shareholder activism to be $3.1 billion between 1992 and 2005. Unrelated to the focus list program, CalPERS has also pursued social activism (e.g., the divestment of tobacco stocks). In general, I argue that institutional activism should be limited shareholder activism where there is strong theoretical and empirical evidence indicating the proposed reforms will increase shareholder value. At times, institutions will be forced to engage in social activism and take positions on sensitive issues. In these situations, portfolio managers should pursue the moral values or political interests of their investors rather than themselves.