Disadvantage question remains how the (alleged) short-termism of

Disadvantage of Shareholder Engagement

Investors may not choose to intervene because in doing so
they will breach the legal rules. An example would be diversification
requirements for mutual funds or pension funds might not allow investors to
take a stake that is sufficiently large to incentivize engagement. Rules on
“acting in concert” can also discourage engagement because they imply a legal
risk to investors coordinating engagement.1
Finally, disclosure regulations (e.g., “Regulation Fair Disclosure” in the
United States) might discourage investors or managers from engagement.2 Increased
regulation could reduce quality of engagement. Risk that further regulation in
the governance arena would be counterproductive, leading to more box ticking
and boilerplate reporting rather than more effective engagement.3

However, that institutional investor activism most of the
times takes place behind the scenes4,
which makes it very hard to detect. Subsequently, further research in this area
is of utmost importance. Moreover, do shareholder activism and shareholder
engagement have positive effects? Several academics believe in an overall
benign effect of shareholders’ activism5.
The evidence remains limited, however. Academic research also pointed to
evidence on a more long-term oriented shareholder engagement by hedge funds6, but
the question remains how the (alleged) short-termism of shareholder engagement
could be dealt with, if at all. Moreover, recent theoretical models even show a
more beneficial result of activism through exit than activism through voice.

There is a huge range of investment managers. In 2001, Paul
Myners, who was just concluding a term as chairman of the board of pension fund
manager Gartmore, issued a government commissioned report on institutional
investment in which he expressed concern about the reluctance of fund managers
to engage actively with companies in which they had holdings.7

Hedge funds do not give a damn they just want to know about
short-term share price moves at the opposite end of the spectrum are the
activist firms they are in the minority but noisy.8
Likewise, the fund managers who invest on behalf of institutional investors are
geared up to focus on trading decisions and thus are neither incentivised nor
resourced to act as an ‘owner’.9 Moreover,
institutional investors, as custodians of others’ funds, typically prefer not
to be ‘locked in’ by a policy of intervention and instead want there to be
ample scope to off-load underperforming assets when appropriate.10

Governance remains important to the majority of equity
investment firms although only a few cited it as an important part of their
investment process and there is concern about the lack of interest from
clients.11
They feel that their clients have little interest in their governance
engagement work the vast bulk of shareholders are not very interested in
governance.

The disadvantage of shareholder engagement is that majority
of them will lack information of the company’s managers and another source of
doubt is that of the level of experience of the institutional investors.12 One
of the arguments is that shareholders have an informational disadvantage
compared to the management because of the lack of inside information, and that’
shareholders lack sufficient incentives to obtain and assess all of the public
information.13 Concerns
about insufficient expertise provide one obstacle, with many shareholders
believing that it is unrealistic for the as opposed to the board of directors to
ascertain if a company is losing its way and generate well-informed solutions.14
Some commentators argue that institutional investor activism can encounter the
monitoring and incentive problem, whilst their counterparts contend these
investors lack the skills, knowledge, time and interest to monitor the firm’s
management.15Winter
notes:

“The knowledge and
expertise institutional investors need… is mainly related to the market and
only to a limited extent to individual companies and their long term prospects…
There is usually no in-depth insight into the prospects and risks of individual
companies, nor a real interest in the governance of those companies”.16

Bebchuk argues that even if management has sometimes more
and better information, this does not entail that they will make the right
decisions.17 However,
it is perhaps no bad thing that managers and directors should have to meet any
challenge to their conduct and persuade shareholders to vote with them.18 In
accordance with the Directive, some forms of electronic participation should be
mandatory, such as proxy voting19 and
electronic proxy voting20.
The rationale behind these rules and behind the Directive is in the recitals:

“Shareholders shall be able to cast informed votes at, or in
advance of the general meeting, no matter where they reside”21.

By facilitating cross-border voting, shareholders can be
inclined to cast their votes at the general meeting more frequently, which can
enhance their engagement with the company22.
As already mentioned, shareholder engagement seems to play a pivotal role in an
effective corporate governance framework.23

Companies typically engage with shareholders only during
scheduled shareholder events, such as the annual shareholder meeting, analyst
calls, or public announcements. These engagements tend to be mere formality and
of little value, as they do not translate into positive votes at the annual
meeting.24  Outside of these traditional forms of
communication, communication with shareholders is, more or less, limited to
times of crisis or when performance issues arise.25
Showing that shareholders can have private interests that do not fully
harmonize the general interests of all shareholders.26
The Association of British Insurers, in its 2009 submission to the Treasury
Committee investigation of the banking crisis, expressed doubts that
collaboration was likely to occur, saying it:

”Believed other shareholders ‘were less concerned about
governance’ than insurance companies, meaning in turn it was ‘easier for
companies to override efforts by concerned shareholders to achieve change”.27
Intervention can further be impeded because of the structure of the investment
management industry. Fund managers might not engage if their own investors do
not sufficiently reward activism or if the investment process is outsourced to
other asset managers.28Lord
Myners, then Financial Services Secretary to the Treasury, characterised the
institutional investors who currently dominate share ownership in publicly
quoted UK companies as ‘absentee landlords’.29

The distribution of benefits from successful shareholder
interventions compounds matters, in that shareholders who remain passive get
the same upside as the institutional shareholders who took the initiative. As
the Walker Report observed, ‘Shareholders who do not exercise such governance
oversight are effectively free-riding on the governance efforts of those that
do.30Most
important, the costs associated with shareholder engagement can cause a
deterrent effect on institutional shareholders.31
However, they state, “even the most sophisticated investors seem to find
engagement in a company’s decision-making process daunting, since it concerns
costly and time-consuming discussions.32
Winter contends that his findings indicate that institutional investors would
only be willing to pay for the expensive engagement efforts if they believe to
find additional value in it.33

Winter recognizes three levels of shareholder engagement:
compliance, intervention and stewardship, with an increasing degree of
involvement.34 Level
of engagement these investors are interested in varies from
compliance-engagement to sometimes intervention-engagement, while continuous
ability to trade, portfolio diversification and measuring relative performance
remain the basics of institutional investment practice.35
These findings urge winter to conclude that meaningful engagement seems an
illusion for the mainstream institutional investor.36

 

 

 

 

 

1 Joseph
A. McCahery, Zacharias Sautner, Laura T. Starks, ‘Behind the Scenes: The
Corporate Governance Preferences of Institutional Investors’ para (47) 10
November 2016 accessed
26 December 2017.

2 Joseph
A. McCahery, Zacharias Sautner, Laura T. Starks, ‘Behind the Scenes: The
Corporate Governance Preferences of Institutional Investors’ para (47) 10
November 2016
accessed 26
December 2017.

3 Jan
Hall, Thomas O’Malley, ‘A Study of Investors Company and Adviser Perspectives
Conducted by the JCA Group for the Financial reporting Council’ (JCA) Section
2, page 3 < www.jcagroup.net/perch/.../corporate-governance-shareholder-engagement.pdf>accessed
16 December 2017.

4 Joseph
A. McCahery, Zacharias Sautner, Laura T. Starks, ‘Behind the Scenes: The
Corporate Governance Preferences of Institutional Investors’ 15 March 2010
available at:
. From Van
Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 17, Master’s Thesis 2011-2012
accessed 28 December 2017.

5 Gaetane
Schaeken Willemaers, ‘The European Call for More Shareholders’ Engagement: State
of Play and Way Forward’ 25 January 2012 available at: .
From Van Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is
Shareholder Engagement the Answer? A Critical Assessment’ page 16, Master’s
Thesis 2011-2012 accessed 28
December 2017.

6 William
W. Bratton, ‘Hedge Funds and Governance Targets’ (2007) 95 Georgetown Law
Journal 80 available at: < https://papers.ssrn.com/sol3/papers.cfm?abstract_id=928689>. From Van Campe
Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder Engagement
the Answer? A Critical Assessment’ page 16, Master’s Thesis 2011-2012
accessed 28 December 2017.

7 P.
Myners, Institutional Investment in the UK: a Review (London: HM Treasury,
2001) 89-91. From Brian R. Cheffins, ‘The Stewardship Code’s Achilles’ Heel:
Legislation and Reports’ (2010) 73(6) MLR 1009.

8 Jan
Hall, Thomas O’Malley, ‘A Study of Investors Company and Adviser Perspectives
Conducted by the JCA Group for the Financial reporting Council’ (JCA) Section
2, page 7 < www.jcagroup.net/perch/.../corporate-governance-shareholder-engagement.pdf>accessed
16 December 2017.

9 P.
Skypala, ‘Expert in How to be a Good Owner Looks Forward to New UK Codes’ Fin.
Times, 7 June 2010, FT fm, 4. From Brian R. Cheffins, ‘The Stewardship Code’s
Achilles’ Heel: Legislation and Reports’ (2010) 73(6) MLR 1015.

10
A. Hill, ‘Preacher Myners is Right to Raise Hell with Investors’ Fin. Times, 22
April 2009, 18. From Brian R. Cheffins, ‘The Stewardship Code’s Achilles’ Heel:
Legislation and Reports’ (2010) 73(6) MLR 1015.

11 Jan
Hall, Thomas O’Malley, ‘A Study of Investors Company and Adviser Perspectives
Conducted by the JCA Group for the Financial reporting Council’ (JCA) Section
2, page 3 < www.jcagroup.net/perch/.../corporate-governance-shareholder-engagement.pdf>accessed
16 December 2017.

12 Professors
Gordon and Gilson, ‘Shareholder Engagement: Finding the Right Balance’1 March
2012 available at: .
From Van Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is
Shareholder Engagement the Answer? A Critical Assessment’ page 29, Master’s
Thesis 2011-2012 accessed 30
December 2017.

13 Lucian
A. Bebchuk, ‘The Case for Increasing Shareholder Power’ 118 Harvard Law Review
3 available at:
. From Van
Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 46, Master’s Thesis
2011-2012 accessed 1 January
2018.

14
P. Skypala, ‘Heads Lock on Shareholder Oversight’ Fin. Times, 12 March 2009,
FT, fm, 6. From Brian R. Cheffins, ‘The Stewardship Code’s Achilles’ Heel:
Legislation and Reports’ (2010) 73(6) MLR 1014-1015.

15 Marco
Becht, Julian Franks, Colin Mayer, Stefano Rossi, ‘Returns to Shareholder
Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund’ (2008) 22
The Review of Financial Studies 8 (3093-3129) available at: < https://academic.oup.com/rfs/article/22/8/3093/1589687>. From Van Campe
Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder Engagement
the Answer? A Critical Assessment’ page 5, Master’s Thesis 2011-2012
accessed 28 December 2017.

16 Jaap
W. Winter, ‘Shareholder Engagement and Stewardship: The Realities and Illusions
of Institutional Share Ownership’ page 5, 20 June 2011 available at: .
From 23escommercial, ‘Is Shareholder Engagement a Good Thing? Para (6), 2012
accessed
27 December 2017.

17 Lucian
A. Bebchuk, ‘The Case for Increasing Shareholder Power’ 118 Harvard Law Review
3 available at:
. From Van
Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 46, Master’s Thesis
2011-2012 accessed 1 January
2018.

18 23escommercial,
‘Is Shareholder Engagement a Good Thing? Para (6), 2012
accessed
27 December 2017.

19 Article
10(1) of Directive 2007/36/EC.

20 Article
11(1) of Directive 2007/36/EC.

21 Recital
6 of Directive 2007/36/EC.

22 Christoph
Van der Elst, Erik P. M. Vermeulen, ‘Europe’s Corporate Governance Green Paper:
Do Institutional Investors Matter?’ Tilburg Law School Research Paper No.
014/2011 9 June 2011 available at:
. From Van Campe
Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder Engagement
the Answer? A Critical Assessment’ page 31, Master’s Thesis 2011-2012
accessed 30 December 2017

23 Christoph
Van der Elst, Erik P. M. Vermeulen, ‘Europe’s Corporate Governance Green Paper:
Do Institutional Investors Matter?’ Tilburg Law School Research Paper No.
014/2011 9 June 2011 available at:
. From Van
Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 31, Master’s Thesis
2011-2012 accessed 31 December
2017.

24 Tarun
Mehta, Advisor, ISS Corporate Services ‘Shareholder Engagement: Maximizing the
Shareholder Relationship’ (2013) Exec Comp 13.3 at 1.

25 Tarun
Mehta, Advisor, ISS Corporate Services ‘Shareholder Engagement: Maximizing the
Shareholder Relationship’ (2013) Exec Comp 13.3 at 1.

26 Iman
Anabtawi, ‘Some Skepticism about Increasing Shareholder Power’ UCLA School of
Law, Law-Econ Research Paper No. 05-16 15 August 2005 available at: .
From Van Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 46, Master’s Thesis
2011-2012 accessed 1 January
2018.

27 From
Brian R. Cheffins, ‘The Stewardship Code’s Achilles’ Heel: Legislation and
Reports’ (2010) 73(6) MLR 1022-1023.

28 Joseph
A. McCahery, Zacharias Sautner, Laura T. Starks, ‘Behind the Scenes: The
Corporate Governance Preferences of Institutional Investors’ para (48) 10
November 2016
accessed 26
December 2017.

29 Lord
Myners, ‘Association of Investment Companies’ (speech by the Financial Services
Secretary) (21 April 2009) available at: .
From R. Cheffins, ‘The Stewardship Code’s Achilles ‘heel: Legislation and Reports’
(2010) 73(6) MLR 1006.

30
Walker Report. From R. Sullivan, ‘Collective Engagement Picking up Steam’ Fin.
Times, 9 November 2009, FT fm, 3. .From Brian R. Cheffins, ‘The Stewardship
Code’s Achilles’ Heel: Legislation and Reports’ (2010) 73(6) MLR 1015.

31  Lynne Dallas, ‘Short-Termism, the Financial
Crisis, and Corporate Governance’ (2011) 37 Journal of Corporation Law 12
available at: < https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2006556>.
From Van Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is
Shareholder Engagement the Answer? A Critical Assessment’ page 29, Master’s
Thesis 2011-2012 accessed 30
December 2017.

32 Christoph
Van der Elst, Erik P. M. Vermeulen, ‘Europe’s Corporate Governance Green Paper:
Do Institutional Investors Matter?’ Tilburg Law School Research Paper No.
014/2011 9 June 2011 available at: .
From Van Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is
Shareholder Engagement the Answer? A Critical Assessment’ page 31, Master’s
Thesis 2011-2012 accessed 31
December 2017.

33 Jaap
W. Winter, ‘Shareholder Engagement and Stewardship: The Realities and Illusions
of Institutional Share Ownership’ 20 June 2011 available at:
. From Van
Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 48, Master’s Thesis
2011-2012 accessed 1 January
2018.

34 Jaap
W. Winter, ‘Shareholder Engagement and Stewardship: The Realities and Illusions
of Institutional Share Ownership’ 20 June 2011 available at: .
From Van Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is
Shareholder Engagement the Answer? A Critical Assessment’ page 47-48, Master’s
Thesis 2011-2012 accessed 1
January 2018.

35 Jaap
W. Winter, ‘Shareholder Engagement and Stewardship: The Realities and Illusions
of Institutional Share Ownership’ 20 June 2011 available at:
. From Van
Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 48, Master’s Thesis 2011-2012
accessed 1 January 2018.

36 Jaap
W. Winter, ‘Shareholder Engagement and Stewardship: The Realities and Illusions
of Institutional Share Ownership’ 20 June 2011 available at:
. From Van
Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 48, Master’s Thesis
2011-2012 accessed 1 January
2018.

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