Intermediated Corporate Governance
Lead Research Organisation:
London School of Economics and Political Science
Department Name: Financial Markets Group
Abstract
In the research programme outlined in this grant proposal, we shall study corporate governance in economies with intermediated equity ownership.
When public corporations are characterised by dispersed equity ownership, blockholders - holders of non-trivial percentages of a company's shares - are key to good governance. In contrast to small shareholders, who have neither the incentive nor the capacity to effectively monitor management, blockholders are able to govern firms to the benefit of all.
The governance role of blockholders must be viewed in the backdrop of the large-scale intermediation of equity ownership in recent decades. Fifty years ago households directly owned around 70% (55%) of US (UK) equity. Today direct ownership accounts for only around 20% (10%) of US (UK) equity. The rest is indirectly owned via institutional investors such as pension funds, mutual funds, and hedge funds. Thus, a majority of blockholders in public corporations in the US and the UK today are money managers. In other words, modern-day corporate governance is intermediated: Funds that manage other people's money must monitor company executives who make business choices funded by external investors, a case of agents watching agents.
Several questions arise immediately. What are the consequences of myopia induced by asset management contracts on the nature of governance? Intermediation of equity ownership increases the distance between ultimate owners and ultimate decision makers while ownership chains also fragment equity holdings: how does this affect coordinated shareholder engagement and corporate decision making? Are there systemic stability concerns that arise from the predominance of asset managers as monitors of firms? In the aftermath of the financial crisis, prominent policy reviews have highlighted several such questions. Yet, the academic literature is yet to engage comprehensively with these issues.
We propose to fill this gap. By a combination of theoretical and empirical methods, we shall develop a comprehensive analysis of several key facets of intermediated corporate governance that are of interest to policy makers. The work will be carried out via seven, interrelated, projects. The emphasis throughout will be on the incentives of asset managers and how these impact the nature of corporate governance in firms in which they hold blocks. We shall document the landscape and legal environment of intermediated ownership around the world, delineating how incentives vary along the ownership chain (Project 1). We shall examine theoretically and empirically how such incentives affect the nature of coordinated engagement in settings with multiple small blockholders (Projects 2 and 3), engender long ownership chains (Project 4), and provide commitment mechanisms for monitoring (Project 5). We shall also examine whether the ways in which such incentives induce asset managers to govern firms foster new channels for systemic risk (Projects 6 and 7).
Our research approach will be positive: in other words, the projects will develop conceptual frameworks backed up by empirical analysis to provide a basis for understanding intermediated governance as it exists today. It is only by gaining such understanding that we can carefully evaluate the normative proposals in the policy reviews for what intermediated governance should be.
We shall facilitate knowledge exchange between the academic and policy communities. By engaging carefully with issues highlighted by policy reviews, we shall enhance awareness of policy-relevant questions amongst academic researchers. By providing thorough theoretical and empirical analyses of issues of direct interest to policy makers, we shall facilitate the development of informed and effective policy to regulate the role of institutional investors in corporate governance.
When public corporations are characterised by dispersed equity ownership, blockholders - holders of non-trivial percentages of a company's shares - are key to good governance. In contrast to small shareholders, who have neither the incentive nor the capacity to effectively monitor management, blockholders are able to govern firms to the benefit of all.
The governance role of blockholders must be viewed in the backdrop of the large-scale intermediation of equity ownership in recent decades. Fifty years ago households directly owned around 70% (55%) of US (UK) equity. Today direct ownership accounts for only around 20% (10%) of US (UK) equity. The rest is indirectly owned via institutional investors such as pension funds, mutual funds, and hedge funds. Thus, a majority of blockholders in public corporations in the US and the UK today are money managers. In other words, modern-day corporate governance is intermediated: Funds that manage other people's money must monitor company executives who make business choices funded by external investors, a case of agents watching agents.
Several questions arise immediately. What are the consequences of myopia induced by asset management contracts on the nature of governance? Intermediation of equity ownership increases the distance between ultimate owners and ultimate decision makers while ownership chains also fragment equity holdings: how does this affect coordinated shareholder engagement and corporate decision making? Are there systemic stability concerns that arise from the predominance of asset managers as monitors of firms? In the aftermath of the financial crisis, prominent policy reviews have highlighted several such questions. Yet, the academic literature is yet to engage comprehensively with these issues.
We propose to fill this gap. By a combination of theoretical and empirical methods, we shall develop a comprehensive analysis of several key facets of intermediated corporate governance that are of interest to policy makers. The work will be carried out via seven, interrelated, projects. The emphasis throughout will be on the incentives of asset managers and how these impact the nature of corporate governance in firms in which they hold blocks. We shall document the landscape and legal environment of intermediated ownership around the world, delineating how incentives vary along the ownership chain (Project 1). We shall examine theoretically and empirically how such incentives affect the nature of coordinated engagement in settings with multiple small blockholders (Projects 2 and 3), engender long ownership chains (Project 4), and provide commitment mechanisms for monitoring (Project 5). We shall also examine whether the ways in which such incentives induce asset managers to govern firms foster new channels for systemic risk (Projects 6 and 7).
Our research approach will be positive: in other words, the projects will develop conceptual frameworks backed up by empirical analysis to provide a basis for understanding intermediated governance as it exists today. It is only by gaining such understanding that we can carefully evaluate the normative proposals in the policy reviews for what intermediated governance should be.
We shall facilitate knowledge exchange between the academic and policy communities. By engaging carefully with issues highlighted by policy reviews, we shall enhance awareness of policy-relevant questions amongst academic researchers. By providing thorough theoretical and empirical analyses of issues of direct interest to policy makers, we shall facilitate the development of informed and effective policy to regulate the role of institutional investors in corporate governance.
Planned Impact
The main (non-academic) beneficiaries of this research are policy makers and regulators. Our research will provide guidance for enrichment of policy in regulating the role of institutional investors in corporate governance. Policy in this area is typically governed by national "stewardship codes." Such codes are usually less than a decade old, galvanized by the financial crisis. The UK was an early adopter of a formal stewardship code in 2010. The most significant recent development in this area is the EU's adoption of the 2017 Shareholder Rights Directive (Directive 2017/828, henceforth SRD). The SRD represents a major enrichment of existing code, attempting to tackle issues highlighted in the policy literature (see the Case for Support) such as fragmentation of shareholding, ownership chains, shareholder coordination, and conflicts of interest. Yet, many of the aspects of the SRD represent only first steps. We outline the anticipated impact of our projects in the context of the SRD.
Project 1 will establish the first comprehensive empirical characterization of the institutional ownership landscape along with a characterization of incentives along the chain. A full appreciation of this landscape and of incentives is an essential starting point for enriching policy on the institutional stewardship.
Project 2 will help refine policy to coordinate shareholder voice. It shows that flow motivations can form a basis for overcoming free riding in engagement within visible activism events. This suggests that policy aimed at coordinating voice should be targeted towards aiding "hidden" shareholder engagement that occurs "behind the scenes". Project 3 in turn will help to formulate policy to coordinate governance via trade. Preliminary findings indicate that - in the context of the exit governance mechanism - there are unexpected benefits to the presence of flow-motivated shareholders (e.g. mutual funds). They correlate exits with those of an engaged blockholder, enhancing the ex ante threat of the engaged blockholder's exit. Thus, in terms of stewardship, the full composition of the blockholder base matters, and policy must account for such subtlety. While the SRD proposes concrete steps for the identification of the shareholder base to company management, Projects 2 and 3 suggest that it may be helpful to make shareholders aware of each other's identities.
Long ownership chains are problematic and policies are proposed to cull them: e.g., the 2012 Kay Review (KR) proposes (6.13, p. 46) that "the chain of intermediation should be shortened." The SRD emphasizes ownership chains, and proposes that incentives along the chain are reported and revealed. While transparency is desirable, it is no panacea. It is only by understanding why ownership chains form that they can be effectively regulated. This is what Project 4 will do. The KR proposes - as part of a solution - that punishments on asset managers who do not deliver be increased: those who fail "should not expect to be employed" (6.19, p. 47). Our preliminary analysis provides a cautionary note: our conceptualization of the underlying forces suggests that any increase in downside risk to managerial labour income is likely to increase the incentives to delegate.
Projects 6 and 7 deal with an even more nascent area of policy. Following the deleveraging of banks after the financial crisis, policy-makers have very recently become concerned about other sources of systemic risk, e.g., arising from the asset management sector (e.g. 2015 IMF Global Financial Stability Review). In order to regulate and mitigate such new forms of systemic risk, it is key to formally characterize how such risks can arise. By modeling and documenting specific mechanisms by which asset managers foster systemic risk in the real economy (Project 6) and in financial firms (Project 7), these projects will enable better monitoring of systemic risk and provide foundations for policy in this area.
Project 1 will establish the first comprehensive empirical characterization of the institutional ownership landscape along with a characterization of incentives along the chain. A full appreciation of this landscape and of incentives is an essential starting point for enriching policy on the institutional stewardship.
Project 2 will help refine policy to coordinate shareholder voice. It shows that flow motivations can form a basis for overcoming free riding in engagement within visible activism events. This suggests that policy aimed at coordinating voice should be targeted towards aiding "hidden" shareholder engagement that occurs "behind the scenes". Project 3 in turn will help to formulate policy to coordinate governance via trade. Preliminary findings indicate that - in the context of the exit governance mechanism - there are unexpected benefits to the presence of flow-motivated shareholders (e.g. mutual funds). They correlate exits with those of an engaged blockholder, enhancing the ex ante threat of the engaged blockholder's exit. Thus, in terms of stewardship, the full composition of the blockholder base matters, and policy must account for such subtlety. While the SRD proposes concrete steps for the identification of the shareholder base to company management, Projects 2 and 3 suggest that it may be helpful to make shareholders aware of each other's identities.
Long ownership chains are problematic and policies are proposed to cull them: e.g., the 2012 Kay Review (KR) proposes (6.13, p. 46) that "the chain of intermediation should be shortened." The SRD emphasizes ownership chains, and proposes that incentives along the chain are reported and revealed. While transparency is desirable, it is no panacea. It is only by understanding why ownership chains form that they can be effectively regulated. This is what Project 4 will do. The KR proposes - as part of a solution - that punishments on asset managers who do not deliver be increased: those who fail "should not expect to be employed" (6.19, p. 47). Our preliminary analysis provides a cautionary note: our conceptualization of the underlying forces suggests that any increase in downside risk to managerial labour income is likely to increase the incentives to delegate.
Projects 6 and 7 deal with an even more nascent area of policy. Following the deleveraging of banks after the financial crisis, policy-makers have very recently become concerned about other sources of systemic risk, e.g., arising from the asset management sector (e.g. 2015 IMF Global Financial Stability Review). In order to regulate and mitigate such new forms of systemic risk, it is key to formally characterize how such risks can arise. By modeling and documenting specific mechanisms by which asset managers foster systemic risk in the real economy (Project 6) and in financial firms (Project 7), these projects will enable better monitoring of systemic risk and provide foundations for policy in this area.
Organisations
- London School of Economics and Political Science (Lead Research Organisation)
- University of Illinois at Urbana-Champaign (Collaboration)
- Frankfurt School of Finance and Management (Collaboration)
- University of Mannheim (Collaboration)
- Hanyang University (Collaboration)
- Boston College (Collaboration)
Publications
Brav A
(2022)
Wolf Pack Activism
in Management Science
Burkart M
(2023)
Equity Issuance Methods and Dilution
in The Review of Corporate Finance Studies
Burkart M
(2021)
Competition for Flow and Short-Termism in Activism
in The Review of Corporate Finance Studies
Burkart M
(2023)
Why Do Boards Exist? Governance Design in the Absence of Corporate Law
in The Review of Financial Studies
Cvijanovic D
(2022)
The Wall Street stampede: Exit as governance with interacting blockholders
in Journal of Financial Economics
Sautner Z
(2021)
Institutional Investors and Corporate Governance
in Foundations and TrendsĀ® in Finance
Description | Bank of England Round-Table on Systemic Risk Arising from Asset Management Sector |
Geographic Reach | National |
Policy Influence Type | Participation in a guidance/advisory committee |
Impact | This round-table at the Bank of England considered issues related to systemic risk arising out of the long-only asset management sector, and potential regulation to deal with it. The panel was made up of senior policy makers at the Bank of England and the Financial Conduct Authority as well as a few senior academics. The regulation of potential systemic risks arising from the asset management sector is a key and evolving area of prudential interest. |
Description | Invited panelist at policy relevant event organized by securities regulator |
Geographic Reach | Multiple continents/international |
Policy Influence Type | Participation in a guidance/advisory committee |
Impact | The audience for this presentation involved senior and mid-career regulators, senior public figures, and academics. The discussion generated significant interest and influenced thinking on the ongoing regulatory processes. |
URL | https://www.youtube.com/watch?v=iZQlWg406mw |
Description | Bond Funds and Credit Risk |
Organisation | Hanyang University |
Country | Korea, Republic of |
Sector | Academic/University |
PI Contribution | This is a research collaboration on the growth of the open ended bond mutual fund sector as corporate financiers on corporate credit risk. My collaborators are Jaewon Choi (Illinois) and Ji Yeol Jimmy Oh (Hanyang). The project has both theoretical content and empirical content. I contributed to the former. |
Collaborator Contribution | This is a research collaboration on the growth of the open ended bond mutual fund sector as corporate financiers on corporate credit risk. My collaborators are Jaewon Choi (Illinois) and Ji Yeol Jimmy Oh (Hanyang). The project has both theoretical content and empirical content. Choi and Oh contributed to the latter. |
Impact | A working paper (still underoing substantial work) available at https://ssrn.com/abstract=3490683 |
Start Year | 2019 |
Description | Bond Funds and Credit Risk |
Organisation | University of Illinois at Urbana-Champaign |
Country | United States |
Sector | Academic/University |
PI Contribution | This is a research collaboration on the growth of the open ended bond mutual fund sector as corporate financiers on corporate credit risk. My collaborators are Jaewon Choi (Illinois) and Ji Yeol Jimmy Oh (Hanyang). The project has both theoretical content and empirical content. I contributed to the former. |
Collaborator Contribution | This is a research collaboration on the growth of the open ended bond mutual fund sector as corporate financiers on corporate credit risk. My collaborators are Jaewon Choi (Illinois) and Ji Yeol Jimmy Oh (Hanyang). The project has both theoretical content and empirical content. Choi and Oh contributed to the latter. |
Impact | A working paper (still underoing substantial work) available at https://ssrn.com/abstract=3490683 |
Start Year | 2019 |
Description | Excessive Delegation |
Organisation | University of Mannheim |
Country | Germany |
Sector | Academic/University |
PI Contribution | This is joint collaboration with Ernst Maug. The project theoretically considers the existince of multiple ownership layers and delegation chains in asset management. Each coauthor contributes to the theoretical development. |
Collaborator Contribution | This is joint collaboration with Ernst Maug. The project theoretically considers the existince of multiple ownership layers and delegation chains in asset management. Each coauthor contributes to the theoretical development. |
Impact | A working paper will be in circulation later in the year. |
Start Year | 2019 |
Description | Institutional Investors and Corporate Governance |
Organisation | Boston College |
Country | United States |
Sector | Academic/University |
PI Contribution | This is a three-way research collaboration between Vyacheslav Fos (Boston College -- Carroll School of Management), Zacharias Sautner (Frankfurt School) and myself on documenting the role of institutional investors in corporate governance; synthesizing the legal framework under which institutioanl investors operate across the globe; establishing new stylize facts; and reviewing the state of play in the academic literature, paving a path to new research endeavour in this area. The whole team was involved in all aspects of this project. |
Collaborator Contribution | This is a three-way research collaboration between Vyacheslav Fos (Boston College -- Carroll School of Management), Zacharias Sautner (Frankfurt School) and myself on documenting the role of institutional investors in corporate governance; synthesizing the legal framework under which institutioanl investors operate across the globe; establishing new stylize facts; and reviewing the state of play in the academic literature, paving a path to new research endeavour in this area. Fos and Sautner were involved with the empirical aspects of the project. Dasgupta was involved with the laying out the intellectual framework, providing research leadership, synthesizing legal and theoretical aspects. |
Impact | A paper published in Foundations and Trends in Finance, volume 12, issue 4, September 2021. |
Start Year | 2020 |
Description | Institutional Investors and Corporate Governance |
Organisation | Frankfurt School of Finance and Management |
Country | Germany |
Sector | Charity/Non Profit |
PI Contribution | This is a three-way research collaboration between Vyacheslav Fos (Boston College -- Carroll School of Management), Zacharias Sautner (Frankfurt School) and myself on documenting the role of institutional investors in corporate governance; synthesizing the legal framework under which institutioanl investors operate across the globe; establishing new stylize facts; and reviewing the state of play in the academic literature, paving a path to new research endeavour in this area. The whole team was involved in all aspects of this project. |
Collaborator Contribution | This is a three-way research collaboration between Vyacheslav Fos (Boston College -- Carroll School of Management), Zacharias Sautner (Frankfurt School) and myself on documenting the role of institutional investors in corporate governance; synthesizing the legal framework under which institutioanl investors operate across the globe; establishing new stylize facts; and reviewing the state of play in the academic literature, paving a path to new research endeavour in this area. Fos and Sautner were involved with the empirical aspects of the project. Dasgupta was involved with the laying out the intellectual framework, providing research leadership, synthesizing legal and theoretical aspects. |
Impact | A paper published in Foundations and Trends in Finance, volume 12, issue 4, September 2021. |
Start Year | 2020 |
Description | Conference involving academics and practitioners |
Form Of Engagement Activity | Participation in an activity, workshop or similar |
Part Of Official Scheme? | No |
Geographic Reach | International |
Primary Audience | Professional Practitioners |
Results and Impact | On 7-8 June 2022 we organized a major international conference under the auspices of this ESRC grant involving both academics and practitioners. The conference was held in person at the Financial Markets Group of the London School of Economics and co-sponsored by the Paul Woolley Centre for Capital Market Dysfunctionality. The conference focused on the theme of "Institutional Investors, Corporate Governance, and Capital Markets," i.e., the core themes of this grant. Institutional investors can affect decisions in the firms where they invest, through their equity or debt stakes in the firms. Is their governance role beneficial, and how does it depend on the type of institutional investor, e.g., mutual fund vs hedge fund, or active fund vs passive fund? How do different types of institutional investors interact in their governance activities? How does the change in the composition of institutional investors, e.g., the shift from active to passive, affect corporate governance and market prices? The conference consisted of invited papers by academics and a panel that involved both academics and practitioners. We were fortunate to be able to attract the leading academics working in this area, both as paper presenters and discussants as well as two senior heads of stewardship at two of the UK's major institutional investors. The conference generated both key interactions between academics in this field but also provided an important interface between senior academics and senior practitioners. |
Year(s) Of Engagement Activity | 2022 |
URL | https://www.fmg.ac.uk/events/14th-annual-paul-woolley-centre-conference |
Description | Invited participation in Bank of England Macroprudential Round-table |
Form Of Engagement Activity | A formal working group, expert panel or dialogue |
Part Of Official Scheme? | No |
Geographic Reach | International |
Primary Audience | Policymakers/politicians |
Results and Impact | Following the PI's 9th January talk, he was invited to participate at a round-table at the Bank of England on issues related to systemic risk arising out of the long-only asset management sector, and potential regulation to deal with it. The panel was made up of senior policy makers at the Bank of England and the Financial Conduct Authority as well as a few senior academics. |
Year(s) Of Engagement Activity | 2020 |
Description | Invited presentation at conference organized by the Securities and Exchange Board of India (SEBI) on the role of Institutional Investors in Corporate Governance with a focus on regulatory aspects |
Form Of Engagement Activity | A talk or presentation |
Part Of Official Scheme? | No |
Geographic Reach | International |
Primary Audience | Policymakers/politicians |
Results and Impact | The Securities and Exchange Board of India (SEBI) is involved in regulating institutional investors in India and have been developing stewardship codes for this purpose. I was invited to speak at a special conference on "Rebooting Financial Regulation" in January 2022 summarizing some of the lessons from research carried out under this grant on the ideal way to regulate institutional investors in their corporate governance role, with a special focus on the Indian context. |
Year(s) Of Engagement Activity | 2022 |
URL | https://www.nism.ac.in/event/rebooting-financial-regulation-ways-and-means-conference-by-nism-src-ls... |
Description | Keynote panel speaker at conference hosted by a regulatory body |
Form Of Engagement Activity | A formal working group, expert panel or dialogue |
Part Of Official Scheme? | No |
Geographic Reach | International |
Primary Audience | Policymakers/politicians |
Results and Impact | On December 16, 2022, the PI was an invited keynote panelist at a conference organized by the Securities and Exchange Board of India (SEBI) via its educational arm, the National Institute of Securities Markets (NISM). The panel involved two speakers: the PI and Mr Amarjeet Singh, one the Executive Directors of the Securities and Exchange Board of India. It was attended by senior regulators, senior members of industry, and academics. The topic of the panel was "The Growth of Asset Management: Impact on Markets and Firms with a Focus on India," essentially exploring the iimplications of the research under the auspices of this ESRC grant for the regulation of both asset management and corporate governance in India, both areas in which there is a great deal of ongoing activity at present. Mr Singh provided an overview of recent developments in the asset management sector in India and in its regulation and outlined the visible impact on corporate governance to date. The PI based his comments on research undertaken under this grant and outlined the implications for an extended approach towards the regulation of the asset management sector with the goal of enhancing the role of this sector in fostering good corporate governance. The full set of comments is available to the public on YouTube at https://www.youtube.com/watch?v=iZQlWg406mw. |
Year(s) Of Engagement Activity | 2022 |
URL | https://www.nism.ac.in/wp-content/uploads/2022/12/Technical-Schedule-CMC-2022.pdf |
Description | Presentation at public-access webinar organized by the European Corporate Governance Institute to showcase work under this grant |
Form Of Engagement Activity | A talk or presentation |
Part Of Official Scheme? | No |
Geographic Reach | International |
Primary Audience | Professional Practitioners |
Results and Impact | The European Corporate Governance Institute organized a public access "spotlight", specifically focussed on one of the research projects under the grant. The PI, along with his coauthors, presented the paper "Institutional Investors and Corporate Governance," which will be published by Foundations and Trends in Finance in 2021/22 (final version in preparation to deliver to publisher in mid-2021). The webinar attracted 467 registered participants, drawn from professional practitioners, regulators, academics, postgraduate students, and members of the public and was livestreamed on YouTube. The recording is available below. |
Year(s) Of Engagement Activity | 2021 |
URL | https://ecgi.global/video/institutional-investors-and-corporate-governance |
Description | Presentation to the Bank of England Capital Markets Group |
Form Of Engagement Activity | A talk or presentation |
Part Of Official Scheme? | No |
Geographic Reach | National |
Primary Audience | Policymakers/politicians |
Results and Impact | On 9th January 2020 the PI presented a research paper on corporate/economic risk factors arising from the incentives of long-only open-ended funds to the Capital Markets Group at the Bank of England. This is currently a topic of significant interest to them. This led to a follow-up invitation to participate in a Round-Table at the Bank of England on such topics a few weeks later, which I describe in the next engagement activity. It has led to multiple follow-up exchanges, and the PI will be meeting two Bank of England colleagues in May to engage further with them on these topics. |
Year(s) Of Engagement Activity | 2020 |