Week 6

The Role of Institutional Investors in Corporate GovernanceFaisal AlSager

MGT 427 - Corporate Governance

Objectives

✤ To understand the growing influence of institutional investors

✤ To realize the importance of institutional investors’ relationship with their investee companies

Categories of Share Ownership in the UK (1963 & 2004)

1963 (%)1963 (%) 2004 (%)2004 (%)

IndividualsIndividuals 54 14

Insurance Insurance CompaniesCompanies 10 17

Pension FundsPension Funds 6 16

Unit TrustsUnit Trusts 1 2

OverseasOverseas 7 32

2006: Holdings of Institutional Investors in the US

$ billion$ billion

Private Pension FundsPrivate Pension Funds 2,667.7

State/Local Pension FundsState/Local Pension Funds 1,958.4

Mutual FundsMutual Funds 5,018.4

Insurance CompaniesInsurance Companies 1,637.7

Household SectorHousehold Sector 5,482.8

Institutional Investors

✤ By 2002, institutions owned more than 60% of equity of most large multinational companies

✤ 58% of Microsoft

✤ 60% of GE

✤ 58% of Intel

✤ 68% of Cisco Systems

✤ More than 90% of some publicly traded companies

Some Institutional Investors

✤ Bank Trusts

✤ Mutual Funds

✤ Insurance Companies

✤ Universities and Foundations

✤ Pension Plans

Bank Trusts

✤ Trustees for everyone: from pension plans to private estates

✤ The security of the trust business may well be reason for the traditional poor investment performance by the banks

Mutual Funds

✤ They hold about 24% of all US companies

✤ It’s different from previously mentioned trusts because it’s designed for total liquidity

✤ Flexibility: They are designed for investors who come in and out on a daily basis

✤ Thus, concerned more with short-term

Insurance Companies

✤ They have symbiosis with companies they invest in; they are different from other institutional investors in the following:

1. Usually, they are holders of debt securities of any company in which they have an equity investment

2. They typically have - or would like to have - a commercial relationship with the company by providing insurance or a product to meet the company’s pension obligations

Insurance Companies

✤ The collective choice problem makes any form of activism uneconomic

✤ Thus, it’s not surprising that the insurance industry consistently votes with management, regardless of the impact on share value

Universities and Foundations

✤ They are institutional shareholders because they are funded through endowments

✤ This money is put into widely diversified investments, including common stock

Pension Plans

✤ The largest institutional investors are pension funds

✤ They are trustees

✤ Making economies socialist

Exit or Voice?

✤ ‘Exit and Voice’: “dissatisfaction [may be expressed] directly to management” (the voice option) or by selling the shareholding (the exit option)

✤ The exit option is not easy for institutional investors because of

✤ the size of the holdings, or

✤ the policy of holding a balanced portofolio

Influence of Institutional Investors

✤ The institutional investors’ potential to exert significant influence on companies has clear implications for corporate governance, especially in terms of the standards of corporate governance and issues concerned with enforcement

The Combined Code (2006)

✤ Dialogue with companies: Institutional shareholders should enter into a dialogue with companies based on the mutual understanding of objectives

✤ Evaluation of governance and disclosure: When evaluating companies’ governance arrangements, particularly those relating to board structure and composition, institutional shareholders should give due weight to all relevant factors drawn to their attention

✤ Shareholder voting: institutional shareholders have a responsibility to make considered use of their votes

References

✤ Corporate Governance: Mallin, Tina. Oxford.

✤ Corporate Governance (4th Edition): Monks, R. and Minow, N. 2004. (Publisher: Wiley-Blackwell)