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Passive investors go-getters on governance – US study
A US study has found institutional index investors are using their powers to influence corporate governance behaviour. The University of Pennsylvania paper, titled ‘Passive investors, not passive owners’, says its research overturns the common perception that index investing is a hands-off exercise.
“Many worry that passive investors lack both the motives and mechanisms to monitor their large, diverse portfolios, and that the increasing market share of such ‘lazy investors’ weakens firm-level governance and hurts performance,” the report says.
However, the research – based on an analysis of variation of passive investor ownership between the Russell 1000 and 2000 indices – found that “passive investors play a key role in influencing firms’ governance choices; ownership by passive institutions is associated with more independent directors, the removal of poison pills and restrictions on shareholders’ ability to call special meetings, and fewer dual class share structures”.
“Passive investors appear to exert influence through their large voting blocs – passive ownership is associated with less support for management proposals and more support for shareholder-initiated governance proposals,” the study says. “Consistent with the observed differences in governance having a positive influence on firm value, we find that passive ownership is also associated with improvements in firms’ longer-term performance.”
The report suggests passive investors have a strong interest in active corporate governance measures as it may improve absolute market performance – therefore generating stronger flows and fees.
Furthermore, the study says passive investors may be more motivated than even active managers to insist on strong governance precisely because they can’t sell down poorly performing stocks.
“Finally, all institutional investors have a fiduciary duty to manage their funds and vote their proxies in the best interest of shareholders,” the report says.
According to the study, institutional passive investors can influence governance by: voting shares; activist engagement, and; “widespread, but low-cost, monitoring of firms’ compliance”.
– David Chaplin, Investment News NZ
