Shareholder activism has become prevalent in the market in recent years following several high profiled corporate governance breach and mal-disciplined practice cases that had resulted in great financial losses. Collective groups and institutional investors conduct procedures using their stake holding powers to actively manipulate corporate decision and policy making. In doing so, they defy the usual assumption for the rational investor to achieve returns, although the impact of their intervention can help individual investors to make better informed investment decisions. Over time, results have shown significant changes in executive management behaviour and corporate structure. However many are yet convinced by the overall effectiveness of shareholder activists and remain doubtful about the real impact on corporate governance and policies
What is Institutional Investor?
Shareholders are ones that legally hold the share or stock in a company or corporation (BusinessDictionary.com, 2012), and comprises of individuals, or group and organisational investment. In particular, an institutional investor is referred to an organisation that invests in a company in the form of securities, liability and other type of assets. Some typical examples of an institutional investor include banks, insurance and pension fund companies. It is documented that over the last 25 years, the majority of the ownership in corporate shares had been transferred from individuals to institutional investors, who now hold approximately 60% of corporate equities in United State, 79.5% in Europe, 81% in Japan during 1997(Westphal and Bednar, 2008).
The formation of shareholder activism
In response to the constant changes in the economic environment and government policies, institutional investors are encouraged to adopt a more active attitude, focusing on corporate governance. There are several reasons that have contributed to the formation of such shareholder activism.
The enhancement of institutional investors' financial capability through the expansion of their market shares is one of the main reasons that prompted them to become activists. The increase of investment scale and the percentage of shares for institutional investors, fulfilled the conditions that encourage them to change from passive to active investment. At the same time, passively selling large amount of shares when corporate governance encounters issues will serve a negative impact, which may result in losses for institutional investors(Romano, 2000).
In the 1980s, the growing emphasis of merger and acquisition and its associated counter strategies had threatened the welfare for both institutional and individual investors (Taub, 2009). Under this situation, institutional investors cannot minimise their loss from selling shares, but instead need to be aware of any hostile acquisition, and react efficiently with their own financial resources and shares to prevent any severe loss.
In addition, since the new Securities Exchange Commission (SEC) in the United States had changed the rules to encourage further open communication between shareholders, institutional investors have been granted more opportunities for intervention in corporate management through negotiation in 1994 (Silverstein, 1994) . This change does not only reduce the restriction of institutional investors in company's corporate governance, but also initiatively encourages its participation and involvement in influencing management decision making. Regulatory bodies in many countries have formulated standards to support the activism of institutional investors through proxy voting. For example, the labour organisation in the United State has requested pension fund managers to actively vote for any important proposal that will influence the benefits of investors (Gillan and Starks, 2007).
The above reasons have contributed to the rise of shareholder activism, which include the financial capability of institutional investors, regulatory changes, and the change of investment strategy of institutional investors.
The role of shareholder activism
The needs and investment intentions between individual and institutions are different. Unlike individual investors, organisations have the capacity for continuing investment, based on their income retrieved from their business (Lorenzen, 2010). This continuing investment allows the organisation to obtain a higher quantity of shares from the companies they invested in, which enhance their influential power over a range of corporate governance issues through different mechanisms.
In general, the most direct way of activism of institutional investors is the negotiation with fund manager. This negotiation includes several topics, such as executive pays, board members, business strategies and the necessary for merger and acquisition. However, institutional investor fails to see any effectiveness after negotiation; they will use alternatives ways of activism. Some prevalent ways include shareholder proposal, private consultations, proxy voting and exposure of under performed company (Eisenhofer and Barry, 2005).
Shareholder proposal had been employed frequently by institutional investors, and is considered as an efficient method in which quality outcomes are achieved with low cost input. During 1990s, the majority proposals that were raised by institutional investors were related to prevent merger and acquisition, set threshold in executive pays and the independency of board members (Karpoff, 2001). Statistic indicates that the successful rate at around 21% of proposals have been adopted by the management team (Copland., 2011).
Proxy voting is the fight over corporative control but with the premise that the ownership of the company remains the same. Although this approach can result in increasing the face value of shares, but it is usually not the first option of choice for institutional investors. The main issue behind this approach is high cost association, with some minor effect on the individual investors. This can be seen particularly in a company that has wide spread distribution of their shares (Taub, 2009). Institutional investors in such company have limited proportion of shares, for which they would need to seek for support from other investors when they have differences in opinion with the company. Furthermore, executives in company have superiority in obtaining the information from individual investors, in which they will take various approach to avoid the communication between institutional and individual investors. This prevents the activity for shareholder activism and leads to its failure. In order to mitigate potential failure of activism, institutional investors have developed strategies such as establishing department that specifically focuses on proxy voting, and employing consulting firms to conduct decent research on proxy voting. The purpose for institutional investors to obtain proxy right is not to take over the control of the corporate, but rather increase share values by varying management processes (Kang and Sørensen, 1999).
Private consultations or dialogue between institutional investors and targeted company is an unofficial method that can minimise the direct impact on the share value in public, which provides more rooms for negotiation and discussion. With the expansion on the financial capability and investment scale, it is hard for the corporate to disregard the opinions from institutional investors, but further consider their requests for management strategy. The success of private dialogue reduced the employment of shareholder proposal during the 2000s. Research further indicates that private dialogue brings positive impact on the share vales without its revelation to the public (Becht et al., 2010).
Revealing the companies that does not perform well is a larger scale approach of shareholder activism. By exposing these to the public, that company will be experiencing high amount of market and shareholder pressure and force it to respond the expectations by changing their strategies or actions. In late 1990s, the United State Pension fund company, CalPERS, started to publish a yearly catalogue including companies that were not performing well in optimising their share values, and aimed to urge the improvement of their performance by re-evaluating their corporate governance (Romano, 2000).
Implication of shareholder activism
There are still arguments between the effectiveness of shareholder activism towards corporate governance, which it has not yet reach any sort of conclusion. However, it is still valid that the presence of institutional activist has a certain degree of impact on company's internal management structure, corporate behaviour and company performance.
Firstly, institutional activist constantly monitors the performance and evaluates the executive pay of the company. When there is evidence to suggest that the executive pay is not in proportion to the performance (i.e. the pay for CEO remains similarly high when the company records losses in profit), institutional investors will vote to reduce the payment to executives. For example, CalPERS was involved in the protest of overpaid CEO salaries, together with other pension funds, they have forced the executive of New York Stock Exchange (NYSE) to resign due to excessive pay package in 2003 (Landon, 2003).
The research conducted by Gillan and Starks observed the trend of acceptance in shareholder proposals by company has increased from 1987 to 1994, in which institutional investors have received more supports than other types of investors (Gillan and Starks, 2007). It further indicated that institutional investor would be in an advantageous position when negotiating with company managers if there were more than 35% votes for the proposal.
In addition, shareholder activism conducted by CalPERS has exerted impact on the corporate governance or structure in 51 companies from 1987 to 1993 (Smith, 1996). This in particular reflects on the increase of company performance. From 1994 to 2000, about 72% of targeted company had adopted solutions suggested by the institutional investors, after which the value of shareholders had subsequently improved (Smith, 1996). The significant increase of the percentage indicates that the importance of shareholders has increased towards company corporate governance, and the effectiveness of shareholder activism.
Limitation of shareholder activism
In 2001, it was argued by Karpoff that shareholder activism had limited influence to corporate governance especially in the United State. It could trigger some minor changes in the targeted company's structure and corporate strategies, but had insignificant impact on the gain of share values (Karpoff, 2001).
These failed occurrences of shareholder activism usually are associated to three elements: the legal constraints to activism; the different incentives among subsequent institutional investors; and the unrestricted freedom of free riding resulted in insufficient monitoring of the company.
In regards to the legal constraints, majority institutional investors are believed to experience conflicts of interest (Romano, 2000). For example, corporate tends to implement a strategy that needs to consider all stakeholders, which may not bring optimal benefit towards shareholders. Furthermore, different scopes are required for corporate strategic decision making, in which immediate result may not be obvious. This is in conflicts with the interests of shareholders who would like to see immediate benefit on their investment. Romano also suggested that the intention for public pension funds to conduct shareholder activism was for political and social purpose, in such they expect to increase their social status from the public awareness through activism.
The results for successful shareholder activism are said to have limited effect on the corporate structures, due to the regulatory system in protecting directors from shareholders. For instance, shareholders in US, in particular, are very much restricted from nominating and electing board members, even those with minor seating. This prevents the ability to influence the formation of company corporate structure when requested by shareholders and hence lead to the potential failure of achieving their goals (Black, 1990)
Inadequate monitoring of shareholders to the company may be due to diversified investment by institutional investors. Investors tend to diversify, "putting little amount of eggs in numerous baskets", and thus they would only have a small portion of shares in each company. To minimise the investment risks, fund manager tend to invest on index fund, which is also known as tracker fund (Becht et al., 2010). General Index investment necessitate small transaction costs by "setting a particular market index as the goal, performing constant monitoring and tracking of the pattern and hence receiving an average return of stock market" (Investorpedia, 2012). This inhibits the allocation of resources towards shareholder activism, due to limited market return on their share values in comparison to its cost. In this paper, it has indicated that "For Hermes, 28.5% of the U.K. equity is invested in index tracking funds, where only 5.3% that were actively managed." (Becht et al., 2010).
Evaluation of shareholder activism
Shareholder activism has shifted the power of corporate governance from management to shareholders, however, the prevalence of shareholder activism is not widely spread. This may be due to the limitation mentioned before, such as inadequate monitoring intention from shareholders and the conflict of interest between shareholders and company executives (Romano, 2000) .
Shareholder activism can maximise its effect on corporate governance when conducted by institutional investors under adequate circumstances, such as reducing executive pays through shareholder proposal and private negotiation, as evident from CalPERS (Smith, 1996) . On the other hand, shareholders should recognise the presence of uncertainty and risks associated with the monitoring system. For example, the grant of proxy right for institutional investors might encourage them to manipulate the market by working privately with company executives and disadvantage other shareholders, which defeats the purpose of monitoring. In order to monitoring the big companies more efficiently, institutional investors should take both voting and private negotiation into action (Copland., 2011). Shareholder activism by institutional investors can be seen as a supplementary or a replacement approach in corporate governance. It is critical to find the balance where institutional investor can efficiently obtain the benefit for shareholder without given them dominant power over the company executives.
Conclusion
In conclusion, there are different ways for institutional investors to conduct shareholder activism and influence corporate governance. These include shareholder proposal, proxy voting, private negotiation and revealing the underperformed company. Positive results have been observed on the impact of activism, such as adopting shareholder proposals in increasing their share value and benefits. Not only for shareholders, activists also encouraged companies to perform better by adjusting their corporate structures and obtain better profits. Nevertheless, negative impact of activism has limited its prevalence on corporate governance aspects, such as the presence of conflict of interest between shareholders and company, with different perspective towards short term and long-term benefits. Therefore, it is suggested that reasonable involvement of shareholder activism can effectively influence corporate governance, and to avoid over participation.
