Throughout this document, CalPERS has chosen to adopt the term "shareowner" rather than "shareholder." This is to reflect our view that equity ownership carries with it active responsibilities³ and is not merely passively "holding" shares. The underlying tenet for CalPERS' Core Principles of Accountable Corporate Governance is that fully accountable corporate governance structures produce, over the long term, the best returns to shareowners.

CalPERS has found that there are many features that are important considerations in the continuing evolution of corporate governance best practices. Therefore, CalPERS recommends the following Core Principles:

1. Corporate governance practices should focus board attention on optimizing the company’s operating performance and returns to shareowners.
   
   
2. Directors should be accountable to shareowners, and management accountable to directors. To ensure this accountability, directors must be accessible to shareowner inquiry concerning their key decisions affecting the company’s strategic direction.
   
   
3. Information about companies must be readily transparent to permit accurate market comparisons; this includes disclosure and transparency of objective globally accepted minimum accounting standard.
   
   
4. All investors must be treated equitably and upon the principle of one-share/one-vote.
   
   
5. Proxy materials should be written in a manner designed to provide shareowners with the information necessary to make informed voting decisions. Similarly, proxy materials should be distributed in a manner designed to encourage shareowner participation. All shareowner votes, whether cast in person or by proxy, should be formally counted with vote outcomes formally announced.
   
   
6. Each capital market in which shares are issued and traded should adopt its own Code of Best Practices; and, where such a code is adopted, companies should disclose to their shareowners whether they are in compliance.
   
   
7. Corporate directors and management should have a long-term strategic vision that, at its core, emphasizes sustained shareowner value. In turn, despite differing investment strategies and tactics, shareowners should encourage corporate management to resist short-term behavior by supporting and rewarding long-term superior returns.
   
   

A. Board Independence & Leadership

Independence is the cornerstone of accountability. It is now widely recognized throughout the U.S. that independent boards are essential to a sound governance structure. Therefore, CalPERS recommends:

Nearly all corporate governance commentators agree that boards should be comprised of at least a majority of “independent directors.” But the definitional independence of a majority of the board may not be enough in some instances.  

The leadership of the board must embrace independence, and it must ultimately change the way in which directors interact with management.

“In the past, the CEO was clearly more powerful than the board. In the future, both will share influence. In a sense, directors and the CEO will act as peers. Significant change must occur in the future if boards are to be effective monitors and stimulators of strategic change. Directors and their CEOs must develop a new kind of relationship, which is more complex than has existed in the past. . . .”

Jay W. Lorsch, "The Board as A Change Agent," THE CORPORATE BOARD 1 (July/Aug, 1996).

Lastly, independence also requires a lack of conflict between the director's personal, financial, or professional interests, and the interests of shareowners.

"A director's greatest virtue is the independence which allows him or her to challenge management decisions and evaluate corporate performance from a completely free and objective perspective. A director should not be beholden to management in any way. If an outside director performs paid consulting work, he becomes a player in the management decisions which he oversees as a representative of the shareholder...." 

Robert H. Rock, Chairman NACD, DIRECTORS & BOARDS 5 (Summer 1996).

Accordingly, to instill independent leadership, CalPERS recommends that:

5. The board should be chaired by an independent director. The CEO and chair roles should only be combined in very limited circumstances; in these situations, the board should provide a written statement in the proxy materials discussing why the combined role is in the best interest of shareowners, and it should name a lead independent director to fulfill duties that are consistent with those provided in Appendix B.
   
   
6. When selecting a new chief executive officer, boards should re-examine the traditional combination of the “chief executive” and “chair” positions.
   
   
7. Generally, a company's retiring CEO should not continue to serve as a director on the board and at the very least be prohibited from sitting on any of the board committees.⁵
   
   
8. Corporate insiders are not considered independent and should therefore not constitute any more than one board seat.
   
   
9. Certain board committees consist entirely of independent ⁶ directors. These include the committees who perform the audit, director nomination, CEO evaluation, and executive compensation functions.
   
   
10. The full board is responsible for the oversight function on behalf of shareowners. Should the board decide to have other committees (e.g. executive committee) in addition to those required by law, the duties and membership of such committees should be fully disclosed.

B. Board Processes & Evaluation

No board can truly perform its overriding function of establishing a company’s strategic direction and then monitoring management’s success without a system of evaluating itself. CalPERS views this self-evaluation to have several elements, including:

1. The board has adopted and disclosed a written statement of its own governance principles, and regularly re-evaluates them.
   
   
2. The board has adopted and disclosed an annual board, committee, and individual director evaluation process.
   
   
3. With each director nomination recommendation, the board considers the mix of director characteristics, experiences, diverse perspectives and skills that is most appropriate for the company. The board should address historically under-represented groups on the board, including women and minorities. ⁷
   
   
4. The independent directors establish performance criteria and compensation incentives for the CEO, and regularly reviews the CEO's performance against those criteria. The independent directors have access to advisers on this subject, who are independent of management. Minimally, the criteria ensure that the CEO's interests are aligned with the long-term interests of shareowners, that the CEO is evaluated against comparable peer groups, and that a portion of the CEO's total compensation is at risk.
   
   
5. The board should have in place and disclose an effective CEO succession plan, and receive periodic reports from management on the development of other members of senior management.
   
   
6. All directors should have access to senior management. However, the CEO, Chair, or Independent Lead Director may be designated as liaison between management and directors to ensure that the role between board oversight and management operations is respected.
   
   
7. The board should periodically review its own size, and determine the size that is most effective toward future operations.
   

C. Individual Director Characteristics

In CalPERS' view, each director should fit within the skill sets identified by the board as necessary to focus board attention on optimizing the company's operating performance and returns to shareowners. No director, however, can fulfill his or her potential as an effective board member without a personal dedication of time and energy. Corporate boards should therefore have an effective means of evaluating individual director performance.

With this in mind, CalPERS recommends that:

1. The board adopts guidelines and disclose annually in the company's proxy statement⁸ to address the competing time commitments that are faced when director candidates, especially acting CEOs,⁹ serve on multiple boards.
   
   
2. Each board should establish performance criteria not only for itself (acting as a collective body) or for the key committees; but also individual behavioral expectations for its directors. Minimally, these criteria should address the level of preparedness and participation.
   
   
3. Directors should be expected to attend at least 75% of the meetings of the boards and board committees on which they sit.
   
   
4. To be re-nominated, directors must satisfactorily perform based on the established criteria. Re-nomination on any other basis should neither be expected nor guaranteed.
   
   
5. The board should establish and make available to shareowners the skill sets the board seeks from director candidates. Minimally, these core competencies should address accounting or finance, international markets, business or management experience, industry knowledge, customer-base experience or perspective, crisis response, or leadership or strategic planning.

D. Executive & Director Compensation

Compensation programs are one of the most powerful tools available to the company to attract, retain, and motivate key employees, as well as align their interests with the long-term interests of shareowners. Poorly designed compensation packages can have disastrous impacts on the company and its shareowners by incentivising short-term oriented behavior. Conversely, well-designed compensation packages can help align management with owners and drive long-term performance. Since equity owners have a strong interest in long-term performance and are the party whose interests are being diluted, CalPERS believes shareowners should provide stronger oversight of executive compensation programs

In recognition of this, CalPERS believes that companies should formulate executive compensation policies on a periodic basis. CalPERS does not generally believe that it is optimal for shareowners to approve individual contracts at the company specific level. Rather, executive compensation policies should be comprehensive enough to provide shareowners with oversight of how the company will design and implement compensation programs, yet broad enough to permit the board of directors flexibility in implementing the policy.

Implicit in CalPERS’ Core Principles related to executive compensation is the belief that the philosophy and practice of executive compensation needs to be more performance-based. Through its efforts to advocate executive compensation reform, CalPERS emphasizes the alignment of interests between executive management and shareowners, and enhanced Compensation Committee accountability for executive compensation.

1. Executive compensation programs should be designed and implemented by the board, through an independent compensation committee, to ensure alignment of interest with the long-term interests of shareowners while not restricting the company's ability to attract and retain competent executives.
   
   
2. Executive compensation should be comprised of a combination of cash and equity based compensation, and direct equity ownership should be encouraged.
   
   
3. Executive compensation policies should be transparent to shareowners. The policies should contain, at a minimum, compensation philosophy, the targeted mix of base compensation and "at risk" compensation, key methodologies for alignment of interest, and parameters for guidance of employment contract provisions, including severance packages. Appendix C sets forth the specific areas that executive compensation policies should address.
   
   
4. Companies should submit executive compensation policies to shareowners for non-binding approval.
   
   
5. Executive contracts should be fully disclosed, with adequate information to judge the "drivers" of incentive components of compensation packages.
   
   
6. Director compensation should be a combination of cash and stock in the company.
   

E. Audit Integrity

The company should support the development of accurate audited financial statements. CalPERS believes annual audits of financial statements should be required for all companies and carried out by an independent external auditor. This audit should provide an objective opinion that the financial statements present fairly, in all material respects, the financial position of the company in conformity with applicable laws, regulations and standards.

To ensure the integrity of audited financial statements, the corporation’s interaction with the external auditor should be overseen by the Audit Committee on behalf of the shareowners. The Audit Committee should clearly disclose any non-audit services completed by the auditor and provide supporting evidence that the relationship does not affect the auditor’s independence.

1. The selection of the independent external auditor should be ratified by shareowners annually.
   
   
2. The board, through its independent Audit Committee, should ensure that excessive non-audit fees are prohibited. To limit the risk of possible conflicts of interest and independence of the auditor, non-audit services and fees paid to auditors for non-audit services should both be approved in advance by the Audit Committee and disclosed in the proxy statement on an annual basis.
   

F. Corporate Responsibility

Shareowners can be instrumental in encouraging responsible corporate citizenship. CalPERS believes that environmental, social, and corporate governance issues can affect the performance of investment portfolios (to varying degrees across companies, sectors, regions, and asset classes through time.) Therefore, CalPERS joined 19 other institutional investors from 12 countries to develop and become a signatory to The Principles for Responsible Investment (Appendix D).

CalPERS expects companies whose equity securities are held in the Fund's portfolio to conduct themselves with propriety and with a view toward responsible corporate conduct. If any improper practices come into being, companies should move decisively to eliminate such practices and effect adequate controls to prevent recurrence. A level of performance above minimum adherence to the law is generally expected. To further these goals, in September 1999 the CalPERS Board adopted the Global Sullivan Principles of Corporate Social Responsibility.

CalPERS believes that boards that strive for active cooperation between corporations and stakeholders¹⁰ will be most likely to create wealth, employment and sustainable economies. With adequate, accurate and timely data disclosure of environmental, social, and governance practices, shareowners are able to more effectively make investment decisions by taking into account those practices of the companies in which the Fund invests. Therefore, CalPERS recommends that:

1. Corporations adopt maximum progressive practices toward the elimination of human rights violations in all countries or environments in which the Company operates. Adherence to a formal set of principles such as those exemplified in Appendix E, the Global Sullivan Principles,¹¹, is recommended.
   
   
2. To ensure sustainable long-term returns, companies should provide accurate and timely disclosure of environmental risks and opportunities, through adoption of policies or objectives, such as those associated with climate change. Companies should apply the Global Framework for Climate Risk Disclosure¹² (Appendix F) when providing such disclosure.
   
   
3. Corporations strive to measure, disclose, and be accountable to internal and external stakeholders for organizational performance towards the goal of sustainable development. It is recommended that corporations adopt the Global Reporting Initiative Sustainability Reporting Guidelines¹³ to disclose economic, environmental, and social impacts.
   
   
4. When considering reincorporation, corporations should analyze shareowner protections, company economic, capital market, macro economic, and corporate governance considerations.

G. Shareowner Rights

Shareowner rights¹⁴ – or those structural devices that define the formal relationship between shareowners and the directors to whom they delegate corporate control – should be featured in the governance principles adopted by corporate boards. Therefore, CalPERS recommends that corporations adopt the following corporate governance principles affecting shareowner rights:

1. A majority of proxies cast should be able to amend the company's bylaws by shareowner proposal.
   
   
2. A majority of shareowners should be able to call special meetings or act by written consent.
   
   
3. In an uncontested director election, a majority of proxies cast should be required to elect a director. In a contested election, a plurality of proxies cast should be required to elect a director.
   
   
4. A majority of proxies cast should be able to remove a director with or without cause. Unless the incumbent director has earlier resigned, the term of the incumbent director should not exceed 90 days after the date on which the voting results are determined.
   
   
5. Shareowners should have the right to sponsor resolutions. A shareowner resolution that is approved by a majority of proxies cast should be implemented by the board.
   
   
6. Every company should prohibit greenmail.
   
   
7. No board should enact nor amend a poison pill except with shareowner approval.
   
   
8. Every director should be elected annually.
   
   
9. Proxies should be kept confidential from the company, except at the express request of shareowners.
   
   
10. Broker non-votes should be counted for quorum purposes only.
    
    
11. Shareowners should have effective access to the director nomination process.
    
    
12. Shareowners should have the right to cumulate¹⁵ votes in the election of directors.

By adopting the Core Principles of Accountable Corporate Governance, CalPERS strives to influence the market through advancing the corporate governance dialogue while also providing an educational forum by representing a foundation for accountability between a corporation's management and its owners. With continued experience and communication between corporate managers and owners, the issue of accountability can become – if not resolved – more clear.

"As conflict – difference – is here in the world, as we cannot avoid it, we should, I think, use it. Instead of condemning it, we should set it to work for us... So in business, we have to know when to ... try to capitalize [on conflict], when to see what we can make it do.... [In that light] it is possible to conceive of conflict as not necessarily a wasteful outbreak of incompatibilities but a normal process by which socially valuable differences register themselves for the enrichment of all concerned.... Conflict at the moment of the appearing and focusing of difference may be a sign of health, a prophecy of progress."

THE PRICE WATERHOUSE CHANGE INTEGRATION TEAM,
THE PARADOX PRINCIPLES 275
(quoting Mary Parker Follett) (1996)

³“For corporate governance structures to work effectively, Shareowners must be active and prudent in the use of their rights. In this way, Shareowners must act like owners and continue to exercise the rights available to them.” (2005 CFA Institute: Centre for Financial Market Integrity, The Corporate Governance of Listed Companies: A Manual for Investors)

⁴The National Association of Corporate Directors’ (NACD’s) Blue Ribbon Commission on Director Professionalism released its report in November 1996. (Hereafter “NACD Report”) The NACD Report calls for a “substantial majority” of a board’s directors to be independent. The Business Roundtable's Principles of Corporate Governance (November 2005, hereafter "BRT Principles") is in general accord that a "substantial majority" of directors should be independent, both in fact and appearance, as determined by the board. (BRT Principles, p.14) Neither the NACD, nor BRT, define “substantial.”

⁵"What about losing the accumulated experience of the retiring CEO?  That is easily solved.  If the new CEO wants to tap the perceived wisdom and experience of the retired CEO, a telephone call or a quiet meeting does not require a board seat."  (Former Citicorp Chairman Walter Wriston, "Resist the Desire to Stay On," DIRECTORS & BOARDS (Spring 1993) 35.)

⁶As defined in Appendix A.

⁷CalPERS does not believe that each director must possess all of the core competencies. Rather, we believe that each director should contribute some knowledge, experience or skill in at least one domain that is critical to the company.

⁸ See NACD Report, at p. 10-12 recommending that candidates who are CEOs or senior executives of public corporations be "preferred" if they hold no more than 1-2 public company directorships; other candidates who hold full-time positions be preferred if they hold no more than 3-4 public company directorships; and all other candidates be preferred if they hold no more than 5-6 other public company directorships.

⁹"The job of being the CEO of a major corporation is one of the most challenging in the world today. Only extraordinary people are capable of performing it adequately; a small portion of these will appropriately be able to commit some energy to directorship of one other enterprise. No CEO has time for more than that." (Robert A.G. Monks, "Shareholders and Director Section", DIRECTORS & BOARDS (Autumn 1996 p.158)

¹⁰ In accordance with the Global Reporting Initiative: Stakeholders are defined broadly as those groups or individuals: (a) that can reasonably be expected to be significantly affected by the organization's activities, products, and/or services; or (b) whose actions can reasonably be expected to affect the ability of the organization to successfully implement its strategies and achieve its objectives.

¹¹CalPERS adopted the Global Sullivan Principles of Corporate Social Responsibility in September 1999.

¹²Additional information on the Framework and a Guide for Using the Global Framework for Climate Risk Disclosure is available on the CalPERS website: www.calpers-governance.org.

¹³Adoption of the Guidelines will provide companies with a reporting mechanism through which to disclose, at a minimum, implementation of the Global Sullivan Principles and the Global Framework for Climate Risk Disclosure. The Guidelines along with additional information on GRI can be found at www.globalreporting.org.

¹⁴Lucian Bebchuk, Alma Cohen, and Allen Ferrell, "What matters in Corporate Governance," (2004), The John M. Olin Center for Law, Economics and Business of Harvard University: Found that portfolios of Companies with strong Shareowner-rights protections outperformed portfolios of Companies with weaker protections by 8.5% per year.

¹⁵Such a right gives shareowners the ability to aggregate their votes for directors and either cast all of those votes for one candidate or distribute those votes for any number of candidates.