The worldwide growth of institutional investment practices has provided investors with a
comparative advantage by granting them the opportunity to act as good monitors of their
25 Globally, sovereign wealth funds account for more than $6 trillion (Tricker, 2015).
26 The group consisted of 26 countries and met three times to formulate the Santiago Principles and Practices
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investee firms (Gillan and Starks, 2003; Ferreira and Matos, 2008). Institutional investors face
continuous pressure to improve their governance practices; this pressure comes from many
sources, including government agencies, stock markets and the investors’ ultimate
beneficiaries (Mallin, 2016). According to Hirschman’s (1970) framework, institutional
investors may pursue one of two options if and when they become dissatisfied with the
governance practices of their investee firms. They can choose to exercise their voting rights in
order to promote change, or they can elect to leave the company by selling their shares; this is
known as the ‘Vote or Exit Concept’. Since the selling option may not be viable, as it is often considered costly, most institutional investors opt to engage with their investee firms in an
attempt to alter any unfavourable governance structures (Jin, 2006; McCahery et al., 2016).
Institutional investors can adopt many tools in order to facilitate a dialogue with their investee
firms, such as one-to-one meetings, voting, shareholder proposals and resolutions, focus lists
and corporate governance rating systems (Martin et al., 2007; Goranova and Ryan, 2014;
Mallin, 2016). Behind-the-scenes engagement is also considered important, as private
negotiation is a favoured tactic of many institutional investors (McCahery et al., 2016). All of
these tools are discussed below.
4.3.1. One-to-One Meetings
Meetings between institutional investors and their investee firms are considered an essential
means of communication (Mallin, 2016). As such, the Cadbury Report emphasised that
institutional investors should hold regular one-to-one meetings with the corporate boards of
their investee firms (Solomon, 2013). According to the Cadbury Report, ‘institutional investors should encourage regular, systematic contact at [the] senior executive level to exchange views
and information on strategy, performance, board membership [and] quality of management’ (Solomon, 2013). This type of meeting is considered to be an advantage for the institutional
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institutional investors who hold larger stakes in the company (Mallin, 2016). In the context of
the UK, firms usually arrange to meet with large-scale institutional investors on a one-to-one
basis over the course of a year; such meetings typically involve key members of the corporate
board. In these meetings, the targeted audience of institutional investors includes large-scale
shareholders, brokers’ analysts and any significant investors who are seeking to underwrite or sell their shares. Furthermore, investee firms typically reach out to those institutional investors
who have been absent for longer than one year, and any institutional investors who attend these
meetings are contacted to ensure that all concerns have been discussed (Mallin, 2016).
Marston (2008) conducted a comparison study of investor relations meetings held by the top
500 UK firms between 1991 and 2002. He reported that the one-to-one meeting was the most
important communication tool that existed between institutional investors and their investee
firms; he also noted that the demands of institutional investors for this type of communication
increased during the period under study (Marston, 2008). Furthermore, he pointed out that a
higher number of meetings was associated with the number of institutional investors and
analysts present (Marston, 2008). Moreover, the results revealed that companies kept records
of previous meetings in order to better prepare for future meetings, which reveals the
importance of these meetings (Marston, 2008).
Additionally, companies sometimes initiate new investor relations programs whereby they may
increase the number of meetings with investors in an attempt to attract institutional
investments. Using a sample of small and mid-cap firms that were either listed in the Nasdaq
or that operated over the counter (OTC) between 1998 and 2004, Bushee and Miller (2012)
reported that companies that initiated investor relations programs that included face-to-face
meetings with investors were found to attract more institutional investments and greater analyst
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relations programs and encourage one-to-one meetings. The introduction of such activities by
a company was also found to attract media coverage and increase market value.
It is also important to note that institutional investors may engage with their investee firms
through private negotiations, ‘widely known as behind the scene[s] engagement’ (McCahery et al., 2016). This type of intervention is seen as an effective tool that can encourage efficient
corrective actions within an investee firm. Carleton et al. (1998) investigated the extent to
which the TIAA-CREF27, using behind-the-scenes tactics, influenced governance issues within
its 45 investee firms between 1992 and 1996. Their results suggested that the TIAA-CREF
facilitated agreement with investee firms on several governance issues more than 95% of the
time (Carleton et al., 1998). Furthermore, it was found that in 70% of these cases, agreement
was reached through private negotiations, thus indicating the effectiveness of this tool in
altering the governance practices of a particular investee firm (Carleton et al., 1998).
More recently, McCahery et al. (2016) conducted a study to examine the extent to which
institutional investors exercise behind-the-scenes engagement; to this end, he distributed a
survey to ICGN members for two subsequent years, 2012 and 2013. The study surveyed the
143 largest institutional investors in the world, 36% being from continental Europe, 24% from
the United States, 16% from the United Kingdom, and the remainder from other parts of the
world. The results of this study revealed that behind-the-scenes engagement is considered to
be a common channel that exists between institutional investors and their investee firms
(McCahery et al., 2016). For example, they found that 63% of respondents engaged in direct
discussions with the management team in the preceding five years, whilst 45% had private
discussions with a company’s board without the attendance of the management team.
27TIAA-CREF is one of the largest pension funds in the US, and it holds approximately 1% of the total US equity market
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McCahery et al. (2016) also reported that the investor’s horizon (long-term versus short-term) had an impact on the intervention. For instance, long-term institutional investors intervened
more intensively than their short-term counterparts, discussing issues such as corporate
governance structure and firm strategy. The institutional investors involved in the study
emphasised that the exit option could be a viable strategy, 49% of respondents stating that they
had chosen the exit option as a result of performance dissatisfaction. Another 39% of
respondents reported that the exit was due to dissatisfaction with governance structure. The
investors emphasised that they considered the exit option complementary to, rather than a
substitute for, the voice, as institutional investors typically engaged with their investee firms
prior to the potential exit.
McCahery et al. (2016) further illustrated that institutional investors face multiple hurdles, the
major difficulty being the free rider problem. In addition, the study demonstrated that 63% of
the respondents used proxy advisors, about half of them using the services of more than one
proxy advisor. Furthermore, institutional investors using proxy advisors indicated that they
engaged more intensively with their investee firms rather than substituting proxy advice for
their own voice, which indicates that the presence of proxy advisors does not necessarily mean
that institutional investors take a passive governance role.
McCahery et al. (2016) also found that institutional investors who hold more liquid stocks
report more engagement with their investee firms, as they might find the exit is the most viable
option in these firms. This finding is consistent with Edmans et al. (2013), who argued that
stock liquidity determines whether institutional investors choose to voice or exit. Examining
the activist hedge funds that engaged in block acquisitions between 1995 and 2010, Edmans et
al. (2013) reported that liquidity attracted hedge funds to acquire a block, especially in firms with high managerial incentives. Once the block was formed, the blockholder was more likely
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investment (filing Schedule 13D) than passive investment (filing Schedule 13G). The results also indicate that 13D filing is associated with positive announcement returns and
improvements in operating performance, especially in liquid firms.
4.3.2. Voting
The right to vote is considered to be an influential tool used by institutional investors to weigh
in on all issues raised during the annual general meeting (Mallin, 2016). In an effort to enhance
the activism of institutional investors, the Cadbury Report (1992) encouraged institutional
investors to make positive use of their voting rights. Furthermore, there have been clear
statements from various international organisations regarding voting rights and the
responsibilities of share-owners. For instance, OECD has dedicated one of its six principles to
the rights of shareholders and key ownership functions. This principle stated that ‘shareholders should be able to vote in person or in absentia, and equal effect should be given to votes whether
cast in person or in absentia’ (OECD, 2004). Furthermore, in its global corporate governance
principles, which were revised in 2009, the International Corporate Governance Network
(ICGN) stated that ‘shareholders should actively vote at annual and extraordinary general meetings, and votes should always be cast in a considered manner’ (ICGN, 2009).
In the context of institutional investor voting in the UK, institutional investors used to register
their views of a vote by using the postal service; however, nowadays this process can be
completed electronically where such a service is available (Mallin, 2016). Generally,
institutional investors attempt to sort out any conflicting views prior to a vote date, even
pursuing private negotiations with the management in an effort to do so. However, if these
private negotiations fail, institutional investors may abstain or vote against a particular
resolution (Mallin, 2016). The dissatisfaction of shareholders is taken into consideration by a
corporate board during attempts to alter the governance structure of a firm. It is also important
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support the casting of meaningful votes. Examining the activism of US institutional investors
by investigating their vote casting in 43 countries outside of the US between 2003 and 2009,
Iliev et al. (2015) found that the laws and regulations governing shareholder voting in non-US
countries allowed for meaningful votes to be cast. In addition, the study revealed that voter
dissent was more frequently reported when the institutional investors feared expropriations. In
addition, greater voter dissent was associated with higher director turnover and increased
mergers and acquisitions.
Del Guercio et al. (2008) studied the extent to which a campaign of ‘just vote no’ could influence a corporate board’s decision to improve corporate governance structures; to this end, the team examined 112 US-listed companies in operation between 1999 and 2003. They found
that activist institutional investors often convinced their fellow investors to also withhold their
votes when it came time to elect directors during a general meeting, which frequently led to
the embarrassment of the corporate board (Del Guercio et al., 2008). As a result of such
campaigns, several improvements were noted in terms of governance structure and the
performance of investee firms, including abnormal discipline related to CEO turnover and the
improved performance of the firm. More recently, Aggarwal et al. (2015) examined the US
securities lending market in an attempt to investigate the behaviours and attitudes of
institutional investors towards any shares that were on loan prior to the record date. In the
securities lending market, shares cannot be voted upon if they are on loan on the day of voting.
This study emphasised that the supply of lendable shares was very low prior to the proxy record
date, as institutional investors began to recall their loaned shares before the voting date
(Aggarwal et al., 2015). The study also showed that the corporate governance practices of
investee firms was one of the major reasons behind the recalling of shares, as institutional
investors recalled shares from weak governance firms (Aggarwal et al., 2015). More
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to be recalled; additionally, the level of recalled shares was noted to be high when antitakeover
or compensation proposals were listed in the voting agenda (Aggarwal et al., 2015).
4.3.3. Shareholder Proposals/Resolutions
Shareholder proposals, or shareholder resolutions, are quite common in the US as compared to
the UK (Mallin, 2016). On average, between 800 and 900 shareholder proposals are introduced
in the US per year, most of which are related to the social environment and ethical issues; there
is an expectation that this number will increase in the future due to widespread dissatisfaction
with regard to executive remuneration packages (Mallin, 2016). In the UK, however, the
relatively low number of shareholder proposals presented in the AGM is the result of a process
in which a resolution must be requested by (i) members who own at least 5% of the company’s voting power, or (ii) 100 or more shareholders whose paid-up capital averages at least £100
each. Given the difficulty of meeting these two conditions, the number of shareholder proposals
tends to be low in the UK, normally not exceeding 10 per year (Mallin, 2016). Although, the
number increased following the financial crisis.
As far as the US is considered, private negotiations between institutional investors and their
investee firms may cause many shareholder proposals to be withdrawn prior to the AGM date.
For instance, Bauer et al. (2015) examined the determinants of proposal withdrawals by
considering 1,200 proposals filed by institutional investors in S&P1500 firms between 1997
and 2009. The results demonstrated that shareholder proposals were often withdrawn prior to
the AGM because institutional investors were able to reach an agreement with their investee
firms through private dialogues (Bauer et al., 2015). Their results also showed that the
withdrawal cases were mainly initiated by influential institutional investors rather than their
private investor counterparts (Bauer et al., 2015). Furthermore, long-term and passively
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was initiated by institutional investors; however, negative relationships between CEO
ownership and withdrawal cases were documented (Bauer et al., 2015).
4.3.4. Focus Lists
A number of institutional investors have established ‘focus lists’ with regard to underperforming companies (Mallin, 2016). These types of indices also identify those firms
that do not respond to the queries of institutional investors. Examining a sample of 93 firms
appearing on the focus list of the Council of Institutional Investors from 2000 to 2005, Ward
et al. (2009), reported that institutional investors reduced their holdings in firms that appeared
on the focus list; this was seen as a signal for underperforming firms to improve their
performance. However, this relationship was moderated by the composition of a corporate
board. In particular, a board’s level of independence was found to mediate the reduction of institutional holdings in these types of firms, thus indicating that institutional investors pay
particular attention to the composition of corporate boards within these firms (Ward et al.,
2009). The study also reported that firms with higher levels of independence tend to be more
responsive to institutional concerns than their counterparts; consequently, these firms adopt
various reactive measures, such as scrutinising the incentives given to the company’s CEO (Ward et al., 2009).
4.3.5. Corporate Governance Rating Systems
For several years, many parties around the world have assessed and scored governance quality
at the firm and country levels. According to Mallin (2016), the most well-known firms to have
initiated corporate governance rating systems are Deminor, Standard and Poor’s (S&P), and
Governance Metrics International (GMI). Deminor focuses on European countries, while S&P
concentrates on other countries including Russia. The GMI rating covers a range of countries
and regions, including the US, Europe and various countries in Asia-Pacific (Mallin, 2016).
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quality of corporate governance. However, corporate board structures and processes are of the
main categories involved in most corporate governance rating systems (Van den Berghe and
Levrau, 2004).
Corporate governance rating systems are beneficial for the investor as well as for the country.
For instance, such systems enable investors to assess the governance quality of their investee
firms and of the companies in which they intend to invest in the future. Additionally, such
systems allow governments to assess their governance quality in comparison to that of other
countries; thus, they may be able to enhance the overall governance structure of their country
in order to attract foreign investors (Mallin, 2016).