Considering the role of institutional investors in influencing corporate governance is critical to effective corporate decision making. Broadly, dissatisfied institutional investors choosing to act can do one of the following: (a) intervene with management, either cooperatively or uncooperatively as dissident shareholders, or (b) exit by selling their shares. Many theories have been put forward to explain investor conduct, but who better explain the rationale behind it than investors themselves? In a new article entitled Behind the Scenes: The Corporate Governance Preferences of Institutional Investors (Behind the Scenes), the authors survey 143 institutional investors worldwide to find out whether they are more likely to intervene or exit, and what drives their decisions.
How are institutional investors choosing to act?
Intervention comes in varying forms and degrees. As set out in Behind the Scenes, 63% percent of respondents surveyed engaged in direct discussion with management in the past five years. Moreover, nearly half had private conversations with a company board when management was not present. In comparison, dissident shareholder proposals had been brought by 16% of the respondents, and legal action had been brought by 15%.
Threatening to exit was seen as effective by 42% of respondents and the evidence indicates that institutional investors are not afraid to follow through. Nearly half (49%) reported exiting because of performance-related dissatisfaction, and 39% reported exiting because of dissatisfaction with corporate governance.
While intervening or exiting are often seen as opposite approaches, the authors note that these governance mechanisms are often complementary – in the majority of cases, institutional investors will attempt to intervene before making an ultimate exit.
What influences their decisions?
The authors conclude that the events more likely to cause institutional investors to intervene are fraud, inadequate corporate governance, excessive management compensation and poor corporate strategy. Long-term investors are more likely to intervene, while short-term investors typically intervene less frequently. Correspondingly, investors who cared more about liquidity engaged less. Interventionist actions can thus be understood as aimed at long-term goals, not short-term gain.
In choosing how to act, 60% of institutional investors surveyed relied on proxy advisors, although they did not necessarily take on a more passive role as a result. Instead, the respondents who used proxy advisors still report that they make the final decisions themselves. When choosing not to act, respondents similarly provided a number of reasons, include insufficient incentive (for instance, if their stake was low or the perceived benefit too small) or legal concerns, particularly regarding the rules against concerted actions.
Ultimately, Behind the Scenes is clear that dissatisfied institutional investors will, at a minimum, engage management in a discussion. On the more extreme end, institutional investors will take dissident action to influence corporate governance to shape and challenge the management of a corporation. In all cases, when trying to predict potential actions of an institutional investor, the first step is understanding the underlying rationale for potential courses of action.
The author would like to thank Kira Misiewicz, articling student, for her assistance in preparing this legal update.
 Joseph A McCahery, Zacharias Sautner & Laura T. Starks, “Behind the Scenes: The Corporate Governance Preferences of Institutional Investors” (2015), Journal of Finance.