Shareholder cooperation as a tool for active corporate ownership, and a means by which to effectively voice concerns about corporate governance and performance, is on the rise. While wolf packs formed by activist hedge funds with the aim of bringing about significant corporate changes at targeted companies is the form of cooperative intervention that has attracted greater consideration, there exist other forms of shareholder coordination that can be viewed as an alternative to wolf pack-like initiatives and promote a non-activist-driven approach to collective engagement.
Different pathways for collective engagement by non-activist institutional investors have developed, also based on the recommendations provided by stewardship principles adopted in several countries. Over the last few years, representative organizations, such as, to some extent, the Council of Institutional Investors (CII) in the US, and even more so the Investor Forum in the UK, Eumedion in the Netherlands, Assogestioni in Italy, and many more, have emerged as a cost-saving and efficient tool for supporting institutions’ active stewardship collectively.
Collective engagement initiatives promote more active conduct by institutional investors by favoring the redistribution of the engagement costs among the investors that carry out engagement activities collectively, thereby increasing the net return earned by each institutional investor involved. In doing so, collective engagement initiatives also lower the free-rider problem that significantly contributes to non-activist investors’ ‘rational reticence’. Moreover, collective engagement initiatives can enhance reputational incentives for being active owners, as institutional investors may be incentivized to join collective initiatives where these prove to be successful or are viewed positively by end clients.
Drawing on empirical and anecdotal evidence of the relevance of such an alternative shareholder cooperation model that does not mean to achieve or influence corporate control (Dimson, Karakas, Li (2019) and Doidge and others (2017)), in a recent paper we develop an analytical framework for non-activist shareholder cooperation by extending the perspective for analysis beyond hedge-fund wolf packs. We aim to demonstrate that collective engagement by non-activist institutions based on the coordination function performed by a third-party enabling entity can be a promising lever by which to foster a more convincing and viable corporate governance role for non-activist institutional investors and provide an alternative to wolf packs and activist-led initiatives à la Gilson-Gordon.
First, a coordinating entity can reduce the risk that engagement costs are borne by a limited number of investors, while benefits are shared by all other investors who are shareholders in the same investee company. For example, the coordinating entity could adopt engagement-related cost allocation mechanisms that charge the participating investors proportionately with the size of their holdings. A third-party coordinating entity can also facilitate the circulation of information and agreement among institutional investors. Such a facilitating role is especially important in order to save costs and time when the investors involved in collective initiatives have different geographic and cultural backgrounds.
Second, a third-party coordinating entity can help to reduce potential disincentives against joint collective engagement initiatives posed by regulatory hurdles and also to lessen compliance costs. Specifically, a third-party entity taking on an active coordination function (which function will be most effectively performed where it is based on specific formal procedures and safeguards) can work as an effective tool to reduce the risk of concerted action, group formation, or the selective disclosure of relevant information in breach of Regulation Fair Disclosure or the Market Abuse Regulation in the EU. In doing so, the coordinating entity can help to overcome problems posed by the small size of leading institutional investors’ investment stewardship teams.
Third, an adequately organized third-party coordinating entity employing high-skilled professionals can play a key role in providing institutional investors that intend to cooperate with the necessary expertise concerning relevant issues related to the engagement and company-specific information. For example, enabling institutions can help to identify issues of interest to heterogeneous investors as well as investors that may potentially be interested in joining the collective engagement, or to develop an engagement strategy that meets with the expectations of all investors concerned.
Against this background, collective engagement initiatives should be incentivized by clarifying the remaining grey areas within the relevant regulatory framework. In particular, the current regulatory framework for blockholder filings remains a roadblock that can thwart engagements by non-activist investors. Therefore, there is the need for the SEC to provide greater clarity concerning the circumstances in which collective engagement through an enabling organization will not, as a rule, be regarded as control-seeking or concerted action and will not trigger group filing obligations under Section 13D of the Securities and Exchange Act. Taking the ESMA’s approach into account, the SEC could adopt a similar view to provide a safe harbor for collective engagement initiatives that do not seek to gain control of the company. In particular, the SEC could consider providing a list of engagement-related activities that, in themselves, are considered to fall beyond the scope of section 13D, unless it is demonstrated on the basis of a case-specific analysis of all relevant circumstances that such activities have control-seeking purposes.
In addition, the SEC could explicitly recognize the role of those coordinating entities in promoting collective engagement initiatives in line with the applicable regulatory framework. Specifically, the SEC should accept that —unless a control-seeking purpose can be inferred from the relevant circumstances of the case— collective engagement will not be relevant under Section 13D where the institutional investors participating in the initiative have explicitly committed not to form a control-seeking group and have appointed a third party to monitor compliance with the agreement, according to predefined frameworks governing the process of engagement, and establishing rules of conduct for participating investors. That would help the CII or similar institutions to play a more significant role in promoting effective institutional investors' stewardship, following the patterns of counterparty institutions in other countries.
This post first appeared on the Columbia Law School Blue Sky blog here.
Gaia Balp is Associate Professor of Business Law at Bocconi University.
Giovanni Strampelli is Professor of Business Law at Bocconi University.