Active investors are piling the pressure on boards and companies to change their ways or improve their governance, but the effects of all that engagement are notoriously difficult to measure. With the help of some complex statistical analysis, a group of academics have concluded that active institutional investors do indeed bring about better governance through communicating a robust policy.
The conclusions come after four academics from universities in the UK, Spain and the US looked at what happened to companies when Norway’s huge sovereign wealth fund (NBIM) issued a white paper in 2012 declaring that it had changed its expectations of governance among investee companies.
Using complex statistical analysis, the professors found a positive outcome. Firstly, the overall standing of NBIM’s governance level improved. Secondly, the fund also began to focus more on investments in companies with high governance scores on an index, and moved away from those with lower scores. Thirdly, companies reacted to the policy change and its implementation by improving their own governance. Lastly, NBIM’s “investment weights” became more sensitive to a company’s improving governance performance on the index. A virtuous investment circle was uncovered.
The researchers conclude: “Overall these results show that this active institutional owner did change its investment strategy following the announcement and that firms also reacted by enhancing their corporate governance following the fund expectations.
“Our results add evidence of the monitoring role of active owners and, in particular, SWFs (sovereign wealth funds).”
The writers also highlighted two influential properties of the change in NBIM’s policy, what they dub as an “exit” channel and a “voice” channel. The exit sees the active investors move their capital away from companies that fail to meet the governance standards set out in the 2012 policy document. The voice relates to how NBIM communicates new preferences, “especially behind the scenes”.
“Of course,” the researchers say, “these two effects, voice and exit, interact with each other, as a credible threat of ‘exit’ can be a powerful tool when exercising ‘voice’.”
The researchers focused on NBIM’s 2012 policy change of heart because, they say, doing so enabled them to disentangle whether improvements in governance resulted from the influence of the investors, or whether an investor was simply changing course to integrate evolving governance norms. Only a one-time and unexpected policy change, the researchers says, would offer the opportunity to gauge the causal effects.
NBIM’s 2012 position was a seminal moment in stewardship. It covered expectations of a board’s responsibilities, the standards that should be maintained in terms of quality of boardroom work and transparency of information. It also made clear that board members were “accountable” for their decisions relating to the “sustainable profitability of the business”, the “acceptable treatment of stakeholders” and “corporate governance provisions”, among many others.
Emphatically, NBIM said: “The board should not shield itself or management from being accountable to shareholders by installing or maintaining control or defence mechanisms.”
The latest research findings comes at an interesting moment in the development of governance. Increasingly, regulators and policymakers see shareholder stewardship as the key means of governing corporate behaviour, either through enhancing shareholders’ rights or increasing transparency in corporate reporting, ostensibly for investors. The EU Shareholder Rights Directive is a prime example.
Others efforts involve voluntary programmes, such as Principles for Responsible Investment, which sees investors committing to standards of investment behaviour with a direct impact on investee companies.
Many investors have placed stewardship at the heart of their activities. In a recent note for the Harvard Law School corporate governance blog, Glen Booraem of index fund managers Vanguard writes: “Engagement benefits both shareholders and companies.” And he believes in the links between stewardship and good governance: “Vanguard’s investment stewardship efforts are an important part of our mission, … Ultimately, we want governance practices to improve in investable markets around the world. We believe that a rising tide of good corporate governance will lift all boats.”
Many statements like this are based either on assumptions or anecdotal evidence. Academics may now have provided the statistical evidence to show that stewardship policies really do affect corporate governance.