Project leader: Simon Deakin
Research Associates: John Buchanan (CBR), Dominic Chai (Manchester Business School), Andrew Johnston (University of Queensland), Sue Konzelmann (Department of Management, Birkbeck College, London), Wanjiru Njoya (Faculty of Law, University of Oxford)
Project Dates: 2007-11
Funding: Belspo (Belgian Science Foundation); additional funding from the Japanese Ministry of Education COE grant to ITEC, Doshisha University, and the CBR
Aims and Objectives
This project, funded by the Belgian Science Foundation (Belspo), is looking at issues of pension fund governance and socially responsible investment ('SRI') from the perspective of reflexive governance theory, with the CBR working as part of a network with teams from the Catholic University of Louvain and the University of Liège. The work began in 2007. The CBR's empirical work is contained in two working papers which are currently at the work-in-progress stage: Buchanan and Deakin on pension fund governance, and Buchanan, Chai and Deakin on shareholder (both pension fund and hedge fund) activism. Theoretical and policy papers include work by Johnston on EU corporate governance and takeover bids, Njoya on the relationship between employment law and corporate governance, and Konzelmann and Deakin on the implications for corporate governance of the financial crisis.
There is currently a complex mix of contractual governance (auto-regulation), coordinated self-regulation (co-regulation), and hetero- (or external) regulation in the case of UK defined-benefit pension schemes. The basic legal concept of the trust which governs pension funds in the UK is a highly flexible one, and companies have traditionally had considerable leeway in constructing defined-benefit pension schemes according to their particular needs. The most recent trend has been towards ever tighter regulation of scheme deficits, which are regarded as debts due from the scheme sponsor (the employer). From 2004 the Pensions Regulator (TPR) was given far-reaching powers to order shortfalls in funding to be met by scheme sponsors. This is one of the factors making defined-benefit schemes less attractive to employers, who are starting to close them to new entrants, and, in some cases, to existing members (with respect to future service). Another factor is that potentially open-ended liabilities under defined-benefit pension schemes are seen as reducing shareholder value, in the sense of undermining the financial position of the sponsor company. This trend has been exacerbated by changes to the accounting treatment of schemes associated with the actuarial valuation standard, FRS17, which came into force in the early 2000s.
These various pressures have highlighted potential conflicts of interest affecting scheme trustees, in particular those trustees who are also senior managers and/or directors of the scheme sponsor. Our work has shown that conflicts of interest are particularly sharp during takeover bids. Trustees have a duty to ensure that takeovers are consistent with the solvency of the fund while, as directors or employees of the sponsor company, they may also have a view on whether they are in the interests of the company's shareholders and/or its workforce. More generally, we have found that pension funds have been altering their practices in such a way as to recognize the need for trustee independence from the sponsor company, but that this trend is tempered by the perception that members and sponsors also have interests in common. Thus members have a strong interest in maintaining the support of sponsors for the continuation of schemes, in a situation where those sponsors have the legal option of terminating or modifying them.
Pension funds also shape the wider corporate governance system as investors. The regulatory framework for pension fund activism is set, initially, by general principles of fiduciary law, which see trustees as fiduciaries, under a duty to obtain the maximum returns for members which are consistent with the long-term sustainability of schemes. Our empirical work suggests that while socially responsible investment (SRI) practices are growing in influence, this trend remains limited in the UK market. There is scepticism among trustees of the value to members of an SRI-based approach. Although most trustees and advisers now accept that an SRI-based approach is not incompatible with trustees' fiduciary duties (a major change from two decades ago), few accept the argument, that some international agencies have made, that it is necessary for funds to take SRI criteria into account as one aspect of a balanced portfolio.
In practice, few UK-based pension funds engage in activist strategies directly, in contrast to the position in the US. However, many UK funds are investors in hedge funds and private equity funds which take a strongly financially-orientated, shareholder-value approach to governance. Our case studies suggest that both these types of investment create sharp tensions between short-term shareholder value, on the one hand, and stakeholder concerns, on the other. We have made a detailed study of interventions by activist hedge funds in British and Japanese listed companies. The Japanese cases are interesting for the opportunity they provide to study the clash between the financially-driven, shareholder value orientation of the mostly British and American hedge funds and the stakeholder-orientated or communitarian ethic of many of the Japanese firms in which they invest. While a first phase of activist interventions was successful in generating above-market rates of return for the hedge funds in Japan, in a second phase the funds were less successful, as the result of resistance from target managers, limited support from other shareholders (including many non-Japanese investors), and widespread approval, in but also beyond government, for a communitarian ethic in corporate governance.