Posts Tagged ‘Institutional Investors’

What are the Agency Problems raised by Institutional Investors?

In this post we will analyze the contributions made by Bebchuk, Cohen and Hirst (1) and Fisch, Hamdani and Davidoff (2) regarding institutional (passive or active) investors and their (eventual) incentives to use the “voice” corporate governance (CG) mechanism.

Bebchuk et al. find the (generally accepted) result that investment managers capture just a fraction of the profits deriving from their costly research thus suffering from “free riding”. Competition with other managers does not solve this, and finally they may also face conflicts of interest that make them closer to managers than desired.

They also support the reasoning that active (and mainly activist) investors have more incentives to use their “voice”. Bebchuk at al. basically try to draft a model showing how managers`behavior can deviate from the best stewardship standards, (3).

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Stewardship and Engagement

May 11, 2018 1 comment

Dr John Mellor, FGRE’s (Foundation for Governance Research and Education ) Founder and Director of Research, published in May 2013 an article the topic, in cooperation with several institutions such as Schroeders and other asset management houses, (1). In June 2011 he had also published a report on stewardship together with Charles Cronin, (2), in which they stated the very relevant role asset managers may have in developing the engagement activity, without introducing though a regulatory recommendation.

In the 2013 article their insights consider the engagement managers´role in light of the directors´fiduciary duties, looking not only at equity holders but also at debt holders.

The UK Stewarship Code (3) defines stewardship as ”Stewardship aims to enhance the quality of engagement between institutional investors and companies to help improve long-term returns to shareholders and the efficient exercise of governance responsibilities.” Nevertheless, the 2013 updated code (4) goes beyond engagement and even accepts stewarshhip could be a different thing: “Stewardship aims to promote the long-term success of companies in such a way that the ultimate providers of capital also prosper. Effective stewardship benefits companies, investors and the economy as a whole.” This takes into account for instance the nature of short-term focused investors or funds. Read more…

The Case Against Passive Shareholder Voting, by Dorothy Shapiro Lund

The increase in the power of shareholders faces big challenges as regulation is not necessarily followed by a correct valuation of voting (the most powerful of their capacities), by them. The One Share One Vote principle is affected by dual-class share systems and no voting shares; but shareholders also suffer from rational apathy and collective action problems, so that the objective of empowering shareholders is not easily reached. See my previous posts on the topic here (1)

Dorothy Shapiro Lund from the University of Chicago recently published an article in which she analyzes the effect on rational voting practices stemming from the shift of investors (American in her study) from actively managed funds investing into (indexed) passive funds. (2) She states this trend will damage the market for corporate influence, thus lowering the discipline imposed on managers. Their investment in Corporate Governance (CG from now on) and/or in gathering firm-specific information leaves them with the cost and only a small fraction of the eventual profit…so they lack the financial incentive to invest. Furthermore, passive funds are less likely to channel funds to hedge funds, (which could help correct the problem, -see (3)), and will adhere to low-cost governance solutions, following proxy advisors or simple-not-so-smart criteria).

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Agency Costs and Institutional dominated share ownership: activists and governance

July 9, 2017 1 comment

Summary: Institutional Investors (II) -such as mutual funds- are rational while not doing research and issuing shareholder proposals; activists and hedge funds may have a role issuing those proposals, so that others have an option to increase their voting value. (See (1) and (2) by Gilson, Ronald J. and Gordon, Jeffrey N. and by Bebchuk, Lucian A. and Cohen, Alma and Hirst, Scott respectively.

The fact that property is concentrated in II makes the world of Berle and Means outdated. A new agency problem arises between record owners, (II now) and managers, but also between record owners and beneficial owners, (this is what they call “Agency Capitalism”, where II or agents hold investments on behalf of final or beneficial owners).

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Disclosure and Corporate Governance.

It is often understood that Corporate Governance is highly connected to “transparency and disclosure”. But there is a need to clarify the actual relationship between the two, not only in one direction, but in both.

Adrian Fong from the Faculty of Law, Chinese University of Hong Kong, in his working paper “ Practicing Corporate Governance Through Corporate Disclosure?”, does a good contribution to this effort. (1)

As he points out, “Corporate disclosure is the timely and accurate release of all material matters regarding the [company], including the financial situation, performance, ownership, and governance of the company”. “The purpose of corporate disclosure is to release ….. information to shareholders, employees, possible investors, and the broader community about the company”. Read more…