An Approach for Effective Governance Assessment

In the compensation and governance world, it is commonly known that shareholders are relatively quiet when companies are successful and driving returns. However, when things go south, shareholders question more and demand to know how corporate governance can be improved. These demands are accentuated for public pensions. When pension funds are performing well, there is little pressure, but after weathering through the past two recessions and, for some, experiencing co-payment holidays, under-funding status levels are understandably correlated to the increased level of pressure they are experiencing today.

In 2007, Ambachtsheer, Capelle, and Lum published The State of Global Pension Fund Governance Today. This study found that on an annual basis poor governance costs pensions 100 to 200 basis points (1%-2%). In our current market, where each basis point is precious, it is clear that governance is low hanging fruit on which all pensions should be focused.

An understood best practice in publicly traded companies is to conduct governance effectiveness assessments and disclose this activity on an annual basis. Due to the financial impact governance has on the success of publicly traded companies, the pension community should be proactively embracing this practice.

Pensions that undertake regular governance assessments can evaluate were they stand; maintain proactive improvement strategies; enable their Boards to become more effective in their oversight roles; and drive higher levels of financial success and sustainability for their funds.

When conducting assessments, pensions need to focus on:

1. Their Board members’ knowledge and ability to oversee investment and financial operations.
2. The composition of their Board members and the skills they possess.
3. Their governance frameworks and strategic improvement aligned to their longer-term strategies.
4. Ensuring that there is clarity on the roles of the Board and management, which enables both groups to function at their highest levels.
5. The establishment and maintenance of high-performance cultures that include competitive compensation and proactive incentives (that only reward positive results).

It is our experience that pension Board members are committed to ensuring that their fund can deliver on the pension promise to its members. The bottom line is that Board members “do not know what they do not know.” Undertaking a simple governance assessment is a recognized best practice in the governance world; and a great way to improve areas that pension fund board members never knew could be improved. This best practice ensures funds are able to safeguard 100 to 200 basis points for the benefit of their members.