Investors, Academics and Corporates Share Views on Important Issues
On 11 February 2019 the European Corporate Governance Institute (ECGI) teamed up with the International Corporate Governance Network (ICGN) to present the Academic Day on Corporate Governance and Stewardship at the Amsterdam offices of the Dutch institutional investor APG Group N.V. It was a stimulating day of cross-fertilising discussion and debate between practitioners (mainly from the investor community) and academics doing research in governance. The conference examined four papers on three primary topics: common ownership, annual general meetings (AGMs) and the agenda on environmental, social and governance (ESG) issues and investor engagement (two papers on this latter issue).
'Re-thinking Adam Smith'
The first discussion, addressing the antitrust risks stemming from common ownership, began with empirical evidence that may suggest anticompetitive effects and higher fares in the airline industry as a possible result of common ownership. More specifically, anticompetitive effects are alleged to arise in the form of reduced incentives for companies to compete aggressively, in order not to undermine portfolio profits of their “common owners”. At least in theory this creates the possibility of a tripartite trade-off between, diversification, governance and competition. The observation was made that Adam Smith’s textbook model of self-interested competition assumes that the owner’s wealth is concentrated in one firm which is not always the case with company ownership models nowadays.
A lively debate ensued, during which strong criticism was advanced on the actual existence of anticompetitive outcomes and the scope of institutional investors’ intervention in firms’ decision-making. On the one hand, it was claimed that overwhelming empirical evidence would be needed showing that anticompetitive incentives stemming from common ownership never cause anticompetitive outcomes, in order to reject such a prediction. Removing anti-competitive incentives (instead of removing voting rights) was offered as one future regulatory possibility, though an unbiased understanding of the problem was firstly espoused. On the other hand, the magnitude of anticompetitive incentives was called into question, as was the idea that the motivation of companies to compete depended in any way on the interests of institutional investors, arguing instead that the desire to win market share is the principal natural motivation of any company. The nature of dialogue between companies and institutional shareholders was described as focusing on high-level corporate governance issues, long-term strategies and financial results, rather than on pricing strategies. The potential for negative ramifications such as investors’ inability to diversify or to conduct stewardship through voting and engagement was strongly forewarned. The need for further empirical studies on the issue, in order to better understand the mechanisms at play and to better inform potential policy initiatives, was a fundamental conclusion from the discussion.
'To vote or not to vote'
The second paper focused on corporate voting and more specifically, on the decision of shareholders that are not legally mandated to vote, of whether to vote. Building on the literature on political voting, the paper shows, both theoretically and empirically, a freerider and an underdog effect in corporate voting, with voters opposing a contentious voting resolution being overrepresented because of the relatively high probability of being pivotal in the decision. Conversely, voters supporting the resolution tend to free ride on other shareholders who are legally mandated to vote. This results in an over-representation of the underdogs in the voting outcome, with a probability of swinging the results (3,7% in the sample used by the authors).
The ensuing discussion explored its applicability in the European context of concentrated ownership, and also in light of the new Shareholders Rights Directive. The analysis also highlighted that both the type and the sponsor of the proposal matter for the participation rate and the shareholder’s engagement. Another point was that minority investors, both retail and institutional, often use votes to “signal” their concerns to investee companies, even if they know it may not affect the ultimate outcome, and it was observed that the UK Corporate Governance Code requires companies to take certain actions if the threshold of shareholders voting against companies exceeds 20%. Initiatives of this nature to empower the voice of minority shareholders may also provide new incentives for voting participation.
'When it pays to engage (on ESG)'
The second half of the academic day focused on two papers relating to investor engagement on ESG. The first paper studied a large proprietary dataset on ESG engagement. The study concludes that ESG engagement positively impacts on the financial performance of the target corporation. It then seeks the determinants of the engagement and its success, finding that activists are more likely to engage with high profile companies with a higher than average market share. The likelihood of a successful engagement correlates with the ESG scores of target corporations, showing a higher probability of success for ex-ante high scores of the target. The study finds little impact on real performances of the targeted corporations, with the notable exceptions of the increase on sales, while target corporations usually increase their ESG scores after the engagement. The discussion also highlighted the importance of the willingness of the target to be engaged.
'The importance of coordination'
The second paper presented on ESG focused on the ESG engagement of the signatories to the Principles for Responsible Investment (PRI) supported by the United Nations. It examines the coordination of engagements on ESG projects across international investor networks. Results show that in many cases a two-tier engagement strategy, combining influential local lead investors and supporting international investors, increases project success and improves both the financial and accounting performance of the target firms.
The ensuing panel discussion highlighted the difference between early comers and those who began to engage much later. In Europe active ownership was adopted earlier by investors than for example in Asia. It was observed that while collaboration with a clear and active lead member is often the best way to ensure successful engagements, some big passive investors are engaging too, but usually on their own. The necessity to improve the comparability of non-financial disclosure and, especially, to link such information to the long-term impact of investments was emphasised. In this respect, SDGs and ESG engagement are closely linked and can help investors understand the systemic risks associated with their activities and embed those risks in their risk assessments in a more precise and consistent manner.
The conference provided a useful platform for the exchange of viewpoints on these very topical issues. A detailed report of the discussions, written by Elena Ghibellini (Amsterdam Center for Law and Economics (ACLE)) and Edoardo Martino, LLM (Amsterdam Center for Law and Economics (ACLE)) is available here.
Azar, José and Schmalz, Martin C. and Tecu, Isabel, Why Common Ownership Creates Antitrust Risks (June 16, 2017). CPI Antitrust Chronicle June 2017. Available at SSRN: https://ssrn.com/abstract=2988778
Cvijanovic, Dragana and Groen-Xu, Moqi and Zachariadis, Konstantinos E., Free-Riders and Underdogs: Participation in Corporate Voting (January 2019). Available at SSRN: https://ssrn.com/abstract=2939744 or http://dx.doi.org/10.2139/ssrn.2939744
Barko, Tamas and Cremers, K. J. Martijn and Renneboog, Luc, Shareholder Engagement on Environmental, Social, and Governance Performance (September 2018). CentER Discussion Paper Series No. 2017-040; European Corporate Governance Institute (ECGI) - Finance Working Paper No. 509/2017 ; TILEC Discussion Paper No. DP 2017-021. Available at SSRN: https://ssrn.com/abstract=2977219 or http://dx.doi.org/10.2139/ssrn.2977219 or https://ecgi.global/working-paper/shareholder-engagement-environmental-social-and-governance-performance