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From Securities Regulation Daily, September 24, 2018

Peirce criticizes California’s female-directors bill for catering to stakeholders

By Anne Sherry, J.D.

In remarks at the SEC Hot Topics Conference, Commissioner Hester Peirce took aim at the prioritization of environmental, social, and governance (ESG) issues in corporate governance, such as a recent California bill on board gender composition. Such measures cater to a broad group of stakeholders, Peirce said, rather than allowing corporations to focus on its shareholders. Meanwhile, long-developed corporate law rests on the assumption that the board owes its principal duty to those shareholders.

Stakeholders don’t get a say. Peirce noted that the preface of the California bill, which has not yet been signed, says that improving women’s representation on boards "will boost the California economy, improve opportunities for women in the workplace, and protect California taxpayers, shareholders and retirees." Although shareholders are mentioned, the list of stakeholders is much broader. In other areas of life, stakeholders are not able to dictate others’ behavior, Peirce continued. She cannot tell her condominium neighbors not to cook fish even though the smell wafting over to her unit makes her a stakeholder.

Corporate directors have a fiduciary duty to their shareholders to maximize the value of the company, although they may prefer to cater to a more nebulous stakeholder group in part to make their performance harder to measure. "If the law allows directors and managers to elevate certain stakeholders over shareholders, the law is complicit in a breach of fiduciary duty," Peirce asserted. She added that requiring a company to cater to other interests compromises the public interest by interfering in board decisions and obstructing the price discovery function of the securities markets.

ESG is broad and ill-defined. The California bill cites evidence suggesting that companies with women on their boards are better than other companies in a number of respects. In this case, Peirce said, companies already have strong incentives to consider that evidence, along with other factors that might affect long-term value. By forcing corporations incorporated or headquartered in California to consider all women as stakeholders, the bill opens "a wide door [that] introduces uncertainty and political influence into corporate operations."

The effectiveness of ESG criteria is difficult to measure because the factors comprise a broad range of corporate behavior, Peirce continued. Although she does not take issue with funds that pursue stated social-interest goals—as long as those institutional investors do not force companies to take steps that harm long-term value—Peirce highlighted problems that can arise when managers make investment decisions on behalf of others who do not share their ESG objectives. This issue arises particularly with captive individual investors, such as pension beneficiaries.

Although about 70 percent of managers use ESG factors in evaluating their investments, it is difficult to say for any given company that those factors in particular resulted in higher returns. And because ESG is not well defined, a company may count the good practices it has used for centuries as ESG measures. This highlights another issue with ESG factors: it has been presented as comparable to financial reporting, but it lacks the uniform standards present in financial reporting. Furthermore, regulators lack the expertise to assess how well companies adhere to ESG standards and properly disclose their compliance. "We have a tough enough time with non-GAAP metrics," Peirce quipped.

Efforts are underway to establish ESG standards, but many ESG factors are not susceptible to comparability. There is also subjectivity in the setting and application of standards. Finally, once a standard is set, it is hard to determine whether a company meets it. Peirce concluded by saying that as one type of stakeholder, a regulator, she looks forward to listening to people’s views on these issues.

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