Transcript Role and responsibilities of institutional investors as shareholders

Role and responsibilities of
institutional investors
Professor Laura T. Starks
Presentation to the
International Symposium on
Corporate Governance Reform in Korea
December 5, 2008
Outline
 Size, growth and influence of institutional investors
in equity markets
 Role and responsibilities of institutional investors in
monitoring and corporate governance issues
 Focus on union pension funds, mutual funds, and
hedge funds
 Role and responsibilities of institutional investors in
monitoring and social and environmental issues
Growth in mutual fund assets
worldwide
30
25
20
15
10
5
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
In trillions of USD, from Investment Company Institute
Growth in mutual fund assets
worldwide
30
?
25
20
15
10
5
0
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
In trillions of USD, from Investment Company Institute
Growth in assets under management
in mutual funds in Asia and Pacific
markets
4,000,000
3,500,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
0
2000
(in millions of USD)
2001
2002
2003
2004
2005
2006
2007
Growth in institutional equity
investment in the United States
18000
16000
14000
12000
10000
8000
6000
4000
2000
19
5
19 2
5
19 4
5
19 6
5
19 8
6
19 0
6
19 2
6
19 4
6
19 6
6
19 8
7
19 0
7
19 2
7
19 4
7
19 6
7
19 8
8
19 0
8
19 2
8
19 4
8
19 6
8
19 8
9
19 0
9
19 2
9
19 4
9
19 6
9
20 8
0
20 0
0
20 2
0
20 4
0
20 6
08
0
Source: Federal Reserve (in millions of USD)
Percentage of U.S. corporate equities
owned by institutional investors
80%
70%
60%
50%
40%
30%
20%
10%
19
52
19
54
19
56
19
58
19
60
19
62
19
64
19
66
19
68
19
70
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
20
08
0%
Source: Federal Reserve
How institutional investors can affect
stock prices through their actions
Institutional Investors
Trading
Monitoring
Role of institutional investors
 Institutional investors are now the dominant
shareholders in the stock market
 Institutional investors affect firms’ management through
their trading of their securities.
 The institutional investors are individually large investors
with strong ability to monitor firm management
 Institutional “voice” can add value because of greater
monitoring. This voice can come in part from more
concentrated holdings and coordinated actions.
One aside on trading
Recent market movements in the Dow
Jones Industrial Average
Volume at the end of the day!
Institutional investors and
monitoring
Institutional
Investors
Boards of
Directors
Large
Blockhldrs
Lenders
Stock market
Mechanisms to mitigate
agency problems
Labor
Legal and competitive
environments
Limiting factors for institutional
monitoring
 Fiduciary duties
 Costs of monitoring
• Concerns about the liquidity of their portfolios
• Loss of potential business relations with firm
• Free-rider problem
Can fiduciary duties of the institutional
investors have negative effects on markets?
Reserve Primary Fund situation in September 2008
• Being an institutional money market fund the Fund’s holdings
were transparent. The institutions knew that the $62 billion
Reserve Fund had an investment of $785 million in Lehman
securities.
• When Lehman went bankrupt, the institutional investors had a
fiduciary duty to exit the Reserve Fund and preserve the capital
of their beneficiaries, participants or shareholders.
• There was consequently a run on the fund. This had negative
effects for the remaining investors.
When unhappy with a company, what
choices do institutional investors
have?
 Vote with their feet (Sell their shares)
 Exercise voice (Hold shares and try to influence
management decisions)
Termed “shareholder activism” or “engagement”
 Hold shares and do nothing
Voting with their feet
 Also called
Wall Street Rule or Wall Street Walk
 Why should management care whether any of
their institutional investors sell their shares?
Management cares about the
composition of their shareholder base
 Want institutions that provide them with more
credibility
 Want institutions that are more likely to vote with
management
 Want institutions with a longer-term focus
But does the institutional selling
affect stock prices?
Evidence suggests yes
 Institutions’ selling or avoidance of shares can have
price effects
• Heavy selling by institutional investors can put
downward pressure on stock price.
• Evidence shows that changes in institutional investor
ownership is associated with changes in returns
How do institutional investors monitor
corporate managers?
Private monitoring (behind the scenes)
• Direct negotiations with management
• Direct contact to directors
Public monitoring
• Submission of shareholder proxy proposals
• Publicly targeting firms
What strategies would institutional
investors be most likely to pursue?
90%
80%
70%
60%
50%
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ith
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From McCahery, Sautner, and Starks, 2008
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40%
30%
20%
10%
0%
Evidence on private institutional
investor activism
From a study of TIAA-CREF’s activities
 Institutional investor reached agreement with
targeted firm over 95% of the time
 In at least 87% of these cases, the targeted firm
took actions to comply with the agreement
Example of private activism taken
public
In 2007 Fidelity publicly announced that they would
vote against the buyout of one of their portfolio
companies. Fidelity owned 9% of the firm.
The Tweedy Browne Funds helped unseat Conrad M.
Black from Canada's Hollinger in 2003 and
successfully fought German automaker Volkswagen
to push one of the Porsche family members off
VW's supervisory board.
Evidence that institutional investors
care about corporate governance
 Surveys
 Creation of governance indexes
• To assess country environments
• To assess corporation’s practices
• To serve as the basis of index funds
 Investors’ reactions to corporate governance-related activities
– stock prices change on announcements
2007 survey on importance of
specific mechanisms
Equity ownership by managers
87%
Use of equity-based compensation
86%
Independence of the board
86%
Transparency about holdings of large shareholders
85%
High free float of shares
85%
Ownership concentration
80%
From McCahery, Sautner, and Starks, 2008
Public activism:
Which firms get targeted?
Poorly performing firms
 With high institutional ownership
 With poor corporate governance
 Low inside ownership
Public activism:
Does it work?
Metrics:
•
•
•
•
Short-term market reactions
Long-term performance
Voting outcomes on shareholder proposals
Other effects
These metrics lead to mixed conclusions on
whether public activism is effective.
Increasing interest in proxy
proposals
 According to the IRRC, 8,600 shareholder proposals
were put on proxies between 1973-2004
 Less than 10% won majority support
 But more than half of these majority votes occurred
in the last four years of the period
ec
u
1987-1994
e
Issues
2001-2005
co
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O
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on
bo
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Au
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Su
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is
ed
ifi
at
iv
ul
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C
e
im
in
at
ss
la
lc
tiv
El
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ea
Ex
R
Percentage of all corporate governance proposals
Changes in proposal issues over
time
Corporate governance proposal issues across two periods
35.0%
30.0%
25.0%
20.0%
15.0%
10.0%
5.0%
0.0%
Changes in percentage votes on
proposals over time
Voting outcomes for proposals
70%
Average % votes for the proposal issue
60%
50%
40%
30%
20%
10%
0%
Repeal classified
board
Eliminate poison
pill
Cumulative voting
Supermajority
Issue
1987-1994
2005
Audit-related
Board-related
Executive
compensation
Changes in sponsorship of
proposals over time
Sponsors of Corporate Governance Proposals
80.0%
Percentage of all corporate governance proposals
70.0%
60.0%
50.0%
40.0%
30.0%
20.0%
10.0%
0.0%
Union funds
Public pension funds
Religious organizations
Sponsors
1987-1994
2004-2005
Other shareholder groups
Individuals
Mutual fund voting records on 2007
corporate governance proposals
New shareholder proposals for 2008
 Proposals to create compliance committees to oversee
boards’ roles in managing risk
 Requests to improve how companies manage risk
 Enhanced disclosures of lending practices
• Financial institutions
• Home builders (due to concerns about their mortgage lending
arms' dealings in high-risk loans)
 Moody’s and McGraw Hill received proposals that called for
the board to adopt policies to bar the employment of any
individual who worked for a client within the past year.
New kids on the block: Hedge fund
activism
Forms of hedge fund activism –
all seeking changes in the firms’ strategy
• Publicly targeting the firm
• Privately targeting the firm
• Getting representation on board of directors
• Litigation
• Targeting firm for change in control
Growth in hedge funds
Assets Under Management at
Hedge Funds compared to Mutual Funds
in millions of USD
14000
12000
mutual funds
10000
8000
6000
17.5%
4000
7.3% of mutual fund assets
2000
hedge funds
0
1996
In millions of USD
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Why have hedge funds turned to
activism?
Returns on hedge fund strategies
0.4
0.35
0.3
0.25
0.2
Long\short
Event
0.15
conv arb
Merger arb
0.1
0.05
0
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
-0.05
-0.1
Avg returns: 1990-1999: 19%
Merger arb
14%
2000-2005: 9%
5%
Study finds that hedge funds only
made above average returns on
targeted firms that were acquired
 Other studies have concluded that hedge funds
have been able to make a difference
Effects of institutional investor
activism
 Some evidence that public activism works
 Much evidence that private activism works
Role of institutional investors in firm
corporate governance
Preponderance of evidence suggests that:
 Institutional investors have substantial influence on
firms’ corporate governance
 This influence has generally positive consequences
Role and responsibility of
institutional investors in corporate
social responsibility issues
New acronym
Who are the social activist
shareholders in the U.S.?
 Religious organizations, e.g., Interfaith Center on
Corporate Responsibility (ICCR)
 Individuals
 Socially Responsible Investing (SRI) funds
 Social organizations, e.g., Noyes Foundation, PETA
 Labor unions
Example of 2008 global warming
resolution at ExxonMobil
Global Warming
Emissions Reduction - Oil & Gas Companies
Exxon Mobil Corporation (Similar resolutions filed at a number of
U.S. companies in the oil & gas, utility, home building, and
automotive industries)
After the whereas:
 THEREFORE, BE IT RESOLVED: shareholders request that the
Board of Directors adopt quantitative goals, based on current
technologies, for reducing total greenhouse gas emissions from
the Company's products and operations; and that the Company
report to shareholders by September 30, 2008, on its plans to
achieve these goals. Such a report will omit proprietary
information and be prepared at reasonable cost.
Changes in rationale for corporate social
responsibility shareholder proposals
 Previous rationale:
• CSR factors are important for ethical/moral/social
reasons
 Recently added rationale:
• CSR factors are important because they can affect
company performance.
Shareholder proposals
Who gets targeted?
Corporations with largest number of social
responsibility proposals (1992-2002):
•
•
•
•
•
•
•
General Electric
Chevron/Texaco
Exxon/Exxon Mobil
Phillip Morris
AT&T
General Motors
JP Morgan Chase
86
64
60
54
46
42
38
From Tkac, 2006
Survey: Importance of ESG factors to
mainstream investment considerations
(economic risk/return)
corporate governance
64%
39%
sustainability
38%
33%
employee relations
human rights
26%
water
25%
50%
48%
44%
18%
environmental management
climate change
0%
Mercer Consulting
2006
24%
56%
7%
37%
10%
20%
very imp
30%
somew hat imp
40%
50%
60%
70%
80%
90%
What do investors do?
 Market reactions to announcements of proposals
• Little evidence
 Institutional investor monitoring
• Little evidence except for union funds and religious
funds and more recently SRI mutual funds
Votes on CSR shareholder
proposals
 Low proportion of votes in favor
 Tkac (2006) finds average yes vote over 1992-2002
period is 8.2%
 But, this has been changing…
How do mutual funds react?
% votes in favor of CSR proposals
2004
2005
2006
10 Mainstream
Mutual Funds
5.8%
7.2%
11.3%
7 SRI
Mutual Funds
70.5%
65.8%
74.9%
But even variation within
mainstream funds (2006 votes)
Abstain
Against
For
American
108
3
Fidelity
124
1
TIAA-CREF
42
70
87
Vanguard
164
7
4
Voting in 2008 proxy season
 Votes in favor of CSR proposals this year have
increased to 14.7%
 About 30% of the issues voted on received more
than 20% support
 129 proposals were withdrawn
Major social issues arising in the
2008 proxy season
I.
Climate change
II. Sudan and Darfur conflict
III. Political contributions
IV. Health care proposals
2008 major social issues on proxies
Climate change
 Major issue: greenhouse gas emissions
 Is there an economic effect?
• Possibly – future carbon emissions may have a price
• Possibly – if a company can have a competitive edge
from a position on climate change
• Probably – companies face increased risk because of
the regulatory changes that will occur from concerns
about climate change
2008 major social issues on proxies
Climate change
 Example that underscores the possible economic
effect
 11 multinational corporations have formed the
Supply Chain Leadership Collaboration to work with
their suppliers to reduce greenhouse gas emissions
• Dell, HP, Pepsico, Proctor & Gamble, Unilever, L’Oreal,
Reckitt Benckiser, Cadbury Schweppes, Nestle, Tetco
2008 major social issues on proxies
Climate change: Shareholder positions
 Shareholder proposals on climate change
• Most address greenhouse gas emissions
• Request for a policy of increasing global renewable energy
sources
 Joint institutional investor initiatives
• Carbon Disclosure Project
• 385 institutional investors representing $57 trillion in assets under
management
• On their behalf it seeks information on the business risks and
opportunities presented by climate change and greenhouse gas
emissions data from the world's largest companies: 3,000 in 2008
2008 major social issues on proxies
How much attention are investors paying?
 Goldman Sachs’ view:
“Environmental and social issues count … in an increasingly
complex world, we believe such issues are part of the relative
quality of overall management performance needed to
compete successfully.”
 TIAA-CREF’s view:
“Will generally support reasonable shareholder resolutions
seeking disclosure of greenhouse gas emissions and the
impact of climate change on a company’s business activities.
2008 major social issues on proxies
Sudan
 Divestment
• Pros
• Puts pressure on Sudanese government to end the Darfur
conflict
• Cons
• Shareholder engagement may be more effective than
divestment – studies show that South African divestment
had no discernible effect
• Many institutions have a fiduciary duty to make decisions
solely on the basis of economic returns
2008 major social issues on proxies
U.S. Department of Labor’s View
Interpretation of ERISA and SRI
‘‘A fiduciary must ordinarily consider only factors relating to the
interests of plan participants and beneficiaries in their
retirement income.”
“A decision … may not be influenced by non-economic factors
unless the investment ultimately chosen for the plan, when
judged solely on the basis of its economic value, would be
equal to or superior to alternative available investments.”
Reason for new legislation and presidential orders
2008 major social issues on proxies
 Sudan Divestment Accountability Act of 2007
• Provides safe harbor to states and fund managers
who divest Sudan-related companies from their
portfolios
• Prohibits companies with operations in the military or
energy sector of Sudan from receiving federal
contracts
2008 major social issues on proxies
Proposals at mutual funds
 Mutual Funds Divestment Campaign
• Investors against Genocide (formerly called Fidelity
out of Sudan)
• Have filed proposals at 28 Fidelity funds, 24
Vanguard funds and other funds at Barclays, Franklin
Templeton, and T. Rowe Price
2008 major social issues on proxies
Sudan: Shareholder positions
 Proposals
 Investor coalitions
• Socially responsible investment firms have submitted
proposals at financial services firms: Merrill Lynch,
Morgan Stanley, T. Rowe Price asking their boards to
report to shareholders on how investment policies,
including shareholder engagement, “addresses or
could address human rights issues” (with specific
reference to Sudan)
2008 major social issues on proxies
Political contributions
 Activists have concerns that firms may say one
thing publicly and then fund a trade association that
lobbies for the opposite.
 Shareholder proposals calling for disclosure of
contributions to trade associations
 Support averaged 26.1% in 17 votes on the issue.
2008 major social issues on proxies
Health care proposals
 Proposals ask companies to support universal healthcare.
 Opponents believe this is not an appropriate use of
shareholder proposals as it is asking corporations to
campaign for public policy issues.
 Voting results in 2008
• Support averaged 4.35% in 8 votes on the issue.
• 13 of the 27 total proposals filed were withdrawn.
• 3 health care companies were allowed to exclude the resolutions
because they related to those firms’ “ordinary business.”
Other types of social proposals in
2008
 Stop predatory lending practices
 Prepare report on operations in Burma (Myanmar)
 Prepare report on company activities affecting
indigenous peoples’ rights
 Tobacco related proposals
 Prepare reports on outsourcing
 Prepare reports on connections to pornography
 Ethical criteria for military contracts
But some pushback from other
investors as well
Free Enterprise Action Fund (FEAF) submitted proposals asking
companies to report on the effect of sustainability efforts on
their operations.
The Free Enterprise Action Fund is a shareholder activist mutual
fund that seeks long-term capital appreciation while
aggressively challenging CEOs who use shareholder assets to
advance the liberal political agenda which threatens longterm shareholder value, the free enterprise system and
individual liberty.
So…what should institutional
investors consider?
 Do social responsibility issues affect firms’ risk?
• Potential risk factors
•
•
•
•
•
•
Regulatory risk from future regulations
Supply chain risk
Product and technology risk
Litigation risk
Reputational risk
Physical risk
 Is this risk priced?
Bottom line on social responsibility
shareholder proposals
 According to surveys, a minority of investors believe social
responsibility issues, in general, have important effects on a firm’s
actions and value.
 Traditionally only specialized institutional investors (primarily union
funds and religious funds) have been both interested in and tried to
affect firms’ actions with regard to social responsibility issues. They
have generally not been very successful in changing firms’ actions.
 Recently more institutional investors and individual investors have
become interested, but others have actively fought against such
efforts.
 BOTTOM LINE: The effects of CSR issues on corporations needs to
be better understood.
Conclusions
 Institutional investors have important roles and
responsibilities in the financial markets.
 Through their trading and monitoring they have
substantial effects on firm’s stock prices and on
their actions.
 This monitoring affects both firms’ corporate
governance and may affect firms’ treatment of their
environmental and social issues as well.