America has taken the largest single accumulation of investment capital in the country -- indeed, in the world -- and squeezed it into a suffocatingly narrow range on the investment spectrum, defined by traditional notions of "prudence." Designed to protect the retirement income of America's workers, the pension program's very success threatens its collapse under its own weight. More than $2 trillion is now under the control of laws that effectively relegate pension assets to permanent yet docile holdings in large, established companies. The consequences are devastating, not just for the capital markets, but for the American economy as a whole, and, ultimately, for the security of the very employees the system was designed to protect.

In a sense, that security was purchased with the money that would otherwise have been paid in taxes -- and, as I will argue below, it was purchased with the increased cost of capital that is a result of artificial restrictions on the money allocated for retirement income security. Nearly twenty years later, we must examine what we spent on this program, and whether we got our money's worth. We must do a cost-benefit analysis of the pension system not just in terms of the costs and benefits to retirees, but in terms of the costs and benefits to the American economy and to American society as a whole. We must recognize that the pension system is the source of long term capital for the economy, and we must make sure that the fiscal infrastructure it provides is a strong and stable one.

Experts from the business, academic, and public policy communities have loudly decried the absence of "long term" investment and the scarcity of "savings" for investment in America's future. They ignore the substantial savings held by our retirement funds that are ideal for long term investment capital. At least, they would be if not for the unthinking application of the "prudent man" standard of the traditional trust model.

This standard, so reasonable when seen in a vacuum, has devastating consequences when viewed from a macro perspective. But we have focused only on the micro perspective, considering only the problem of protecting the interests of beneficiaries from the agents retained to administer their assets. As in the classic prisoner's dilemma, what is "prudent" for individuals has an impact that is harmful for the group as a whole. In this case, the group as a whole is the entire citizenship of the US.

The micro focus began twenty years ago, when the laws governing the private pension system were debated. In that debate there was almost no consideration and certainly no study of the impact the proposed new federally insured pension system would have on the economy. The problem that was being addressed was the security of retirement income, and, perhaps because of the compartmentalized nature of the U.S. Congress' committee structure, that was the only focus of the debate.

The years of testimony before Congress covered only the pillage of employee retirement funds. This led in 1974 to the passage of ERISA, which imposed strict rules for the management of these funds, and created tax incentives to encourage employers to establish them. The assumption underlying this statute was that the sanctity of retirement plan assets was the only priority. The tax incentives were justified by the public interest in retirement security for employees. And the strict limitations on investment were justified by the public interest in keeping that money safe.

But what have been the consequences for the capital markets? No one ever imagined that within two decades by far the largest segment of investment capital would be subject to a "prudent" investment standard originally designed for small individual trusts. Can the United States (or, indeed, any country) afford to remove the enormous proportion of its total investable funds committed to pensions from risk investment? Won't the inevitable results be a systemic shortage of risk capital and an inclination to hobble business enterprises with capital unsuitable for a competitive world?

In this paper, I will begin with some background on the rather myopic origins of the private pension system and some of the unintended consequences of that myopia. I will explain the impact of the pension system's "sole" objective, securing the "pension promise," and the implementation of that objective through the "prudent man" rule. I will explain the anomalies and inefficiencies that result from allocating the largest block of investment capital to pension trustees subject to limits of that rule.

I will then view the system from the perspective of the economy as a whole. The U.S. capital system needs long-term owners of the principal industries and it needs an available source of funds for investment in new and expanding enterprises. These needs cannot be met under the existing "prudent man" investment standard. But it is possible to create a "prudent" system that can, while securing the "pension promise" at least as well and probably better.

My conclusion is that national investment policy should flow from the needs of the economy as a whole. This will require new securities and new financial intermediary institutions designed to provide retirement income security for America's workers and a source of INS capital for America's corporations.

* Pension Funds in the US -- Background *

Pension funds are already the largest component of institutional capital in the United States, comprising 38.2% of the total¹.

As of year end 1990, the pension systems aggregated $2.5 trillion of assets, of which 30.5% were public funds and, the balance, $1.737 trillion were private.

Pensions for local government employees ("public plans") are administered subject to the laws of the sponsoring state. Employee benefit plans established by private companies ("private plans") are regulated by the U.S. Department of Labor under the Employees' Retirement Income Security Act of 1974 ("ERISA").

54.6% of private plans and 37.3% of the public ones were invested in equity. Pension plans owned some 54.8% of the total equity of the 100 largest American corporations.

There are two categories of pension plans. The first, with a shrinking majority (53 percent of participants, 66 percent of assets)² is the "defined benefit" plan. In these plans, the employer is committed to a specific payout ("benefit"), no matter what level of contribution is made by the employee and no matter what the performance of the investments. The employer, whether corporate or government, bears the risks; to an extent, the employer is guarantor of a specific defined benefit. In defined contribution plans, on the other hand, the employee bears all the risks.

In the case of both types of pension plan there is incentive to achieve superior investment results. The plan sponsor of a defined benefit plan, whether public or private, clearly wants to reduce its obligation to make additional payments into the pension scheme. It can achieve this to the extent that plan assets are invested to yield a return greater than that assumed by plan actuaries.

Public plans are entirely funded by the taxpayers and private plans are significantly subsidized through tax incentives. So in the case of both defined benefit and defined contribution plans, the pension system is "purchased" by a substantial tax subsidy. Both public and private systems are dealing with what is, in reality, public money. Therefore, it is not only appropriate but it is essential for the government to assure the taxpayers are getting their money's worth. We can accept the "tax cost" of the pension system only as long as the expenditures can compete with other societal needs in serving the public interest. And there is increasing concern about whether that can be done.

Respected economist Alicia H. Munnell, Senior Vice President and Director of Research of the Federal Reserve Bank of Boston, has said that "The U.S. Treasury estimates that personal income tax receipts in fiscal year 1992 would have been $51 billion higher without the special provisions accorded employer-sponsored pension plans. It is at best unclear that taxpayers are getting their money's worth from this large tax expenditure."³ Ms. Munnell's remarks were in the context only of the workings of the pension system itself; that is, she was questioning simply whether the benefits from the level of retirement income security provided by the system are justified by the expense. She did not even raise the larger question of reviewing the overall costs and benefits to the economy as a whole, compared to the many other needs that are conspicuously less well funded.

But pension money has not, by and large, provided needed new capital or new employment. During the decade of the eighties, the S&P 500 corporations typically reduced their capital by buying back stock.⁴ And this (over)investment in the largest companies failed to create new jobs.⁵ Artificial inflation of investment in large-capitalization companies thus had no meaningful benefits either to those companies or to the pension beneficiary investors themselves.

* Pension Funds in the Economy *

At a time when public officials are bemoaning the absence of savings and investment capital, the country is actually enjoying plenty of both. We have failed to appreciate the importance of pension plans in the American financial structure only because the rigidity of economic language gives us no appropriate vocabulary.

For example, during the decade of the eighties, the aggregate size of the pension system expanded hugely as the stock market reflected unprecedented growth in equity values. And yet, economic classification has no place for these "capital gains." "By definition, savings are what is left over from income after consumption. And by definition, realized capital gains are not savings (since they don't depress consumption), but are simply an inflation of existing financial assets. But this is precisely the trouble: These time-honored definitions lead to a misunderstanding of the issue." ⁶ The conventional wisdom bemoans the absence of adequate or suitable capital because literally trillions of dollars of capital gain in the pension system are not taken into account. The fact is that the pension system right now comprises an extraordinarily well-funded aggregate of savings -- in all probability adequate for the nation's public and private needs. As I discuss later in this paper, the problem is more than one of semantics, it is also one of structure -- pension assets have been placed on a fiduciary pedestal, in effect, removed from the normal needs of the society, including investment involving risk.

Public pension funds are an illuminating example of the dilemma of the defined benefit plan. The commitment of the state to pay the promised pension is, in most cases, guaranteed by the state constitution. Whether or not there are adequate funds in the pension trusts, the state is obligated to pay the promised "defined benefit." So it is clear that "funding" is essentially a preferred mode of inter-generational fairness (the generation that receives the benefit of services should pay the taxes to provide the pensions related to those services).

Therefore, the level of funding and the investment policy governing trust assets are a purely political determination of appropriate risk. In that sense, the decisions about the level of risk for investing the assets in the trust "belong" to the state, not the beneficiaries, because the state is guaranteeing payment. Yet I am not aware of any occasion when a decision of this kind has been evaluated as a matter of public policy. The law in America does go a long way towards protecting individual beneficiaries' right to prudent management of system assets, but the question of what that means in macroeconomic terms is never asked.

Other questions have taken precedence. The decisions to "fund" pensions and to require the establishment of separate trust accounts demonstrate just what the priorities were. The most important has been protecting the pension funds from the government. The government has a history of repudiating promises, specifically the promise to pay retirement benefits to employees and retirees. The creation of independent "trust" funds is designed to give some protection from casual appropriation of the funds by government. That is some protection, but not much; any promise can be broken, even a promise to keep a promise. A government that can break one promise can break more than one, if the politics are right. The past year alone has seen several attempted "hostile takeovers" of public pension funds by governors looking for a way to balance the budget without raising taxes or cutting programs.

The same kind of distrust of private employers, based on the same kind of history, led Congress to impose the strictest standard ever developed in our legal system with respect to investment. Congress went back to the ancient English common law of trusts as the basis for proscribing standards of pension administration, and availed themselves of the inveterate and unchanging code of fiduciary conduct. Then they added on still another layer of requirements and prohibitions. Trust law prohibits trustees from benefiting personally from dealings with the trust estate. Trustees must administer pension trusts for the "exclusive benefit" of participants and beneficiaries (a standard explicitly included in the language of ERISA). Trust law provides a framework for effective accountability in administering "plan assets" and for assuring that pension plans will achieve the legislated goals.

* The Prudent Man Rule *

Traditional trust law held fiduciaries to a "prudent man" standard in investment, requiring trustees to behave as a hypothetical prudent man would, under like circumstances. This code has continued to evolve over the last two centuries, starting with the landmark case of Harvard College v. Amory in 1830 and most recently modernized by former SEC Commissioner Bevis Longstreth in Modern Investment Management and the Prudent Man Rule in 1986. ERISA goes further than the common law, requiring a "prudent expert." It is not enough to act as a careful amateur would under like circumstances; an ERISA fiduciary must be knowledgeable enough to act as a careful professional, experienced and educated in trust and financial matters.

"Prudence" is a design standard, not a performance standard. That is to say that it is process oriented, not result-oriented. If a trustee follows an established process that is designed to keep him informed and objective, no court will argue with the results. This is reflected in the two most significant elements of the rule. First is the requirement to diversify.⁷ Second is the exhortation to favor "seasoned" situations that similarly placed institutions find appropriate. This leads to the overwhelming preponderance of pension equity money being invested in the limited number of listed securities of American corporations with large capitalizations. ⁸ It also accounts for the huge increase in the "index" mode of investment.⁹

* Risk-Taking Managers and Risk Averse Investors *

But what happens when a horde of "prudent experts" goes to the marketplace to look for diversified and seasoned investments? Do they respond rationally (in economic terms) or prudently (in legal terms) to investments?

Taking a chance is the essence of making money. Corporate managers allocate available capital according to a risk/reward calculus. Normally, taking into account the inevitable less than perfect information, the potential projects with the most favorable risk/reward characteristics are those that get funded. An executive expects to lose, not infrequently, but, on balance, to come out ahead, largely because some of his risks succeed hugely. At least in theory, corporate managers are compensated according to how successfully they have managed the capital with which they are entrusted. Their incentive should be to take risks. Indeed, in order to be competitive with other companies, they must.

This is in sharp contrast to the position of the trustee. Their compensation is not geared to their success in managing trust assets. A trustee is paid a flat fee for performing his professional service. With rare exceptions, he is legally prohibited from being paid on a performance basis. Their risk is on the downside. Trustees are "surcharged" if any of their investments are deemed to be imprudent. The legal parameters for trust investment, therefore, result in one priority -- avoid risk. The criteria used in making investment choices by the trustee investor, on the one hand, and the corporate manager, on the other, are thus mutually exclusive.

Public fund trustees are sometimes appointed, sometimes elected, and sometimes civil servants who rose through the bureaucracy. They receive no special compensation in excess of their civil service pay for trustee work. Their controlling incentive is to avoid liability or demonstrably poor performance. To paraphrase New York State Controller Edward ("Ned") Regan, the conspicuously successful sole trustee of that state's Common Fund -- "No one ever got elected to anything on the basis of successful investment of the state pension plan." The consequences of poor investment are adverse publicity, notoriety and electoral vulnerability. The consequences of spectacular performance are marginal.

Private fund trustees are largely in the same position, despite the fact that in real world terms every dollar earned by the pension fund should be seen as equivalent to a dollar of increased earnings. The company's annual obligation to contribute to the defined benefit pension plan is reduced to the extent the plan's performance exceeds the actuarial assumptions. With few exceptions, large American companies have not staffed their pension operations with top level investment professionals. The top priority has been to avoid losses. As former General Motors counsel Elmer Johnson said, in An Insider's Call for Outside Direction :¹⁰

Ever since the creation of ERISA in 1974, boards of directors and their legal counsel have been driven chiefly by the fear of legal exposure. In establishing the apparatus for the administration of pension plans, they were mainly concerned with how best to insulate directors and officers from fiduciary liability. As a result, boards abdicated even their ethically nondelegable role of establishing overall direction and purpose. That abdication can no longer be excused in light of the explosion in the size of pension assets and the failure of the investment community to provide a climate conducive to the building of long-term, wealth generating institutions.

* Missing the Economic Forest for the Trustee Trees *

While trustee standards make unarguable sense from the perspective of the individual investor/pension plan participant and even from the perspective of the individual pension plan, those standards do not make sense from the perspective of the largest pension plans and the pension system as a whole.

For one thing, in a very real sense, the pension funds are the market. The pension system equity holdings are approaching $1 trillion ($679 billion - private, $282.5 - public), making up 28.2 percent of the total equity market.¹² There is no way that an investment of that size can achieve better results than the economy as a whole. While individual plans may "outperform" the market (many by substantial margins for significant periods of time), the system as a whole is simply too large to stay healthy in the midst of a sick economy. There is no such thing as a "safe" investment (which is why the standard is "prudence" and not performance).¹³ "Or to put it more directly, the collective performance of a large group of institutional investors is inexorably tied to the business performance of corporate America."¹⁴ The very size of the system has diluted the applicability of "prudence" as the controlling dynamic for pension investment.

What are we are trying to accomplish with the pension fund system. Certainly, it is not the inadvertent banishment of trillions of dollars from much of the capital market. Yet that is exactly where we are headed. And the very pension beneficiaries we are trying to protect are those who will be among the first to be hurt. Our current system establishes pension policy "from the bottom up." We look at what is best for the individual employees and the individual plans heedless of the consequences to the economy as a whole. What I am advocating is that we look at it "from the top down," starting with what we need to make our economy strong and competitive, and designing pension policy to act as a supporting beam in that structure.

Carolyn Brancato concludes from an analysis of the largest 200 pension funds' investment strategies in 1990 that .3 percent was invested in venture capital, .5 percent in leveraged buyouts and 1.5 percent in private placements. This sum of $32.2 billion out of the total holdings of the largest pension funds of $1.415 trillion is a statistical depictation of the results of "prudent man" investing.

The traditional notion of "prudence" limits this kind of investment to only the smallest fraction of the total portfolio. Because non-"seasoned" investments are in something of a Catch-22; they are permitted principally because their performance is statistically immaterial to the performance of the portfolio as a whole. Risk investment is at best a permissible embellishment for a fiduciary. It is not an activity encouraged to generate higher returns or to have ancillary benefits to the economy as a whole. Therefore, pension plans have little incentive to build staff or expertise in this area.

They also do not have the resources to improve the provisions of their "seasoned" investments. The collective choice problem (and regulatory restrictions) prevent any fund from having enough leverage to bargain effectively for change in the investment products being offered. In any other market-based system, a pool of capital of this size would be able to write its own ticket. In this case, pension funds, being themselves exempt from tax, would not rationally choose a mode of investment that was itself subject to tax. And yet this is what happens when pension funds buy "seasoned investments" -- in other words, common stock.

The earnings of corporations are taxed before funds are available for distribution to shareholders. Pension funds would prefer to invest directly in the pre-tax earnings of corporations and still retain the capital appreciation of ownership. While such a mode of investment is common in real estate, it has not been developed for financing industrial companies. "Prudent experts" have no mechanism for negotiating such arrangements.

Pension funds are not like other institutional investors. They have unique and different characteristics. These should be accommodated by the nature of the securities that they purchase. Two considerations are of great importance in designing an ideal security for defined benefit plan participants. The first is that the needs of the plans for liquidity can be determined with great certainty and the second is that pension plans are exempt from federal and state taxation. The liquidity needs of each system can be assured through purchase of appropriate debt securities, and then the balance of the assets can be considered as "permanent capital." What this suggests is that the best way to meet pension system objectives is by investing in unmarketable securities with special features taking advantage of the plan's favored tax status. If all we care about is retirement income security, the particular needs of defined benefit plans can be met by investment in securities specifically designed for that purpose. The ideal holding would be a government bond indexed for inflation. This would secure the riskless payment of a "real pension." This is, of course, exactly the opposite of the present situation in which most pension fund equity investment is in highly marketable taxed common stock. What we have then, is the worst of both worlds, a sub-optimal investment both from the perspective of the pension fund plan participant and the economy as a whole. The pension plan participant pays a premium for liquidity he does not need. The economy removes itself from the energy and support true market-based risk analysis provides.

Why hasn't the institutional structure necessary to service the special needs of public and private pension funds developed? The most important reason is the classical "prisoners' dilemma" or collective choice problem. Without some vehicle for collection action, individual investors, even enormous ones, will act (or fail to act) in a way that is slightly in their interest as individuals even if it is contrary to their interests as a group.

* The Optimal Role for the American Pension System in the Capital

Structure of America *

We clearly have a need for long-term patient capital. Pension funds are ideally situated to play this role, because they have actuarially determined pay-outs decades away from the time of investment. As noted above, risk-averse trustees are faced with a choice between trying to beat the market (all but impossible to do, with no benefit if they succeed and great risk if they fail) and "passive" investment through index funds that replicate the market.

Indexation is the epitome of the "prudent" mode of investment --by definition, participants are diversified, investments are "seasoned" and performance is tied to the market. Furthermore, considering the system as a whole, "indexation" does not involve any performance loss to the participants and beneficiaries of pension plans. The ideal index would be comprised of diversified equity securities that made use of the tax favored nature of pension plans. Even if that cannot be accomplished, pension system investors should be able to achieve, in return for the lack of liquidity, an effective governance mechanism. As has been frequently said, if you cannot economically sell your shares, you have no choice but to inform and involve yourself in the governance of the company; in the language of the late Albert Hirshman, if you cannot EXIT, you must use VOICE. With a governance structure in place, an index-based system of pension fund investments provides exactly the large, long-term ownership base necessary for national industrial prosperity.

The challenge is to convert the pension system into functional ownership of U.S. industry. We must change the perception that institutional shareholders are the mongoose and management is the cobra. David Walker (at the time of the statement, an official of the Bank of England and more recently head of Britain's Securities and Exchange Commission, the SIB) explains how the absence of a monitoring capability either by debt holder or equity investor harms the Anglo-American companies in world competition.

I think it would be a justifiable criticism that institutional shareholders have not been active enough in this respect and that, far from failing to support the companies of which they are major shareholders, they have if anything been insufficiently critical and insufficiently ready to exert their influence in a timely manner, so that drift in performance has tended to continue. Welcome as the relatively low gearing [English for debt/equity ratio] of British companies is in other respects, it does place on shareholders a bigger responsibility for oversight and influence than in situations where debt plays a larger role and bankers are thus more closely involved. I think that the answer lies in building up critical mass in terms of a wider understanding and expectation in both industry and investing institutions that it is responsible behavior for institutional shareholders to take a closer interest in the boards of their companies than has generally been the case in the past."¹⁵

The real need is for owners in contrast to investors or speculators. We noted earlier that the pension system owns approximately 55 percent of the equity of the 100 largest American companies. The trustees of pension funds have no particular qualification to act as the voters of the controlling stock holdings of corporate America. Their qualifications lies in other directions. Having explicitly recognized this problem, we must press on to find ways to take advantage of the fortuity of the huge pension plan "permanent" equity holdings. While I think it is a mistake for the government itself to become involved in the substance of corporate governance,¹⁶ it is certainly appropriate for the government to establish the standard for "prudent" exercise of ownership rights. There has been some evidence recently of effective ownership action, but it is still sufficiently anecdotal and ephemeral that specific governmental mandate would be useful. While fiduciaries clearly understand the need for active shareholder involvement in order to avoid disequity, the collective choice problem is such an obstacle that the risk/return ratio from the optic of a single shareholder, even a large one, is prohibitive. Bearing all the costs of ownership initiative is difficult for a trustee to justify against the prospect only of a pro rata share of value increase, and that, only in the event of success. Clarification of legislative intent would relieve trustees of their present conflict between incurring expense for the benefit of owners generally and their specific responsibility to trust beneficiaries. There is the possibility that emerging Department of Labor policies requiring fiduciary shareholder involvement may already be applicable to public plans.¹⁷ Whether through governmental direction or trustee resolution, pension plans need to reflect the understanding that maximization of the value of their holdings requires effective ownership involvement in public companies. Because shareholding is fractionated and conventional statutes and practice contain no provisions enhancing collective action, the starting point for pension plans should be to use their ownership power to create structure enabling owners "rationally" to be informed and involved. In developing a structure for ownership involvement, public plans will assure that appropriate and different processes and agendas are developed for individual companies. In this way, the substantive interests of public plans can be effectively advanced in a specific framework.

Beyond the need for an "involved" ownership base for traditional industry, there is need for capital to finance expansion and new ventures.¹⁸ The recent recession has highlighted the need of small business for a continuing source of capital. "If the reportedly revived spirits or American small business are to materialize in growth and job creation, somebody has to provide financing. The banks are still greatly distracted, the thrifts have been charred by FIRREA and the insurance companies are feeling their own "mark to market" accounting heat. Overseas sources have their own problems. The public markets have been booming, sure, but companies of less that $200 million in capitalization or sales can't usually muster an offering of sufficient size to ensure mutual funds investors the liquidity they desire. That leaves pension funds - trillions of dollars strong but without a vehicle for buying into this "non-investment grade" sector of U.S. business."¹⁹

It is well known that small business is the primary creator of new jobs in the economy. Small business' annual need for net new capital has been estimated at about $85 billion to finance new startups and to provide expansion capital for the rapid growth companies that generate most of the new jobs in the economy. Simply to illustrate the dramatic impact of facilitated pension plan involvement, five percent of the current two and a half trillion in pension assets would amount to one hundred and fifty billion in institutional financing for small business²⁰ while allocating 25 percent of new pension fund money would provide fifty billion in new institutional financing for small business annually or over twice the current amount of net new financing currently provided by commercial banks and professional venture capitalists.

Direct investment in small businesses takes pension funds out of the ambit of "prudent man" investing. " A trustee cannot properly use trust property in the carrying on of a trade or business, but where a testator leaves his estate in trust and the estate includes his interest in a business.... it is the duty of the trustee to withdraw the testator's property from the business..."²¹ While the amounts involved conceivably could be justified as "diversification" of the entire portfolio, the risk averse characteristics endemic to trusts and trustees would doom such investments to failure. There is need for government to create a special category and to permit investment of a certain portion of the pension system outside of the trustee mode and in the risk/reward mode of traditional business investment. Depending on their skill executing this policy, pension plans might well achieve higher levels of return than from passive investments. What will be needed is a new culture, new expertise and new intermediary and professional service structures. These new structures will need reflect the collective resources and needs of pension plans. The optimal mode of investment may well be through a pooled product: " Most fiduciaries seeking to deploy portfolio funds in venture capital do so through venture capital pools, because, typically, the fiduciaries lack the special expertise required, the most capable managers in the field are available only in the pool mode, and the necessary diversification can readily be achieved this way."²² The establishment of the pension system as the principal financier of small business would ensure any adequacy of capital to finance continuing growth that is essential to a health economy - that, in turn, is the only real assurance that the "pension promise" will be paid.

Summary

1. The pension system must be considered as a whole and not solely from the perspective of individual participants or plans.

2. The "Prudent Expert" standard for investments as it is currently interpreted and applied is not appropriate for the pension system as a whole.

3. Pension assets can be prudently invested to yield better numerical returns than they are achieving now through passive investment by providing that some of the assets be invested actively.

4. Government needs to enact specific new policy in several directions:
   1. The "prudent expert" mode of investment needs to be explicitly superseded by a "modern pension investment policy." This policy should focus on requiring trustees to allocate plan assets between particular categories of investment alternatives. The Federal Employees Retirement System, enacted in 1986 by Congress for its own pension fund and that of other federal employees, provides a model. The menu of alternatives would include equity (3 below), debt (4 below) and a category that might be styled Alternate Emerging Investment Opportunities ("AEIO," 5 below).

   2. Inconsistencies in tax incentive need to be clarified. For example, it seems inefficient to permit tax-exempt entities such as pension funds to participate in equity ownership solely through securities whose income is subject to tax at the corporate level. Some serious study should be given as to the desirability of a fully tax exempt mode of equity financing.

   3. The "equity" choice would be limited to index funds, with a preference for those that represent the economy as a whole in contrast simply to the largest public companies. An ancillary benefit of adopting this investment strategy is in assuring that American corporations have that "creative tension" between ownership and management that assures the most satisfactory performance. Through their index holdings, the pension system as the largest "shareholder" of American companies (and a permanent one) can "prudently" organize to assure that the traditional responsibility of ownership to monitor management is effectively discharged. (See Monks & Minow, Power & Accountability )

   4. The debt choice could include new instruments designed to meet the particular needs of pension funds.

   5. There should be a category for no more than a limited percentage of total plan assets for "alternate emerging investment opportunities," to assure pension fund involvement in meeting the needs for change in the economy.

   6. In order to permit investment most efficiently by the entire pension systems, new financial institutions may well be needed. As the largest "customer" -- that is to say, the source of the most money -- pension funds should have substantial voice in determining the nature of financial products. In order to make this voice heard, special purpose institutions reflecting the particular perspective of the pension system may need be authorized by Government. In order to minimize conflicts of interest, these new institutions probably should be limited to the pension plans.

RETURN TO PAPERS & SPEECHES LISTING





Copyright © 1996, LENS Inc. All Rights Reserved
Comments to webmaster@lens-inc.com