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Benefits of Shareholder Engagement to Corporate Governance

The role of shareholder engagement by institutional Investors
has been puzzling academics already for over 2 decades.1
Those charged with responsibility for recommending improvements to UK corporate
governance have repeatedly advocated closer shareholder involvement in the
affairs of publicly traded companies.2
Being in regular contact benefits both parties by facilitating a better
understanding of the company (for shareholders) as well as the views and
policies of its institutional shareholders (for issuers).3
Indeed, certain forms of engagement by activist shareholders may seem
beneficial since it can be a catalyst for changes in the company’s governance
and it can raise the attention and awareness of other shareholders.4 Sir
David Walker had something similar to say:

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 ‘More productive and informed relationship between directors and
shareholders should help directors in better management of the company’s
affairs”.5

Then again The Financial Reporting Council (FRC), an
independent regulator responsible for corporate governance and financial
reporting that works closely in conjunction with the UK government, said
similarly in 2010:

”More effective
engagement should improve the governance and performance of investee companies,
assist the efficient operation of capital markets and increase confidence in
business. Greater clarity in the respective responsibilities of asset managers
and asset owners and strengthened accountability of institutional shareholders
to their clients will also strengthen trust in the financial system”.6

 

 

 

 

Additionally, in the wake of the financial crisis,
institutional investors are under increasing pressure to understand the
companies in which they invest and use their influence to minimize corporate
governance risk.7
Institutional investors hold shares on behalf of millions of individuals and
other entities, and they have a fiduciary duty to ensure that their holdings
are in the best interest of the underlying investors. Nevertheless, this
responsibility does not end with financial performance; rather, it extends to
ensuring that the companies they invest in have adequate corporate governance
mechanisms.8 Widespread
engagement of the main institutional investors can help to mitigate the
negative engagement of others such as hedge fund activists, since stewardship
will require that they analyse and respond to the proposals put by such
shareholders9. Institutions
should involve those making investment decisions in their governance dialogue
with companies as far as appropriate and ensure those involved in governance
and fund management are ‘joined up’.10
Institutional investors are more receptive and likely to support Management’s
positions when the company has been in contact.11
Although shareholder engagement may not always garner immediate results, it has
the potential to lead to mutual agreements on various matters over time.12

The more who engage in this way and who declare their
policies on voting and their voting activities, the less scope there must be
for malevolent activists to succeed.13
Institutional investors have bigger stakes in the companies, which increase
their incentives to be actively involved than what is the case for dispersed
individual shareholders.14 The
rationale behind this is very straightforward the bigger the proportionate
share of the expected benefits from undertaking disciplining efforts for the
shareholder, the bigger the likelihood that this shareholder will engage in
such disciplining efforts, since he has bigger incentives to do so. The bigger
the concentration of share ownership, it will also become easier to coordinate
actions between the shareholders and hence to share the costs of disciplining
activities.15 Shareholders
believe that their governance activity is of benefit to the whole UK market:
Institutions have an interest to work for better governance to enhance the
integrity of the London market.16

If shareholders step forward and take their role as ‘owners’
of companies seriously, this will do a great deal to keep what are now commonly
referred to as ‘agency costs’ the detrimental effects of managers pursuing
their own agenda rather than seeking to promote corporate success in check.17
It is clear that the key task in shareholder engagement is to improve the
ongoing quality of the dialogue between shareholders and companies.18

A significant advantage of the change in company ownership
over the last thirty years or so is that institutional investors make up a far
more fertile environment for stewardship. There are of course difficulties (at
least in the absence of fiduciary duties) in placing engagement obligations
upon individuals, who are not subject to any regulator and less prone to be
sensitive to how others view them. Individuals are also likely to lack the
expertise and infrastructure to monitor the directors of public companies and
the cost of doing so would be out of all proportion to their interest.
Institutional investors, on the other hand, are in a position placed to
scrutinise their investee companies, with wide experience and access to the
company’s management and information about its business. Moreover, given their
duties to those persons for whom they invest the funds, it would be safe to say
that they owe an obligation to oversee their investees, especially in the
aftermath of the financial crisis.19

Brad Pomfret is of the belief that shareholder engagement is
a good thing and that it should be encouraged amongst other institutional
investors. The exercise of shareholder rights and use of engagement for selfish
purposes ulterior to the long-term success of the investee company is
inevitable given the company structure, but may be reduced by more widespread
and transparent engagement.20It
is incredibly important manifesting itself in the long-term performance of
companies. Well-run companies tend to have support of shareholders, suffer less
volatility at times of maximum stress, with less severe share price falls.21 Institutions
should recognise that governance dialogue can ensure that governance problems
do not build in the companies they hold. Institutions should not wait for
crises to emerge before initiating their own engagement with companies on
governance issues. Mechanisms to allow early conversations should be explored.22

1
Marco Becht, Julian Franks, Colin Mayer, Stefano Rossi, ‘Returns to Shareholder
Activism: Evidence from a Clinical Study of the Hermes UK Focus Fund’ (2008) 22
The Review of Financial Studies 8 (3093-3129) available at: . From Van Campe
Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder Engagement
the Answer? A Critical Assessment’ page 4, Master’s Thesis 2011-2012
accessed 28 December 2017.

2Keeping
Better Company: ‘Corporate Governance Ten Years On’ (2nd edn, Oxford
University Press 2005) Ch.5. From Brian R. Cheffins, ‘The Stewardship Code’s
Achilles’ Heel: Legislation and Reports’ (2010) 73(6) MLR 1008.

3 Tarun
Mehta, Advisor, ISS Corporate Services ‘Shareholder Engagement: Maximizing the
Shareholder Relationship’ (2013) Exec Comp 13.3 at 2.

4 European
Commission’s Green paper on the EU corporate governance framework’ (Brussels)
2011 available at: .
From Van Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is
Shareholder Engagement the Answer? A Critical Assessment’ page 8, Master’s
Thesis 2011-2012 accessed 28
December 2017.

5 Sir
D. Walker, A Review of Corporate Governance in UK Banks and Other Financial
Industry Entities: Final Recommendations (hereinafter Walker Report) (26 November
2009), 78 available at: .
From Brian R. Cheffins, ‘The Stewardship Code’s Achilles’ Heel: Legislation and
Reports’ (2010) 73(6) MLR 1006.

6
Financial Reporting Council, Consultation on a Stewardship Code for
Institutional Investors, January 2010 available at: . From Brian R. Cheffins, ‘The Stewardship
Code’s Achilles’ Heel: Legislation and Reports’ (2010) 73(6) MLR 1006.

7 Tarun
Mehta, Advisor, ISS Corporate Services ‘Shareholder Engagement: Maximizing the
Shareholder Relationship’ (2013) Exec Comp 13.3 at 1.

8 Tarun
Mehta, Advisor, ISS Corporate Services ‘Shareholder Engagement: Maximizing the
Shareholder Relationship’ (2013) Exec Comp 13.3 at 1.

9 Ronald
J. Gilson, Jeffrey N. Gordon, ‘Agency Capitalism: Further

Implications of Equity Intermediation’ February 2014
available at: .
From 23escommercial, ‘Is Shareholder Engagement a Good Thing? Para (9), 2012
accessed
27 December 2017.

10 Jan
Hall, Thomas O’Malley, ‘A Study of Investors Company and Adviser Perspectives
Conducted by the JCA Group for the Financial reporting Council’ (JCA) Section
1, page 7 accessed
16 December 2017.

11 Tarun
Mehta, Advisor, ISS Corporate Services ‘Shareholder Engagement: Maximizing the
Shareholder Relationship’ (2013) Exec Comp 13.3 at 2.

12 Tarun
Mehta, Advisor, ISS Corporate Services ‘Shareholder Engagement: Maximizing the
Shareholder Relationship’ (2013) Exec Comp 13.3 at 2.

13 23escommercial,
‘Is Shareholder Engagement a Good Thing? Para (), 2012 accessed
27 December 2017.

14 Van
Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 44, Master’s Thesis
2011-2012 accessed 1 January
2018.

15 Iman
Anabtawi, ‘Some Skepticism about Increasing Shareholder Power’ UCLA School of
Law, Law-Econ Research Paper No. 05-16 15 August 2005 available at:
. From Van
Campe Frederic, ‘Corporate Governance in a Post Crisis Era: Is Shareholder
Engagement the Answer? A Critical Assessment’ page 44, Master’s Thesis
2011-2012 accessed 1 January
2018.

16 Jan
Hall, Thomas O’Malley, ‘A Study of Investors Company and Adviser Perspectives
Conducted by the JCA Group for the Financial reporting Council’ (JCA) Section
2, page 6 accessed
16 December 2017.

17 Brian
R. Cheffins, ‘The Stewardship Code’s Achilles’ Heel: Legislation and Reports’
(2010) 73(6) MLR 1006.

18
Jan Hall, Thomas O’Malley, ‘A Study of Investors Company and Adviser
Perspectives Conducted by the JCA Group for the Financial reporting Council’
(JCA) page 6 accessed
16 December 2017.

 

19 23escommercial,
‘Is Shareholder Engagement a Good Thing? Para (8), 2012
accessed
27 December 2017.

20
23escommercial, ‘Is Shareholder Engagement a Good Thing? Para (1), 2012
accessed
27 December 2017.

21 Jan
Hall, Thomas O’Malley, ‘A Study of Investors Company and Adviser Perspectives
Conducted by the JCA Group for the Financial reporting Council’ (JCA) Section
2, page 6 accessed
16 December 2017.

22 Jan
Hall, Thomas O’Malley, ‘A Study of Investors Company and Adviser Perspectives
Conducted by the JCA Group for the Financial reporting Council’ (JCA) Section
1, page 7 accessed
16 December 2017.

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