The Case for Institutional Investors’ Collective Engagements

Shareholder cooperation is on the rise as a tool for active corporate ownership and a way to effectively voice concerns about corporate governance and performance. While “wolf packs” of activist hedge funds that aim to bring about significant corporate change at targeted companies have attracted the most attention, there are other forms of shareholder coordination that are not activist-driven.

One is collective engagement by institutional investors guided by the recommendations in stewardship principles adopted in several countries. Over the last few years, representative organizations such as, to some extent, the Council of Institutional Investors (CII) in the U.S. and, to a greater extent, the Investor Forum[1] in the UK, Eumedion[2] in the Netherlands, and Assogestioni[3] in Italy have emerged as a cost-saving and efficient tool for supporting institutions’ active stewardship collectively.

Collective engagement initiatives allow investors to share engagement costs, thereby increasing the net return earned by each institutional investor involved. In doing so, collective engagement initiatives also reduce the free-rider problem that significantly contributes to non-activist investors’ inclination to adopt a passive, or at best a reactive, stance towards engagement with portfolio companies. Moreover, reputational concerns can prompt fund managers to play an active monitoring role over their investee companies, so institutional investors may have an incentive to join collective initiatives that have proven successful or are viewed positively by clients.

Drawing on empirical and anecdotal evidence about a shareholder cooperation model that does not seek corporate control,[4] in a recent paper[5] we develop an analytical framework for non-activist shareholder cooperation by extending the perspective for analysis beyond hedge-fund wolf packs. We aim to demonstrate that collective engagement by non-activist institutions coordinated by a third-party can provide an alternative to wolf packs and activist-lead initiatives à la Gilson-Gordon.[6]

First, a coordinating entity can spread engagement costs and ensure that benefits are shared by all shareholders in the same company. For example, the coordinating entity could adopt engagement-related cost allocation mechanisms that charge the participating investors according to the size of their holdings. The entity can also facilitate the circulation of information and agreement among institutional investors. Such a facilitating role is especially important in saving costs and time when the investors involved have different geographic and cultural backgrounds.

Second, a coordinating entity can help reduce compliance costs and regulatory hurdles to collective engagement initiatives. Specifically, a third-party entity taking on an active coordination function (which function will be most effectively performed where it is based on specific procedures and safeguards) can reduce the risk of concerted action, group formation, or the selective disclosure of relevant information in breach of Regulation FD in the U.S. or the Market Abuse Regulation in the EU. In doing so, the coordinating entity can help overcome problems posed by the small size of leading institutional investors’ investment stewardship teams.

Third, a coordinating entity employing highly-skilled professionals can provide institutional investors with the necessary expertise concerning relevant issues related to the engagement and company-specific information. For example, enabling institutions can help to identify issues of interest to heterogeneous investors as well as investors that may be interested in joining the collective engagement or to develop an engagement strategy that meets  investor expectations.

To encourage collective engagement initiatives, the relevant regulatory framework should be clarified. In particular, current regulations on blockholder filings can thwart engagements by non-activist investors, and the Securities and Exchange Commission (SEC) needs to clarify the circumstances in which collective engagement through an enabling organization will not be regarded as control-seeking or concerted action and will not trigger group filing obligations under Section 13D of the Securities and Exchange Act. Taking the ESMA’s approach into account, the SEC could provide a safe harbor for collective engagement initiatives that do not seek to gain control of companies. In particular, the SEC could consider providing a list of engagement-related activities that would fall outside the scope of Section 13D, unless it is demonstrated on the basis of a case-specific analysis that such activities have control-seeking purposes.

In addition, the SEC could explicitly recognize the role of coordinating entities in promoting collective engagement initiatives in line with the applicable regulatory framework. Specifically, the SEC should accept that, unless a control-seeking purpose can be inferred from the relevant circumstances, collective engagement will not be relevant under Section 13D where the institutional investors participating in the initiative have explicitly committed not to form a control-seeking group and have appointed a third party to monitor compliance with the agreement.  That would help CII or similar institutions to play a more significant role in promoting effective institutional investor stewardship, following the patterns of counterparty institutions in other countries.

ENDNOTES

[1] https://www.investorforum.org.uk/.

[2] https://www.eumedion.nl/en.

[3] http://www.assogestioni.it/index.cfm/1,586,0,49,html.

[4] Elroy Dimson, Oğuzhan Karakaş & Xi Li, Coordinated Engagements 9 (July 1, 2018). https://ssrn.com/abstract=3209072; Craig Doidge et al., Collective Action and Governance Activism (Aug. 30, 2017), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2635662.

[5] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3449989.

[6] Ronald J. Gilson & Jeffrey N. Gordon, The Agency Costs of Agency Capitalism. Activist Investors and the Revaluation of Governance Rights, 113 COLUM. L. REV. 863 (2013).

This post comes to us from professors Giovanni Strampelli and Gaia Balp at Bocconi University’s Department of Legal Studies. It is based on their recent paper, “Institutional Investor Collective Engagements: Non-Activist Cooperation vs Activist Wolf Packs,” available here.

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