Institutional investors, activist funds and ownership structure

Abstract

One of the important developments underlying capital markets is the dramatic increase in the size and influence of institutional investors. The rise in institutional investors’ ownership has produced numerous studies on the corporate governance role of these investors. However, while the academic literature tends to focus on the United States, the governance role of institutional investors depends on a myriad of economic, cultural, and regulatory factors that vary across countries. In this chapter, we focus on one major dimension by which institutional investors’ governance role may vary across countries: the ownership structure of public companies. We claim that the rise of institutional investors reinforces the differences between widely held and controlled companies. At controlled companies the growth of institutional investors is unlikely to have a dramatic effect on the allocation of power between insiders and public investors. As the controlling shareholder dictates the outcome of shareholder votes, even well-incentivized institutional investors have little ability to influence companies in their portfolio. However, even among countries with widely held public companies, we do not expect a uniform rise in the influence of institutional investors. Country-specific regulations, political sentiment, social norms or other factors will determine whether and how institutional investors wield their power. For example, behind-the-scenes tactics are likely to be especially prevalent not only in countries where social norms discourage open confrontation, but also where political sentiment run against concentration of power in the hands of few powerful financial actors. We also analyze the governance implications of the rising influence of traditional institutional investors against the background of another development, namely, the rise of activist hedge funds which are a unique class of institutional investors. We argue that large institutional investors’ size and clout mean that they can influence management behind the scene and without resorting to the aggressive tactics used by activist hedge funds. Finally, some activist interventions—those that require the appointment of activist directors to implement complex business changes—cannot be pursued even by powerful and well-motivated institutional investors. This is true even for countries in which the regulatory framework allows institutional investors to nominate directors. Activist directors, we argue, need to share nonpublic information with the fund that appointed them. Accordingly, this form of intervention could not be pursued by institutional investors without dramatic changes to their respective business models and regulatory landscape.