Toward Healthy Companies and a Stronger Economy: Remarks to the U.S. Treasury Department’s Corporate Women in Finance Symposium
Commissioner Kara M. Stein
April 30, 2015
Thank you Treasurer [Rosie] Rios for the invitation and the warm introduction. It is a pleasure to be here this morning at the Treasury Department.
As always, I need to offer the usual disclaimer that the views I am expressing today are my own, and do not necessarily reflect those of my fellow Commissioners or the staff of the Commission.
At the United States Securities and Exchange Commission (“Commission”), we deal on a daily basis with a wide range of pressing and complicated matters. Accounting standards, corporate disclosures, money-market mutual funds, high-frequency trading, foreign corrupt practices, swap regulation, crowdfunding, credit rating agencies – the list goes on and on. Each of these areas presents its own issues and challenges, and we often work through them individually, through individual rules or cases.
However, it’s also important for all of us, both within government and outside, to step back and consider some of these issues and challenges more comprehensively and within a larger policy framework. This morning’s symposium is a great opportunity to do just that. That’s why I’m so pleased to be here this morning to engage with some of the best and brightest corporate women (and men) in finance.
The topic of today’s symposium is “Opportunities for Investment, Innovation, and Growth through Technology and Corporate Governance.” Your first panel covered innovation and technology in the 21st century, and the second will discuss corporate governance and workforce investment. A key theme throughout is the role of women in all of these areas.
Since I am speaking between these two panels, I thought I would share some thoughts from the securities regulatory perspective that are relevant to each. First, I’d like to explore the debate over short-termism and capital formation in our markets. Are our financial markets supporting the development of healthy companies that can compete, grow, and create jobs for the long-term? Second, I hope to suggest some ways that investments in good corporate governance today may lead to stronger, more inclusive, and more resilient companies tomorrow. I will focus especially on the composition of boards of directors. More than anything, I hope to raise some important questions and get feedback from you, not just today, but also going forward
How Should Securities Regulators Think About “Short-Termism” and Its Effects on the Economy?
In my role as an SEC Commissioner, I spend a great deal of time working on and thinking about capital formation and innovation. Innovation isn’t explicitly part of the SEC mission statement. But the Commission does indeed support innovation — through facilitating capital formation, which is part of the Commission’s three part mission statement.
I have spoken several times about capital formation and innovation during my tenure as a Commissioner, and it has tended to be about small and medium sized companies. I have been thinking about ways to plug the gaps in access to capital for startups and emerging companies. I want to make sure our regulatory architecture evolves to meet the changing marketplace for these companies. I also have been urging the Commission to be creative in its own thinking about capital formation for smaller and medium sized companies. As companies continue to innovate, the Commission has to adapt as well and make sure that our capital formation rules and options keep pace with the marketplace.
Several new capital formation options are currently being considered and discussed by the Commission and staff. Some of these options for growth will succeed and some may be lightly used, which is to be expected. It is important for us to be exploring new ideas and trying some new options in this space. The important point is that we are all engaged in thinking about how to best fund companies given the dramatically evolving global marketplace. The capital formation process and the securities laws should be flexible enough so that businesses have a variety of options that can hopefully suit their unique needs while still protecting investors.
Today, though, I want to talk about capital formation and innovation at the other end of the spectrum – in the context of our largest public companies. In 1954, the President of the New York Stock Exchange spoke about what he called the “Help Wanted” sign of American industry:
American business today needs new partners – men and women willing to advance a portion of their savings to provide industry with the equity capital it must have in the years ahead, to create jobs for those added each year to our working force, to produce new and improved products devised by industrial research, and to continue to raise the standard of our growing population.
He discussed the “necessity” of increasing business expenditures for equipment, new and expanded research and development, and job creation to fuel economic growth.
The question of “short-termism” in financial markets has sparked a debate around whether public companies are currently pinning up the “help wanted” sign, so to speak, to obtain the resources from investors they need to thrive and grow. The heart of the argument is that short-term pressures from certain investors, and markets in general, compel companies to look narrowly at the short-term. As a result, companies become overly focused on meeting quarterly earnings targets. They may regularly offer up large amounts of a company’s earnings as payouts to shareholders. To meet these demands, companies have to cut back on capital expenditures, research and development, workforce training, and other investments that lead to new innovation, higher productivity, and future growth.
Recently, many observers have brought up the issue of short-termism in the context of stock buybacks, which I’d like to spend some time discussing. Many have highlighted the fact that companies are using their cash resources to buy back shares at record numbers, instead of investing in longer-term projects. In fact, stock buybacks have become a significant use of cash by some of the nation’s largest companies. In 2004, companies announced plans to repurchase $230 billion in their own stock.  Last year, total shareholder payouts (including $350 billion in dividends and $553 billion in buybacks) amounted to 95 percent of the companies’ profits, up from 88 percent and 72 percent the two years pervious. Companies are on track this year to spend over 100 percent of their corporate earnings on total payouts. Over the last decade, 90 percent of the companies in the S&P 500 index bought back their own stock, using over $3.4 trillion to do so. That’s an awful lot of cash – and over half of the earnings generated by these enterprises. Why are they deploying their cash in this fashion?
The explanation for why this is occurring is likely multi-faceted and not completely clear. Reasons cited include incentives in the tax code such as the treatment of long-term capital gains, the accounting treatment, the quarterly cycle of corporate earnings targets, short-term trading strategies by some investors, or even a culture of immediate gratification. A combination of weak demand and extraordinary monetary policy may also be a factor.
It’s worth thinking about what effect this uptick in stock buybacks may be having on innovation and capital formation. How is it affecting an ecosystem that supports healthy companies, growth, and job creation?
Stock buybacks have the mechanical effect of increasing a company’s Earnings per Share (EPS) by reducing the number of outstanding shares. This may help to achieve compensation targets and quarterly EPS targets. However, it would be troubling if companies were mortgaging their futures – and the futures of their employees and other stakeholders - just to meet short-term quarterly EPS targets.
I would be remiss, though, if I didn’t also highlight that a meaningful body of research disputes the notion that short-term investment horizons are in conflict with longer-term performance at all. In fact, one recent study found that companies with engaged investors grew return on assets by 9 percent and research and development by 2.6 percent in the first year after their investment.
What are the causes or solutions to this issue, to the extent that we need them? Is the increase in stock buybacks a permanent change in the markets, or a temporary change that copes with current market conditions?
Symposia like today’s – where we are looking at questions of technology, innovation, corporate governance, and their relationship to economic growth and prosperity – are excellent opportunities to think about these and other tough questions. We need to be thinking about what is either incenting or disincenting long-term thinking and sustained, real growth. As a society, we owe it to future generations to think about these issues.
And many of these issues are tough and cut across a number of different policy areas and federal agencies. I think the Commission has a role to play, along with all of our fellow federal regulators. To that end, I hope that we all explore this issue of short-termism going forward. Let’s try to understand the extent to which we may be encouraging behavior that affects long-term outcomes for American business, and if so, get some creative ideas out there for all to consider – regulators, shareholders, and management.
Investing in an Inclusive Approach
I want to shift gears now while still focusing on how we can strengthen our public companies – by discussing the role of boards of directors. Board composition is vitally important as directors certainly play a meaningful role in helping companies make productive investments and good decisions going forward.
An increasing body of research shows that having more inclusive boards of directors benefits a company. For example, studies suggest that women may be better monitors of executives, a central function of boards of directors. Diverse boards appear to help avoid “groupthink,” a priority when corporate success depends heavily on risk management.  Another survey found that boards with above average levels of gender diversity had fewer instances of bribery, corruption, fraud, and shareholder battles. A number of studies suggest that boards with more women outperform other boards on performance metrics like sales and return on equity. So why aren’t boards of directors more diverse?
Several years ago, the SEC implemented a rule requiring modest disclosures related to whether and how diversity factors into the board nomination process. In the intervening years, however, boardroom representation of women and minorities has not increased significantly. As of 2011, just 16.1 percent of board positions were held by women. In 2013, that number increased to just 16.9 percent. For women of color, the numbers are even worse, with just 3.2 percent of board positions in 2013. One tenth of our companies have no women on their board of directors at all. So what is going on, and what can or should be done?
Recently, there have been a variety of suggestions that could help achieve different board compositions – compositions that balance strong directors with institutional expertise, with directors who can provide new, diverse, and potentially challenging ideas. For example, would requiring an independent, third-party evaluation of directors provide insight into potentially underperforming directors? Would directors who know they are not as strong then voluntarily step down to help allow for increased turnover? Are there benefits to requiring board nominee characteristics and qualifications to be presented to shareholders in a matrix? 
Might this lead to the selection of boards that have critically important but diverse skills, like risk management? What are the drawbacks to these ideas? Throughout all of this, it is fundamentally important to keep in mind that that “qualifications – not identity – of the candidate become the driving consideration for selection.”
On another front, could increased shareholder engagement help contribute to changing board composition? If so, how do we empower shareholders and give them a meaningful vote? On February 19, 2015, the Commission held a roundtable to discuss some of these issues. We had a panel on “universal proxy ballots” and a panel on how to increase shareholder engagement more broadly.
As some of you may know, through the strange confluence of federal and state law, shareholders who vote by proxy rather than in person have more limited choices in voting for directors. Specifically, only shareholders who attend the meeting in person can vote for any individual nominated. However, shareholders who vote by proxy are generally limited to choosing from among either the management’s nominees or the shareholder-proponent nominees. They usually cannot pick and choose among the two. A universal proxy ballot would fix this incongruity, and provide better choice for all shareholders, and might even result in a more diverse board.
Can we think of more ways? Are there additional changes to the shareholder voting process that may help? I hope that today’s discussions will be the start of an on-going conversation on these issues.
Looking Towards the Future
To conclude, America’s public corporations are powerhouses around the world. They employ millions of Americans and provide many of the products and services we rely on every day. And our corporate leaders want to and usually are doing the right thing in the vast majority of decisions they make on a daily basis. That is the reason we are all here today. To make sure our companies – small, medium, and large - continue to be strong and healthy not only now but also in the future. Everyone here today has shared goals: strengthening the American economy, keeping our companies innovative and resilient, and ensuring good-paying jobs for future generations of Americans. By bringing together thought leaders from many different parts of the government and the private sector, today’s conversation can get us started on new, creative, and novel thinking about how we can meet these goals.
Thank you, I hope you all enjoy the rest of the symposium.
 The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.
 See, e.g., Commissioner Kara M. Stein, “Supporting Innovation Through the Commission’s Mission to Facilitate Capital Formation,” March 5, 2015, available at http://www.sec.gov/news/speech/innovation-through-facilitating-capital-formation.html.
 G. Keith Funston, “Wanted - More Shareowners,” Dickinson Lectures, Harvard Business School, April 1954, available at http://3197d6d14b5f19f2f440-5e13d29c4c016cf96cbbfd197c579b45.r81.cf1.rackcdn.com/collection/papers/1950/1954_0420_WantedFunstonT.pdf.
 See, e.g., Mike Konczal, Senator Baldwin is Asking the SEC Questions About “Disgorge the Cash,” Next New Deal, April 23, 2015, available at http://www.nextnewdeal.net/mike-konczal; Dominic Barton and Mark Wiseman, The cost of confusing shareholder value and short-term profit, Financial Times, April 1, 2015, available at www.ft.com/intl/cms/s/0/bce20202-d703-11e4-97c3-00144feab7de.html#axzz3YZ6wxTtW.
 See William Lazonick, Stock buybacks: From retain-and-reinvest to downsize-and-distribute, Center for Effective Public Management at Brookings, April 2015, available at http://www.brookings.edu/research/papers/2015/04/17-stock-buybacks-lazonick (Lazonick).
 See id.
 See Matt Levine, Private Companies Will Take Money Public Companies Don’t Want, BloombergView, March 24, 2015, available at http://www.bloombergview.com/articles/2015-03-24/private-companies-will-take-money-public-companies-don-t-want.
 See Lazonick.
 See Lucian A. Bebchuk, Alon Brav and Wei Jiang, The Long-Term Effects of Hedge Fund Activism, Harvard John M. Olin Center for Law, Economics, and Business Discussion Paper No. 802, 12/2014 Revised April 2015 (forthcoming, Columbia Law Review, Vol. 114, June 2015), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2291577.
 See Frank Partnoy, “The Surprising Market Response to Activist Hedge Funds,” Wall Street Journal, April 23, 2015, available at www.wsj.com/articles/the-surprising-market-response-to-activist-hedge-funds-1429743683, referencing C.N.V. Krishnan, Frank Partnoy, and Randall S. Thomas, Top Hedge Funds and Shareholder Activism, Vanderbilt Law and Economics Research Paper No. 15-9, April 3, 2015, available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2589992.
 See Renee Adams and Daniel Ferreirra, Women in the Boardroom and their Impact on Governance and Performance, Journal of Financial Economics, 2009, available at personal.lse.ac.uk/FERREIRD/gender/pdf.
 See Letter to Ms. Elizabeth Murphy, Petition for Amendment of Proxy Rule Regarding Board Nominee Disclosure – Chart/Matrix Approach, March 31, 2015, available at www.nctreasurer.com/inv/Resources/ProxyRuleAmendmentPetition.pdf (Pension Fund Letter).
 See MSCI Executive Summary: 2014 Survey of Women on Boards, Nov. 14, available at https://www.msci.com/resources/research/articles/2014/Executive_Summary-2014_Survey_of_Women_on_Boards.pdf.
 See Yilmaz Arguden, Why Boards Need More Women, Harvard Business Review, June 7, 2012, available at hbr.org/2012/06/why-boards-need-more-women.
 See Securities and Exchange Commission, Proxy Disclosure Enhancements, Securities Act Release No. 9089, Dec. 16, 2009, 74 FR 68443 (Dec. 23, 2009); 17 CFR 229.407(c) (Regulation S-K, Item 4-7(c)).
 See 2013 Catalyst Census, Fortune 500 Women Board Directors, http://www.catalyst.org/knowledge/2013-catalyst-census-fortun-500-women-board-directors; see also 2012 Catalyst Census, Fortune 500 Women Board Directors, available at http://www.catalyst.org/knowledge/2012-catalyst-census-fortun-500-women-board-directors.
 See Pension Fund Letter.
 See Pension Fund Letter, quoting Michele Hooper & Anne Simpson, How to Engage Shareholders When Selecting New Directors, NASD Directorship Magazine, January/February 2013, at 13.
 See Commissioner Kara M. Stein, “Ensuring that Shareholders Have a Meaningful, Effective Vote,” February 19, 2015, available at http://www.sec.gov/news/statement/ensuring-shareholders-have-meaningful-effective-vote.html.