Public Pension Governance, Contracting Relationships and Performance Joel T Harper Oklahoma State University Rotman ICPM / Netspar / Maastricht University Discussion Forum – October 2007 Why Governance Matters • Competence of board members – Strategic planning – Reliance/monitoring of advisors and staff – Investment knowledge and strategy • Independence of board members – Agency Issues – Balancing Stakeholder interests • Board Member Motivation Does Public Governance Matter? • Investment Function • If there is a relationship between governance and performance? – If Yes, what is the optimal board structure/characteristics • If no relationship, then… – Why Not? – What are performance drivers/decision makers? Types of Public Plans • Coverage – Statewide – Municipal • Participants – – – – Public Employees Teachers Safety (Police and Fire) Other and Combined Board of Trustees (Representative Board) Inside Appointments Employees (Elected) Ex Officio Members Outside Members (Appointed) Board of Trustees Contracting Relationships Board of Trustees Executive Director and Staff Pension Consultant Portfolio Manager Portfolio Manager Actuary Portfolio Manager Portfolio Manager Portfolio Manager Investment Board Structure Investment Board Board of Trustees Executive Director and Staff Pension Consultant Portfolio Manager Portfolio Manager Portfolio Manager Actuary Portfolio Manager Portfolio Manager Sample of Plans • Public Plans – Required to provide information – Board Structure can vary • Plans with more than $200 million in assets between 2001 – 2005 • About 325 plan sponsors in the US • 125 plans were asked to provide information Study Sample • Currently, 71 Plans in Sample – 33 State, 36 Municipal – 33 Public Employees, 12 Teachers, 11 Safety, 15 Other or Combined • Average Assets – $5.4 billion mean, $1.5 billion median Board Information Median Total 9.2 16 % Appointed 36.4% 40.8% 100% % Elected 44.4% 41.9% 100% % Ex-Officio 11.1% 18.3% 100% % Outsider 22.2% 24.5% 80% N/A Term (Years) Mean Minimum Maximum 3.80 Outside Trustees “One (1) person who is a resident of the city and shall not be a Participant in the Plan, a City employee or elected City official.” “ four (4) residents of Mecklenburg County as trustees for three year staggered terms, one of whom is designated Chairman of the Board.” “The remaining three are appointed investment experts” Plan Performance • Funding Objective – Are the plans fully funded, or moving toward full funding? • Investment Performance – Fund Returns – Asset allocation Decisions – Manager Selection Plans’ Status • Average sample plan liability increases from $5.8 billion to $8.7 billion during sample period • Average funded level decreases from 96.9% to 83.6% over same period Does Board Governance Affect Performance? • Aggregate Fund Level – Panel Data • Fund Manager Level – Cross-sectional Data • Board Characteristics – % Board Appointed, % Board Outside, % Board Ex-Officio, Board Size, Board Term Fund Level (Gross Return) • Time-Series Cross-Sectional Model Re turni ,t = α + β1 %Out i ,t + β % Elect i ,t + β % ExOff i ,t + β 4Termi ,t + β Bsizei ,t + β Munii ,t + β Sizei ,t + β 8Teachersi ,t + β Funded i ,t + β10 Equity % i ,t + β11 Fixed % i ,t + ε i ,t • Estimate on total return and excess return basis Total Fund Return Empirical Estimations Portfolio Excess Return Empirical Estimations Findings • Board Composition does not affect fund returns • Board term and board size may have a negative effect on fund returns • Larger funds and municipal funds have higher returns • Funding Level is positively related to Excess Return Performance – Funded is a proxy for trustee competence? – Teacher plans also has positive effect Manager Selection • Cross-Sectional Model Estimation – Excess Return = Gross Return - Benchmark Ex Re turni = α + β %Out i + β % Elect i + β % Appt i + β 4Termi + β Bsizei + β ManSizei + β Sizei + β Munii n + β Feei + β10 Funded i + β11Teachersi + ∑ β j Stylei , j + ε i ,t j =1 Empirical Estimations Findings • Outside Board members not improve manager selection • For Fixed Income, Appointed and Elected Board Members improve manager selection • For Equity, board term has a negative impact on manager selection Additional Findings • Amount of assets managed increases excess return – Favoring large clients? • For Equity, higher fees lead to greater excess returns – Pay to play? • For Equity, better funded plans have greater excess returns Does Governance Matter? • Empirically, the effect of board structure is not extremely strong, especially outside board members • Why not? – Boards are similar (mostly representative) – Pension Consultant Impacts • What if? – Boards were not representative – Boards were paid experts • Is Funded level a proxy for trustee competence?