In my book, Corporate Governance after the Financial Crisis
... the costs of institutional investor activism likely outweigh any benefits such activism may confer with respect to redressing the principal-agent problem. Even if one assumes that the cost-benefit analysis comes out the other way around, however, institutional investor activism does not solve the principal-agent problem but rather merely relocates its locus.
The vast majority of large institutional investors manage the pooled savings of small individual investors. From a governance perspective, there is little to distinguish such institutions from corporations. The holders of investment company shares, for example, have no more control over the election of company trustees than do retail investors over the election of corporate directors. Accordingly, fund shareholders exhibit the same rational apathy as corporate shareholders. ... Nor do the holders of such shares have any greater access to information about their holdings, or ability to monitor those who manage their holdings, than do corporate shareholders. Although an individual investor can always abide by the Wall Street Rule with respect to corporate stock, moreover, he cannot do so with respect to such investments as an involuntary, contributory pension plan.
For beneficiaries of union and state and local government employee pension funds, the problem is particularly pronounced. As we have seen, those who manage such funds may often put their personal or political agendas ahead of the interests of the fund’s beneficiaries. Accordingly, it is not particularly surprising that pension funds subject to direct political control tend to have poor financial results.
As an op-ed by Andrew Biggs in today's WSJ makes clear, public pension funds suffer from agency cost problems that are at least as severe as those of the corporations excoriated by activist funds:
State and local pension plans invest roughly twice as much in risky assets as would a prudent individual saving for retirement. ...
... Calpers holds about 75% of its portfolio in stocks and other risky assets, such as real estate, private equity and, until recently, hedge funds, despite offering benefits that, unlike IRAs or 401(k)s, it guarantees against market risk. Most other states are little different: Illinois holds 75% in risky assets; the Texas teachers’ plan holds 81%; the New York state and local plan 72%; Pennsylvania 82%; New Mexico 85%. ...
Public pensions are addicted to risk and, because they are effectively “too big to fail,” require an intervention.
In addition to holding excessively risky portfoloios, of course, public pension funds notoriously are too optomistic in their actuarial assumptions:
While Americans are typically earning less than 1 percent interest on their savings accounts and watching their 401(k) balances yo-yo along with the stock market, most public pension funds are still betting they will earn annual returns of 7 to 8 percent over the long haul, a practice that Mayor Michael R. Bloomberg recently called “indefensible.” ...
“The actuary is supposedly going to lower the assumed reinvestment rate from an absolutely hysterical, laughable 8 percent to a totally indefensible 7 or 7.5 percent,” Mr. Bloomberg said during a trip to Albany in late February. “If I can give you one piece of financial advice: If somebody offers you a guaranteed 7 percent on your money for the rest of your life, you take it and just make sure the guy’s name is not Madoff.”
It's long past time that publc pension funds take a lead from Matthew 7:3-5, and remove the log from their own eyes before going after corporate splinters.
Today's WSJ reports that:
Investors are stampeding into initial public offerings at the fastest clip since the financial crisis, fueling a frenzy in the shares of newly listed companies that echoes the technology-stock craze of the late 1990s.
October was the busiest month for U.S.-listed IPOs since 2007, with 33 companies raising more than $12 billion. The coming week is slated to bring a dozen more initial offerings, including Thursday's expected $1.6 billion stock sale by Twitter Inc., the biggest Internet IPO since Facebook Inc.FB -2.10% 's $16 billion sale in May 2012.
As I document in my article How American Corporate and
Securities Law Drives Business Offshore, in The American Illness
During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.
Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.
In the article, I explained that how the risk of anti-fraud liability adversely affects the competitiveness of U.S. capital markets and how the federalization of key aspects of corporate governance during the last decade generated significant net regulatory costs adversely affecting those markets. None of these structural problems have been solved. Instead, the current book in IPO volume is happening despite them.
The reasons behind the IPO boom in fact make it look like an IPO bubble:
The rush to buy shares of newly public companies is the latest sign of investors' thirst for assets with potential upside, at a time when relatively safe investments are generating scant income due to tepid economic growth and Federal Reserve policies that have kept a lid on U.S. interest rates. ...
To others, however, the demand is an indication that a rally fueled primarily by abundant liquidity from the Fed, and not by earnings growth and economic expansion, is entering dangerous territory.
"When I hear intelligent investors asking me not which companies are good to invest in, but which IPOs can I get into, it scares the heck of me," said Mark Lamkin, a wealth-management adviser based in Louisville, Ky.
As well it should. Once the Fed starts to curb liquidity, the structural legal problems that beset US capital markets will quickly pop the present IPO bubble.
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