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- 14 / The Evolution of Public Sector Pension Plans 267
- 268 Robert L. Clark, Lee A. Craig, and Neveen Ahmed
- 14 / The Evolution of Public Sector Pension Plans 269
- 270 Robert L. Clark, Lee A. Craig, and Neveen Ahmed
- Pension Fund Activism: The Double-Edged Sword
- 272 Brad M. Barber
- 15 / Pension Fund Activism: The Double-Edged Sword 273
- Institutional activism: theory In this section, I formally lay out a simple framework to analyze the expected effects of institutional activism. Shareholders versus Managers
- 274 Brad M. Barber
The member handbook for the New Mexico public employees’ retirement asso-
ciation (PERA 2008: 5) states: ‘New Mexico enacted legislation creating a public
employees retirement system in 1947. New Mexico was the last state in the con-
tinental United States to establish a retirement system for its public employees.’
However, this information conﬂicts with other secondary sources and with data
14 / The Evolution of Public Sector Pension Plans 267
collected by the authors in their survey of current state plan administrators;
‘State welfare pensions for the elderly were practically nonexistent before 1930s’
(Social Security Administration 2008). However, the Great Depression created a
well-recognized crisis in old-age welfare, and by 1935, 30 states had adopted some
form of old-age assistance program. Although these programs were authorized
by the state legislatures, they were typically managed by the counties, and the
establishment of a plan was often a county-level option (USBLS 1931, 1932).
By 1961, the state employees in each of these states participated in Social Security
This statement must be qualiﬁed by the fact that as early as 1930, 21 states offered
some type of pension beneﬁt to their teachers, who made up the single largest
group of state workers. Although teachers’ salaries were typically paid by local
school boards with some combination of state and local monies, the pensions
were administered by the states (Clark, Craig, and Wilson, 2003).
The authority allowing voluntary participation in Social Security by public
employees is contained in section 218 of the Social Security Act. As a result,
these state agreements are referred to as section 218 agreements. Each state’s
Social Security Administrator is responsible for managing these agreements.
Interestingly, legislation enacted in 1986 requires that all state and local employ-
ees hired after March 31, 1986 must be covered by Medicare; to date, no such
mandatory coverage is required for Social Security.
Almost three quarters of the public employees who remain outside the Social
Security system reside in just seven states: California, Ohio, Texas, Massachusetts,
Illinois, Colorado, and Louisiana.
State employees in Alaska were once included in Social Security; however, in
1980, Alaska withdrew its employees from the system.
The Pension Task Force on public pension systems reported that some plans were
terminated and restructured when public employees were ﬁrst covered by Social
Security (US House of Representatives 1978).
In 1999, the GAO (1999) reported that 21 of the 48 states with DB plans had
considered terminating their DB plan and replacing it with a DC plan. However,
eight years later, the GAO (2007) still found only two states with DC plans.
A 2006 survey by the National Association of Government Deﬁned Contribu-
tion Administrators found that on average only 21.6 percent of eligible state
employees made voluntary contributions into in these plans (GAO 2007). Likely
causes of this low level of participation are the absence of matching employer
contributions and the more generous beneﬁts provided by primary pension
plans in the public sector.
Also see Munnell and Soto (2007).
The data in Table 14-4 are for 1984 because the 1982 report did not include
detailed information on contributions.
Of the 46 state plans included in the 1982 regression, 11 plans cover only state
employees, three plans cover state employees and teachers, 14 plans cover state
and local employees, and 19 plans cover state and local employees and teachers.
268 Robert L. Clark, Lee A. Craig, and Neveen Ahmed
In the regressions below, the dummy that represents plans for all three groups of
workers is the omitted variable.
For various reasons, not every state-run plan in the United States is included
in either the Wisconsin study or our data set. For example, the Wisconsin
study includes plans that cover workers other than state employees. Some states
maintain separate plans for teachers or local government workers, and there are
dozens of state-run plans that represent small, well-deﬁned groups, such as state
judges or legislators, that are excluded (see Mitchell et al. : Table 14-2 for
a complete tabulation of systems.) In addition, in 1982 the following plans were
omitted: Indiana Public Employees’ Retirement Fund (PERF) and Teachers’
Retirement Fund (TRF) had a hybrid, 1.1 percent contribution rate combined
with a ‘money purchase’ annuity component; Nebraska School Employees Retire-
ment System (SERS) had a money purchase plan; and Oregon Public Employees
Retirement System (PERS) has 1.5 percent plus a money purchase plan. Also,
Tennessee Consolidated Retirement System (TCRS) had an ‘integrated table’
plan, and Tennessee had some information missing; thus so we used the 1984
formula. For 2006, the deleted plans include: Indiana PERF and TRF has hybrid,
‘money purchase’ option; Nebraska SERS has a money purchase plan; and Ore-
gon PERS has 1.5 percent plus a money purchase plan. For Arkansas, we used 2
percent; and for Massachusetts, we used 2.5 percent instead of 0.1–2.5 percent
age-related state formula.
This is not an indicator of the actuarial soundness of the state plans. However, as
Hustead an Mitchell (2000: 6) note, when it comes to the ﬁnancial state of these
systems, ‘the status of public plans is not always transparent or comparable across
Data are available from the authors on request.
Brainard, Keith (2007). Public Fund Survey Summary of Findings for FY 2006. George-
town, TX: National Association of State Retirement Administrators.
(2009). ‘Redeﬁning Traditional Plans: Variations and Developments in Public
Employee Retirement Plan Design,’ in O.S. Mitchell and G. Anderson, eds., The
Future of Public Employee Retirement Systems. Oxford: Oxford University Press.
Clark, Robert and Ann McDermed (1990). The Choice of Pension Plans in a Changing
Regulatory Environment. Washington, DC: American Enterprise Institute.
Lee Craig, and Jack Wilson (2003). A History of Public Sector Pensions in the United
States. Philadelphia, PA: University of Pennsylvania Press.
Craig, Lee A. (1995). ‘The Political Economy Public-Private Compensation Differ-
ential: The Case of Federal Pensions,’ Journal of Economic History, 55 (2): 304–20.
Fishback, Price V. and Shawn Everett Kantor (1995). ‘Did Workers Pay for the
Passage of Workers’ Compensation Laws?’ Quarterly Journal of Economics, 110 (3):
(2000). A Prelude to the Welfare State: The Origins of Workers’ Compensation.
Chicago, IL: University of Chicago Press.
14 / The Evolution of Public Sector Pension Plans 269
Gruber, Johnathan, and Alan B. Krueger (1991). ‘The Incidence of Mandated
Employer-Provided Insurance: Lessons from Workers’ Compensation Insurance,’
in D. Bradford, ed., Tax Policy and the Economy, Vol. 5. Cambridge, MA: MIT Press,
Hirsch, Barry T. and David A. Macpherson (2007). Union Membership, Coverage,
Density, and Employment by State and Sector, 1983–2007. Union Membership and
Coverage Database from the CPS. Online at www.unionstats.com.
Hustead, Edwin C. and Olivia S. Mitchell (2000). ‘Public Sector Pension Plans:
Lessons and Challenges for the 21st Century,’ in O.S. Mitchell and E.C. Hustead,
eds., Pensions in the Public Sector. Philadelphia, PA: University of Pennsylvania Press,
Mitchell, Olivia S. and Robert Smith (1994). ‘Public Sector Pension Funding,’
Review of Economics and Statistics, 76(2): 278–90.
David McCarthy, Stanley C. Wisniewski, and Paul Zorn (2000). ‘Developments
in State and Local Pension Plans,’ in O.S. Mitchell and E.C. Hustead, eds.,
Pensions in the Public Sector. Philadelphia, PA: University of Pennsylvania Press,
Moore, Michael J. and W. Kip Viscusi (1990). Compensation Mechanisms for Job Risk:
Wages, Workers’ Compensation, and Product Liability. Princeton, NJ: Princeton Uni-
Mueller, Marjorie (1961). ‘Retirement Plans for State and Local Employees,’
Monthly Labor Review, November: 1191–99.
Munnell, Alicia (2005). ‘Mandatory Social Security Coverage of State and Local
Workers: A Perennial Hot Button.’ Issue Brief No. 32. Boston, MA: Center for
Retirement Research at Boston College.
Kelly Haverstick, and Mauricio Soto (2007). ‘Why Have Deﬁned Beneﬁt Plans
Survived in the Public Sector.’ State and Local Pension Plans Brief No. 2. Boston,
MA: Center for Retirement Research at Boston College.
Mauricio Soto (2007). ‘State and Local Pensions are Different From Private
Plans.’ State and Local Pension Plans Brief No. 1. Boston, MA: Center for Retire-
ment Research at Boston College.
Public Employees Retirement Association of New Mexico (PERA) (2008). Public
Employees Retirement Association of New Mexico Member Handbook. Santa Fe, NM:
Public Employees Retirement Association of New Mexico.
Social Security Administration (2007). ‘How State and Local Government Employ-
ees Are Covered by Social Security and Medicare.’ SSA Publication No. 05–10051.
Washington, DC: Social Security Administration.
(2008). Historical Background and Development of Social Security. Washington, DC:
Social Security Administration.
Social Security Board (1937). Social Security in America: Part II Old Age Security.
Washington, DC: Social Security Administration.
Streckewald, Frederick (2005). ‘Social Security Testimony Before Congress.’ Hear-
ing before the House Ways and Means Subcommittee on Social Security, June 9.
Washington, DC: Social Security Administration.
US Bureau of Labor Statistics (USBLS) (1916). ‘Civil-Service Retirement and Old-
Age Pensions,’ Monthly Labor Review, June: 635–51.
270 Robert L. Clark, Lee A. Craig, and Neveen Ahmed
US Bureau of Labor Statistics (USBLS) (1931). ‘Operation of Public Old-Age Pen-
sion Systems in the United States, 1930,’ Monthly Labor Review, June: 1267–80.
(1932). ‘Operation of Public Old-Age Pension Systems in the United States in
1931,’ Monthly Labor Review, June: 1259–69.
(1988). Employee Beneﬁts in State and Local Governments. Bulletin No. 2309.
Washington, DC: US Government Printing Ofﬁce.
(1996). Employee Beneﬁts in State and Local Governments. Bulletin No. 2477.
Washington, DC: US Government Printing Ofﬁce.
(1998.) Employee Beneﬁts in State and Local Governments. Bulletin No. 2531.
Washington, DC: US Government Printing Ofﬁce.
US Department of Commerce, Bureau of the Census (various years). Statistical
Abstract of the United States. Washington, DC: US Government Printing Ofﬁce.
(various years). Census of Governments: Employee-Retirement Systems of State and
Local Governments. Washington, DC: US Government Printing Ofﬁce.
(2004). Census of Governments: Employee Retirement Systems of State and
US General Accounting Ofﬁce (GAO) (1999). State Pension Plans: Similarities and
Differences Between Federal and State Designs. GAO/GGD-99–45. Washington, DC:
US Government Accountability Ofﬁce.
(2007). State and Local Government Retiree Beneﬁts: Current Status of Beneﬁt Struc-
tures, Protections, and Fiscal Outlook for Funding Future Costs. GAO-07–572. Washing-
ton, DC: US Government Accountability Ofﬁce.
US House of Representatives, Committee on Education and Labor (1978). Pension
Task Force Report on Public Employee Retirement Systems. Washington, DC: US Govern-
ment Printing Ofﬁce.
Wisconsin Legislative Council (various years.) Comparative Study of Major Public
Employee Retirement Systems. Madison, Wisconsin: Wisconsin Legislative Council.
Pension Fund Activism:
The Double-Edged Sword
Brad M. Barber
Does institutional activism create value for shareholders? Proponents of
activism argue that institutions are merely providing necessary monitoring
of corporations with poor performance. Critics view activism as the actions
of meddlesome portfolio managers spending investors’ money to interfere
in corporate policy. Who is right?
To answer this question, I begin from basic economic principles and
analyze a simple framework where a portfolio manager has the unfettered
objective of maximizing the value of an investment portfolio.
that the beneﬁts of institutional activism—narrowly for the investors at the
institution and broadly for society—hinge critically on the prevalence of
two agency costs. The ﬁrst agency cost is the well-known conﬂicts of interest
between shareholders and corporate managers; corporate managers may
pursue projects that beneﬁt themselves, but not shareholders. Effective
monitoring by institutions can reduce these agency costs—beneﬁting not
only their investors, but raising the value of stocks for all investors. I refer
to this type of institutional activism as ‘shareholder activism.’
The second agency cost, less widely discussed than the ﬁrst, is the con-
ﬂicts of interest between portfolio managers and investors. Portfolio man-
agers may pursue investment policies that beneﬁt their own objectives, but
not those of investors. The large block of voting rights under the control of
institutional portfolio managers presents the most obvious potential source
of agency costs. Just as this voting power can be used to beneﬁt shareholders
through effective monitoring of corporations, the voting power can be
abused by advancing the interests of portfolio managers
that are different
from those of their investors and reduce the value of the portfolio they
manage. Generally, institutional activism in this arena centers on social
issues, such as disclosure of greenhouse gas emissions, divestment in Sudan,
or tobacco ﬁrms. Thus, I refer to this type of institutional activism as ‘social
Social activism may lead to desirable or important social beneﬁts. For
example, institutional pressure may cause corporations to reduce pollution
272 Brad M. Barber
or be more vigilant in monitoring child labor practices. But pollution
abatement technologies and the monitoring of labor practices is costly.
Consequently, the social gains will often hurt the bottom line and potential
returns earned by shareholders. Thus, a portfolio manager who is attempt-
ing to maximize the value of an investment portfolio would not pursue
social activism when it forces corporations to incur avoidable costs. Many
investors choose socially responsible mutual funds precisely because these
funds invest in ﬁrms that are consistent with their personal values. However,
most institutions (e.g., public pension funds) are not provided with such a
clear moral mandate from their investors.
The two agency costs create a tension that renders the ultimate gains
of institutional activism an empirical question. While admittedly imprecise,
I argue that simple empirical methods—short-run event studies and the
long-run returns of portfolios of targeted stocks—are the best methods
available to estimate the net beneﬁts of institutional activism.
While institutional activism is widespread, my discussion and empirical
analyses focus on the efﬁcacy and prudence of California Public Employ-
ees’ Retirement System (CalPERS) activism—a long-time leader in the
institutional activism. For almost two decades, CalPERS has been active
in pursuing corporate reforms. In recent years, this activism has come
under increased scrutiny as CalPERS took public stands on a wide range of
issues including corporate governance, greenhouse gas emissions, auto fuel
efﬁciency, labor negotiations, investments in tobacco ﬁrms, Iran, Sudan,
South Africa, and the independence of audit committees.
Using simple empirical methods, I estimate the gains to the high proﬁle
activism of CalPERS focus list ﬁrms over the period 1992 to 2007. My short-
run analysis indicates that CalPERS activism yields positive, but small, mar-
ket reactions of 21 basis points (bps) on the date focus list ﬁrms are publicly
announced. These announcement effects are too small to conclude they
are reliably positive. I and many others have previously concluded this
evidence was more persuasive, but in the last two years—particularly 2006—
the so-called ‘CalPERS effect’ has been negative. However, it is worth noting
that these small effects, if truly caused by CalPERS activism, yield wealth
creation of $1.9 billion dollars over the 16 year period that I analyze.
My long-run analysis yields intriguing, but inconclusive results. Portfolios
of focus list ﬁrms earn annualized abnormal returns ranging from 2.1 to
4.5 percentage points annually at holding periods ranging from 6 months
to 5 years. If these abnormal returns are causally linked to the activism of
CalPERS, the wealth creation is enormous—as much as 20 times greater
than the short-run beneﬁts and as large as $39.4 billion through December
2007. Unfortunately, while economically large and positive, the estimates
of long-run abnormal returns are not reliably positive. Long-run returns
are simply too volatile to conclude that the long-run performance of focus
15 / Pension Fund Activism: The Double-Edged Sword 273
list ﬁrms is unusual. I argue that previous studies, which document reliably
positive long-run abnormal returns for focus list ﬁrms, either fail to account
for the characteristics of focus list ﬁrms and/or rely on faulty statistics.
Having established a reasonable estimate of the value of CalPERS activ-
ities surrounding focus list ﬁrms, I review the nature of reforms that
CalPERS publicly pursues at these ﬁrms through shareholder proposals
sponsored by CalPERS at focus list ﬁrms. Without exception, the CalPERS
proposals increase shareholder rights. Empirical research establishes a
strong link between shareholder rights and ﬁrm value and provides strong
support for prudence of CalPERS’ initiatives designed to improve share-
holder rights. Thus, these governance-related reforms at focus list ﬁrms
are uniformly shareholder (rather than social) activism.
However, CalPERS has also pursued social activism unrelated to their
annual focus list ﬁrms. Often, this social activism is pursued at the behest
of either of state legislative action (e.g., divestiture from Sudan or Iran)
or the 13-member board (e.g., tobacco divestiture) that oversees CalPERS
investments. I review some of the high proﬁle decisions made by CalPERS.
Many of these decisions lack clear evidence—empirical or theoretical—
that CalPERS activism would improve shareholder value. CalPERS manages
the assets of over a million public employees, retirees, and their families.
When there is no clear link to improvements in shareholder value, whether
CalPERS activism is in the best interests of those whose money they manage
depends critically on the personal preferences of investors.
The remainder of this chapter is organized as follows. The ﬁrst section
provides an overview of the theory underlying institutional activism. In the
second section, I provide empirical evidence regarding the short-run and
long-run performance of CalPERS focus list ﬁrms. In the third section,
I review the nature of reforms pursued at focus list ﬁrms and provide
anecdotes regarding other activism pursued by CalPERS outside of their
focus list initiative.
Institutional activism: theory
In this section, I formally lay out a simple framework to analyze the
expected effects of institutional activism.
Shareholders versus Managers
. It is well known that conﬂicts of interest
may arise between shareholders, who seek to maximize ﬁrm value, and ﬁrm
managers, who may have interests other than value maximization (e.g.,
empire building or maximizing compensation packages). These conﬂicts
create a cost for shareholders that lead to lower ﬁrm valuations. Absent
these agency costs, the market would reach some maximum agency-cost-
free valuation, call it V
274 Brad M. Barber
Absent any monitoring by investors, agency costs (A) take a (relatively)
large percentage of this maximum valuation. Investors can reduce the
agency cost bite taken out of the valuation pie by monitoring corporations,
but monitoring is costly, varies in effectiveness, and, no doubt, has dimin-
ishing marginal returns. In the top graph of Figure 15-1, I represent agency
costs as a decreasing, convex function of monitoring resources (M).
Large institutional investors invest tens of billions of dollars in stocks—
generally in an index fund or at least an equity portfolio that tracks the
market reasonably well. Nonetheless, even the largest institutional investors
own only a small percentage of the total market. For example, CalPERS,
with US equity investments of $80 billion in January 2008, owns approx-
imately 0.5 percent of the total market, which is valued at approximately
$16.5 trillion in December 2007. For CalPERS to justify investment in the
monitoring of corporate managers as a value enhancing proposition, a
dollar spent on monitoring must increase the value of monitored ﬁrms
by at least $200 ($1/0.5%), since CalPERS only owns a small slice of the
monitored ﬁrms. If CalPERS prudently spends $1,000,000 on monitoring
each year, the expenditure would lead to a minimum increase in ﬁrm value
This analysis presumes the beneﬁts of activism are limited to the ﬁrms
that are directly pursued by an institution. But widespread monitoring by
institutions can also deter corporate malfeasance. If corporations know that
institutions stand ready to publicly excoriate ﬁrms that engage in practices
that reduce shareholder value, corporations will be less likely to engage
in these practices in the ﬁrst place. The deterrence beneﬁts of activism
are exceedingly difﬁcult to measure, but nonetheless provide additional
justiﬁcation for institutional activism.
In general, a savvy portfolio manager will choose a monitoring cost (M
that maximizes the value of his portfolio (P
). In panel B of Figure 15-1,
I depict the manager’s portfolio value as a function of the monitoring
costs that he incurs. In principle, the optimal level of monitoring (M
will be achieved when the marginal cost of monitoring equals the marginal
beneﬁt (i.e., reduction in agency costs realized in the manager’s portfolio).
Unfortunately, in practice, it is nearly impossible to estimate precisely the
marginal beneﬁt of monitoring. Thus, it is difﬁcult to determine ex-ante
whether institutions are investing in an optimal amount of monitoring.
Even with the beneﬁt of over a decade of hindsight, it is difﬁcult to precisely
estimate the total value of the gains resulting from CalPERS activism. I
discuss this issue at length in the empirical section of this chapter.
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