The impressive growth of shareholdings controlled by large fund families has drawn a renewed attention to investor stewardship as one of the pillars of corporate governance. The concern, however, is that large institutional investors, powerful though they may be in theory, have limited governance influence in the reality. Minimal rewards and various conflicts of interest weaken their incentives to be responsible shareholders by investing in stewardship or opposing corporate managers. Finite stewardship resources impose additional natural limits on the exercise of stewardship. But an influential argument —first proposed by John Pound and developed by Professors Ronald Gilson and Jeffrey Gordon—that interactions between institutional investors and activist shareholders can encourage diversified investors to become more involved in stewardship suggests that large institutional investors can make a bigger contribution to improving the quality of governance in firms.
The question then is whether large fund families have incentives to work with activist shareholders and whether such interaction does in practice concentrate the attention of institutional investors on firms with problems and supply investors with better information for voting. In a recent paper, ‘Different Visions of Stewardship: Understanding Interactions Between Large Investment Managers and Activist Shareholders’, forthcoming in the Journal of Corporate Law Studies, I attempt to answer those questions by analysing the voting behaviour of large investment managers in the FTSE 350 companies targeted by activist demands during 2013-2018.
The United Kingdom has a lively setting for shareholder activism with the largest number of annual activist demands in Europe. Shareholders made 106 public demands during 2013-2018 targeting the FTSE 350 companies. More than 41% of those demands came from a small pool of mostly US-origin hedge funds; investment managers, pension funds, and their associations initiated another one-third of the activist demands; the rest were demands put forward by individual shareholders. The paper classifies all demands into six categories based on the demand topic: balance sheet activism, board related activism, business strategy activism, M&A activism, remuneration activism, and governance activism (including environmental and social matters). In the empirical part of the paper, I compare the associations between the voting behaviour of the largest 40 investment managers responsible for voting the shares in targeted firms and the presence of an activist demand. The underlying assumption is that higher opposition to management voting recommendations is an indication of stronger stewardship efforts because engaged shareholders are unlikely to follow management recommendations on all matters voted on during shareholders’ meetings. In other words, if activist demands have an informational role, then we would expect higher opposition to management voting recommendations during meetings where there is an outstanding contested demand compared to meetings not affected by an activist demand (or if the demand has been settled).
The findings show that associations between activist demands and the voting behaviour of top investment managers vary based on activist types and demand topics. Demands initiated by hedge funds and individuals, as well as on business and operating matters such as balance sheet and M&A activism receive less support. To the contrary, large investors align stronger with management voting recommendations in the presence of those demands. By contrast, large investment managers are likelier to increase opposition to management where an activist demand is initiated by one of their peers (or investor associations) or targets remuneration and governance topics.
In addition, the study finds evidence that notwithstanding differences between fund groups with predominantly passive and active investment strategies, passive fund groups cannot be blamed for silencing the voice of activist shareholders. Neither passive nor active funds are receptive to activist demands on various business matters. That said, active funds are likelier to increase opposition to management in the presence of an activist demand dealing with remuneration and governance topics. Remarkably, UK-based asset managers, —consistent with the central role of institutional investors in promoting compliance with governance recommendations in the United Kingdom, —are the main backers of governance activism.
To sum up, the findings show that many activists and large institutional investors do not have overlapping stewardship preferences. This means that some good activist demands, even if they question justifiably business and operating practices, are unlikely to trigger broad support among large institutional investors because of different stewardship visions. This finding is consistent with the traditional governance model of the publicly traded firm where most diversified shareholders have adopted a careful hands-off way of dealing with firms where they invest. Instead of directly interfering with managerial decisions, shareholder efforts aim to improve the decision-making processes at the level of the board of directors because effectively functioning boards monitor executives better and reduce managerial agency problems. Overinvolvement in business and operating matters leads to the duplication of the board’s functions in an area where the board is perceived to have better expertise than diversified shareholders. Furthermore, recent studies (see here and here) explain that investors with diversified portfolios, unlike many activists, prefer to focus their attention on general themes that address market-wide systematic risks. Accordingly, firm-specific stewardship over business and operating matters is not a priority for diversified institutional investors.
Two implications of the findings are highlighted. First, that some activist demands do not find support among diversified investors does not mean that those demands do not add value. To the contrary, shareholder oversight over a broad range of topics requires an active role for investor groups with different stewardship preferences. As such, the last section of the paper discusses different reform proposals that may encourage activism over pluralistic matters and thus prevent the convergence of shareholder stewardship towards a narrow range of topics that are priority for a few influential investors. Second, the findings also make clear that those influential investors need a new breed of ESG-conscious activists that share a similar stewardship vision and can supply them with the relevant information for better stewardship.
Suren Gomtsian is Associate Professor in Business Law at University of Leeds School of Law.