Behind the Scenes: The Corporate Governance Preferences of Institutional Investors

Research Retrieved: August, 2016 (PDF below) or get the latest version on SSRN
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There are two active choices investors have when they are unhappy with a firm: exit and voice.

Yet, many of these activities happen behind the scenes which makes it difficult to analyse what institutional investors actually do in such cases. Which actions do investors prefer to take? Is the threat of selling the stake actively used and if so, is it considered successful? And, do investors address the company themselves or do they make use of a proxy advisor?

Key Findings

The authors shed light on the importance of voice and exit through a unique sample of 143 institutional investors, consisting of asset managers, mutual funds and pension funds. 35% of the institutions have assets under management of at least $100 billion. These investors report on shareholder engagement actions they themselves have been involved in.

Voice: Primarily, investors rely on voicing their concerns through behind the scene discussions with management (63%). A longer holding period causes investors to use voice more intensively as they have stronger incentives to intervene. Liquidity needs however reduce engagement as these investors tend to hold more liquid stocks which allow to cut and run.

Exit: Around 40% of respondents made use of selling their shares due to dissatisfaction with corporate governance. Threatening to exit improves the effectiveness of voice under three main conditions: (1) selling by other investors for the same reason (72%), (2) managerial equity ownership (70%), and (3) the presence of large shareholders in the firm (67%). These answers go along well with existing exit theories. Investors need a certain size in order for their threat to be effective. Yet, if a single investor is too large, the threat loses its credibility as selling the entire stake upon the arrival of negative information becomes more difficult because of the large price impact.

Proxy voting: The current debate on proxy advisors circles around their quality and possible conflicts of interest; they advise companies on corporate governance issues as well as its investors on voting practices. However, 60% of the respondents use at least one proxy advisor, most of them even two. In addition, the majority of investors (55%) reports that while proxy advisors help them make better voting decisions, the investors themselves remain their own decision-makers.


Meaning for Practice

Insights into the actions of (long horizon) institutional investors are highly relevant as it reveals fundamental knowledge about their corporate governance preferences. These findings allow investors to organize their shareholder engagement strategies more concertedly as they nurture a better understanding of their own institutional environment. When should investors voice their concerns and when should they threaten to exit? The very profound survey questions allow investors to get a feeling for how their peers think and react in concrete situations. This understanding will further increase the effectiveness of shareholder engagement and help to increase shareholder value.