Governance metrics tell an intriguing tale. But a checklist of standards detailing the makeup of a good corporate citizen reveals only part of the story. It takes judgment, observation, reflection and insight to flesh out the rest of the plotline.
Let’s be clear from the start, though: metrics do matter. There are certain rules of the game that serve as key benchmarks in creating a uniform understanding of what makes for good governance and good companies. At CalPERS, we have holdings in thousands of companies in dozens of countries. We require a playing field leveled by metric analysis to begin the decision-making process on where to invest. Yet we have only to look at the recent wild financial frontier and the near-collapse of the global economy to know that in so many cases, good governance principles were blindly, even disdainfully, ignored. In these volatile times, governance metrics can help lead the way to safety—and increased shareowner value.
Take a look at one vitally important area where metrics can help us cut through the dense financial landscape: executive pay. What the statistics show is clear. CEOs now receive nearly 400 times more in compensation than the average employee, sums wholly untethered to any kind of corresponding growth in profitability or creation of wealth. We may not have a metric to tell us how much is too much, but we do have metrics that can tell us if pay has become outrageously detached from performance, if pay is rewarding short-term measures, or if pay has become disturbingly oblivious to risk. Return on invested capital, total shareholder returns, and even share price, as fickle and as imperfect an indicator of performance as it is, can help investors determine whether compensation is anchored to a legitimate long-term strategy or whether it is adrift in a short-term sea of visionless mediocrity.
Still, the clarifying light of good governance metrics can only illuminate so much. This is where critics have rightly challenged proxy voting firms. Not all key corporate operations can be analyzed by marking off columns of boxes during a due diligence review. Not all information yields to metric equations and statements of principle. What’s missing, as Yale’s Jeffrey Sonnenfeld pointed out in his critique of good governance metrics, is “the human side of governance.”
Nowhere can we find a better example of this than the corporate boardroom. To outside observers, for example, an objective laundry list of well-considered metrics detailing the DNA of an independent director may be sufficient, even satisfying, but in reality it’s a two-dimensional document with a defining weakness: It’s an account of what the independent director is not.
The real calculations begin with a list of what the directors are: Competent? Objective? Fearless and energetic? Some proxy ratings firms have constructed good governance blueprints from formulas that neglected to factor in the qualitative aspects of human behavior. Structural issues that follow a uniform, consistent path respond nicely to a nudge from these kinds of metric-based analytics; boardroom actions typically do not.
We’re working with industry colleagues to build a diverse database of potential board candidates, keenly aware that a qualitative metric built around human dynamics is a central component of any serious discussion. Among the core traits we’re looking for are collegiality, the ability to listen and the willingness to be part of a team.
But how do you assess these characteristics? Not easily—and not simply from a cold stare at a matrix of metrics, though the outline of the story might begin there. This is an area where a tale of traits is revealed through hard work, meticulous research…and the simple, uncomplicated act of meeting and talking with a potential candidate. It can’t be done from afar. Do metrics matter? Yes, but…
Anne Simpson is senior portfolio manager for corporate governance at the California Public Employees’ Retirement System (CalPERS).