The Firms’ Reaction to Changes in the Governance Preferences of Active Institutional Owners

Institutional investors are becoming increasingly influential on firm policies. The rise in intermediated investment, coupled with growing investors’ demand for engagement has fuelled institutional shareholder activism. Among institutional investors, those with universal holdings are of particular interest. Their investment policies and preferences can affect investee firm policies in a systemic way, thus affecting the broad population of firms in their portfolio. This universal influence can go beyond the specific needs of a given firm and, instead, coordinate firms into new standards or a new equilibrium.

Specifically, large active institutional owners (pension funds, mutual funds and sovereign wealth funds) tend to hold broad, diversified, often universal, long-term oriented portfolios, with infrequent rebalancing. However, active owners also generally have the ability to deviate from their stated investment benchmark, thus sharing some characteristics of activist investors. In particular, active owners have the potential to enter and augment the shareholder stake, as well as present a reasonable “threat of exit.” All these represent engagement tactics to influence firm policies.

In this paper, we exploit a sudden change in the investment stance of Norway’s sovereign wealth fund (NBIM) with respect to corporate governance practices to shed light on the systemic influence of active owners on investee firm policies. We use this sudden change in aggregate governance preferences as a natural experiment to understand shareholder influence among active investors. We start by establishing how the fund rebalanced its portfolio and its investment strategy to fulfil this governance objective. We then show how the firms in the NBIM portfolio reacted by catering to the fund’s new stated governance preferences. We show that the intensity of the firm’s reaction depends on how important the firm is for the fund, but also on how important the fund is as an investor of the firm. We also examine the heterogeneous response of firms to this institutional influence across firm and characteristics. Finally, we focus on the new equilibrium correlations between changes in governance and the fund investments.

This paper advances the existing research on active owners’ influence on firms and, particularly, on how universal owners’ policies may foster systemic changes in firms’ corporate governance.