The Role of Institutional Investors in Reforming Corporate Governance

November 18, 2013

Corporate governance continues to receive considerable interest from policy makers and market participants in response to the financial crisis of 2008.  Institutional investors have become a lot more engaged in affecting governance at firms.

Though an important topic for businesses, investors and policy makers, little research has been done on the direct involvement of institutional investors in changing corporate governance since much of what they do happens behind the scenes.

However in the recent paper, The Role of Institutional Investors in Voting: Evidence from the Securities Lending Market, Professor Reena Aggarwal and her co-authors Jason Sturgess and Pedro Saffi pull back the curtain to unveil that institutional investors value their vote and use the proxy voting process as an important channel for bringing about change at companies. By observing the behavior of institutional investors in the securities lending market, Aggarwal finds that just before the proxy record date, institutions selectively recall loaned shares in order to regain voting power.

“Institutional investors are large entities with significant power to make a difference. We find that these investors are truly engaged – and when they are engaged – they can bring about tremendous change,” said Aggarwal. 

Institutional investors effectively use the voting process as a tool to affect outcomes, particularly at firms with weak corporate governance, poor performance, and when contentious proposals related to compensation, anti-takeover and corporate control are on the ballot. The influence of proxy advisory firm ISS is also evident in the voting outcome.

“We have seen several cases of shareholder activism where institutional investors are voting to bring about changes at even large companies like JP Morgan, Microsoft and Apple,” said Aggarwal.

By understanding institutional investor preferences regarding corporate governance, firms can make strategic decisions when attracting new investors, and developing strategies to engage with shareholders. Policy makers can consider these findings when evaluating the proxy voting process and the role of large investors.  

As shareholder activism and shareholder engagement receive an increasing amount of attention, Aggarwal encourages regulators to use these findings when determining how much proxy access to allow shareholders, and how to change the proxy voting process.

In the paper, The Role of Institutional Investors in Voting: Evidence from the Securities Lending Market, Professor Reena Aggarwal and her co-authors (Jason Sturgess and Pedro Saffi) use the securities lending market to examine if institutional investors influence firm-level corporate governance through proxy voting. Understanding institutional investor preferences regarding corporate governance is important for firms trying to attract new investors as well as policy makers considering the regulation of different governance mechanisms. The activities of institutional investors in the securities lending market provide one of the few opportunities to directly examine the behavior of institutional investors in influencing firm-level governance.

Professor Aggarwal found that institutional investors selectively restrict lending supply and/or call back loaned shares prior to the record date in order to exercise their voting right. The results suggest that institutional investors put in considerable effort into determining when it is important to vote.

The authors estimate the value of voting rights in a simultaneous equation framework. They find institutions place a greater value on voting rights for firms with weak corporate governance, poor performance, and higher institutional ownership. The value of the vote is also higher when contentious proposals such as non-routine and those related to compensation, anti-takeover and corporate control are on the ballot. Examining the subsequent vote outcome, Aggarwal found higher recall to be associated with less support for management and more support for shareholder proposals. The influence of proxy advisory firm ISS is also evident in voting outcome. If ISS opposes management, then we find the higher recall to be associated with less support for the proposal. The results indicate that institutional investors value their vote and use the proxy voting process as an important channel for affecting corporate governance.

Tags: Reena Aggarwal