Proxy votes are public pension fund financial assets.¹ They can be used to protect interests of the State of Michigan Retirement Systems (SMRS), reduce portfolio exposure to risks, foster good corporate governance and enhance the long-term value of trust fund holdings. A number of studies have linked sound corporate governance practices with shareholder value. The SMRS recognizes that proxy votes can effect corporate governance practices and must be managed for the exclusive benefit of trust fund beneficiaries and with the same care, skill, prudence and diligence as any other financial asset.

The following Core Principles and Guidelines were adopted to serve as the foundation for management of SMRS proxy votes. Together with analyses provided by the SMRS proxy voting consultant, they are intended to guide SMRS fiduciaries in determining what is in the best interests of trust fund beneficiaries when casting proxy votes. They should be viewed, together with SMRS investment and portfolio monitoring practices, as part of an integrated and proactive approach to corporate governance that is focused on sustainable long-term corporate performance. However, they also function as a living document that will require modification from time to time as shareholder rights and corporate governance best practices evolve.

SMRS votes thousands of proxies each year. Some proposals will inevitably fall outside the scope of these Principles and the associated Policies or involve countervailing shareholder interests. In such cases, SMRS will assess each proposal individually and vote in the manner determined to best enhance corporate accountability and the long-term value of SMRS investments. Among other things, analyses and proxy voting policies used by similar fiduciaries and SMRS' proxy voting consultant may be used to inform SMRS in making such determinations.

CORE PRINCIPLES

Diverging objectives and conflicts of interest are inherent to the corporate form of ownership in today's markets. In public companies there is a separation of ownership and control, whereby shareholders own the company but management and oversight duties are delegated to officers and directors. Under this structure, the interests of officers and directors may not always be fully aligned with those of outside shareholders. In addition, outside shareholders do not have the same access to company information as do management and directors and are not in a position to run the company. However, shareholders are entitled to and need accurate information to make investment decisions and monitor portfolio holdings. Conflicts may even arise between different shareholders. For instance, short-term holders may want the company to be managed in a way that generates current value at the expense of long-term wealth creation, to the disadvantage of investors that will be exposed to the company for many years.

Proxy votes are one of the primary tools used by shareholders to manage these conflicts of interest that are inherent in the corporate form of ownership. As a large public pension fund, the SMRS is broadly invested in the market and has a long-term investment horizon. Consequently, it generally seeks to exercise proxy votes in a way that will protect shareholder rights, promote corporate accountability to shareholders and encourage development of sustainable company value over the long term. However, because circumstances may vary between companies, the SMRS must also retain flexibility to apply its proxy voting policies in a way that avoids a "one size fits all" approach.

In seeking an appropriate balance of these varying considerations, the SMRS recognizes the following corporate governance Core Principles that provide the context for its proxy voting activities.

1. Boards: Directors are the shareholders' representatives and should be both elected by and accountable to shareholders. Long-term shareholders that have a significant ownership position should be able to nominate director candidates for inclusion on the company's proxy. Directors should be elected annually, and shareholders should be given sufficient information on candidates to be able to cast an informed vote. A majority of the board and all members of its key committees should be fully independent and able to exercise independent judgment. Each board should have capable, independent leadership, separate from the CEO. Boards should contain individuals with a mix of skills appropriate for the company, each of whom should have sufficient energy and time to diligently perform their duties. Directors should be compensated with, and hold a personally material position in, the company's stock until after their service on the board. They should regularly receive training from independent sources and follow best corporate governance practices, as are applicable to the company.
2. Responsiveness: Boards should provide a process for regular communications with shareholders. Advisory shareholder resolutions that receive a majority vote should be implemented or the board should provide a detailed explanation as to why they are not being implemented.
3. Advisors: The company's independent auditor and executive compensation consultant should be hired by and report to the board or a committee of independent directors. They should be free of conflicts of interest and not perform other duties for the company that could be seen as compromising their independence. Any compensation received from the company for other services should be disclosed. Boards and key board committees should be able to directly retain legal counsel and other advisors as needed.
4. Anti-Takeover Devices: Anti-takeover devices should not be used to insulate management. All such plans or devices should be subject to shareholder approval. Payment of greenmail should be prohibited.
5. Voting: Shareholders should have the right to vote in proportion to their economic stake in the company. Each share of common stock should have one vote. Broker non-votes should be counted for quorum purposes only. Shareholder approval or action should require a simple majority of the shares voted. Shareholders should have the right to vote on issues separately, without bundling of different items on the proxy. Companies should provide for confidential voting.
6. Executive Compensation: Executive compensation should be related to sustained, long-term performance, both on the upside and downside. Boards should provide for a fair split of company profits between management and shareholders and regularly obtain feedback from all shareholders on the company's executive compensation practices. Executive compensation plans should provide for internal pay equity between management levels that reflects a viable executive succession plan. Gratuitous payments to executives and change in control payments that reward underperformance should be avoided. Boards should provide maximum transparency to meet executive compensation disclosure requirements.
7. Strategic Planning: Boards should take responsibility for regularly reviewing and evaluating the company's strategic plan and the long-term risks faced by the company. This should include the potential long-term financial effects of social, environmental and integrity concerns. The board should report to shareholders on all risks that it believes could have a financial impact on the company, to the fullest extent practicable. In addition, the board should undertake reasonable efforts to report on its evaluation of specifically identified risks if requested by the holders of a significant percentage of its shares that consider those risks when making investment decisions.

¹ The Federal Department of Labor first determined in what is referred to as the Avon Letter, issued on February 23, 1988, that proxy votes are an asset of ERISA pension funds, to which the same fiduciary duties apply as to other financial assets. See 15 Pension Reporter 391. Although the SMRS is not directly subject to ERISA, the fiduciary duty applicable to management of SMRS assets, which is set forth in MCL § 38.1133, is virtually identical to the ERISA standard. In addition, trustees have a duty under the common law to exercise reasonable care in voting proxies for stock held in a trust fund. See Restatement 3d of Trusts, § 227, Reporters' Notes, Comment d.
² For example, see "Does Corporate Governance Matter to Investment Returns?" Corporate Accountability Report, Vol. 3, No. 37, Sept. 23, 2005.