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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.
Finally, disclosure regulations (e.g., “Regulation Fair Disclosure” in the United States) might discourage investors or managers from engagement. 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.
However, that institutional investor activism most of the times takes place behind the scenes, 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’ activism. The evidence remains limited, however. Academic research also pointed to evidence on a more long-term oriented shareholder engagement by hedge funds, 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. 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. 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’.
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. 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. 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. 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. 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.
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.Winter 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”.
Bebchuk argues that even if management has sometimes more and better information, this does not entail that they will make the right decisions.
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. In accordance with the Directive, some forms of electronic participation should be mandatory, such as proxy voting and electronic proxy voting. 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”. 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 company. As already mentioned, shareholder engagement seems to play a pivotal role in an effective corporate governance framework. 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. Outside of these traditional forms of communication, communication with shareholders is, more or less, limited to times of crisis or when performance issues arise.
Showing that shareholders can have private interests that do not fully harmonize the general interests of all shareholders. 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’’. 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.
Lord 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’.
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.Most important, the costs associated with shareholder engagement can cause a deterrent effect on institutional shareholders.
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