As stewardship by institutional investors is an integral part of an adequate system of corporate governance, the growing diffusion of stewardship codes can be seen as a principal reaction to institutional investors’ reticence in monitoring the companies they invest in. According to a recent survey[1], there are currently about 20 stewardship codes (or similar initiatives) in force around the world. Although all of the codes are intended to promote institutional investors’ monitoring of investee companies, as suggested by a recent study[2], these codes can be divided into three categories depending on the nature of the entities that developed them. The first category includes the stewardship codes issued by national supervisory authorities or by government institutions or committees (e.g. UK, Denmark, Japan and Hong Kong).  In other countries, stewardship codes are drawn up by private institutions representing different categories of stakeholders in the financial market (e.g. South Korea, South Africa). The third category includes the stewardship codes drafted by the same institutional investors or the institutions or associations that represent them (e.g. EFAMA Stewardship code[3]; International Corporate Governance Network’s Global Stewardship Principles[4]).

Notwithstanding these differences,  the content of the stewardship codes is remarkably similar. The codes generally promote the adoption by investors of policies that define the procedures and purposes of their stewardship activities. Investors are also generally required to monitor the companies in which they invest in order to promote the creation of value in the long term, implementing – on the basis of the policies adopted – adequate forms of engagement and, in particular, continuous dialogue with the companies in their portfolios on corporate governance, risk management, environmental and social issues and business performance. Equally widespread is the recommendation to exercise voting rights  and to adopt a policy for doing so  in the exclusive interest of investors in the funds managed by institutional investors. In order to promote the engagement of institutional investors, the codes generally encourage mutual cooperation within the limits of the law and, in particular, provisions on acting in concert.

In a recent paper, we analyze how stewardship codes can promote a more active role for institutional investors in the corporate governance of investee companies. This issue is particularly relevant in the EU, where the so called Shareholder Rights Directive II assigns to institutional investors the task of monitoring the conduct of directors and exercising their voting rights in order to ensure long-term growth of investee companies. However, the European approach creates a number of uncertainties. First, the meaning of  “engagement,” ”stewardship” or ”activism” of institutional investors is unclear. Second, it is doubtful that institutional investors have adequate incentives to exercise careful and continuous monitoring of investee companies. At least for traditional investors, the diversification of portfolios and the consequent reduced size of the shareholdings in each company could render disinvestment (exit) more efficient than voting (voice). Voting and engagement require the costly acquisition and processing of information, and other investors could take advantage of the increase in value resulting from such activities without incurring paying for it (free riding).

In addition, we analyze risks arising from the absence of a clear regulatory framework. We consider whether the contacts and exchange of opinions and information among investors, or cooperation in order to achieve a certain result, can be classified as acting in concert under European takeover regulations. We also consider whether and to what extent disclosure and insider trading rules can apply to the dialogue between directors and investors. This concern is significant not only because that dialogue could qualify as  “selective” and thus unlawful, communication of inside information, but also because the assimilation of confidential information hinders an investor’s ability to trade the shares before the information becomes public.

Therefore, against the framework described above, we aim to analyze how stewardship codes can stimulate institutional investors’ engagement activities. After an historical overview of the origins of shareholder activism and clarification of the meaning of  “engagement” (understood as a technique of dialogue with the issuer management) and “stewardship” (understood as a set of initiatives with which asset managers protect the value of their beneficial owners’ investment), we emphasize that any attempt to evaluate the role of stewardship codes must take into account that adherence to the code can signal a commitment by institutional investors to monitor the investee companies and thus an increase in value  of the equity portfolio. Moreover, the role of the stewardship codes could be further enhanced by: i) assigning a rating to how well an investor has implemented the code; ii) legally requiring the institutional investor to publicly disclose how it implements the code; and iii) introducing a legal presumption that thorough implementation of the code constitutes an indicator of compliance with the fiduciary duties that the institutional investor owes to its beneficiaries.

ENDNOTES

[1] Ernst & Young, ‘Q&A on Stewardship Codes’ (August 2017) <hiips://www.ey.com/Publication/vwLUAssets/ey-stewardship-codes-august-2017/$FILE/ey-stewardship-codes-august-2017.pdf>.

[2] Jennifer G Hill, ‘Good Activist/Bad Activist: The Rise of International Stewardship Codes’ (2018) 41 Seattle University Law Review 497.

[3]  https://www.efama.org/Publications/Public/Corporate_Governance/EFAMA%20Stewardship%20Code.pdf.

[4] https://www.icgn.org/sites/default/files/ICGNGlobalStewardshipPrinciples.pdf.

This post comes to us from Simone Alvaro at CONSOB (the Italian Companies and Exchange Commission), Marco Maugeri at the European University of Rome, and Giovanni Strampelli at Bocconi University’s Department of Law. It is based on their recent paper, “Institutional Investors, Corporate Governance and Stewardship Codes: Problems and Perspectives,” available here.