Active Ownership Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015 Flashcards
the analysis of a database of corporate social responsibility engagements with U.S. public companies from 1999–2009, where successful participation in CSR has positive returns, while no engagement or unsuccessful engagements has zero abnormal returns.
CONTEXT
Major institutional investors nowadays are called “universal owners” as they have very diversified
holdings and have significant ownerships. Since these investors own most of the equities in the
market, they are exposed to risks they are interested in minimizing their costs and maximizing
their benefits.
At the same time, attracting more attention is socially responsible investing (SRI), which attempts to
deliver not only financial benefits, but social benefits as well: GSIA (2015) estimates that $21.4
trillion of professionally managed assets worldwide incorporate ESG concerns into their decisions
Active engagement by universal owners on ESG issues (hereafter “ESG activism” or “active
ownership”) differs in motivation from traditional shareholder activism and hedge fund activism
typically focus on issues related to the shareholder activism by institutions, such as pension funds and
mutual funds interests of shareholders only, whereas ESG activism focuses on issues related to the
interests of a broader range of stakeholders.
QUESTIONS PROPOSED
- Which firms do active owners engage, and how are these engagements executed?
- Do active owners compete or collaborate with other shareholders, and with what effect?
- How do engaged firms respond?
- What determines the success of these engagements?
- How does the market react to engagements?
- Do active owners succeed in implementing their objectives?
- How do ESG activities affect firm performance?
SETUP
Highly intensive engagements on environmental, social, and governance areas, each of which is
further divided into different themes and issues.
Given the relative lack of research on environmentally and socially themed engagements, the authors
emphasize the environmental and social (ES) engagements throughout the paper and use the
corporate governance (CG) engagements as a basis for comparison.
Which firms do active owners engage?
Firms are more likely to be engaged if they are in the late stage of business maturity (think business
cycle) and have a suboptimal performance. The likelihood of being engaged is further increased if
the asset manager and other socially conscious institutional investors (such as pension activists
and SRI funds) have high shareholdings in the firm.
Reputation also a determinant of the likelihood of a company undertaking the activities (matters
more for firms with ES themes), as well as having inferior governance.
Success is more likely if the target firm has reputational concerns, a capacity to implement
change (the two most prominent elements, as the others are costly in the ES context), economies of
scale, and headroom for improvement.
How are these engagements executed?
Collaboration by the asset manager with other activist investors and/or initiatives plays an important
part in the asset manager’s engagement strategies. Two major categories are selected based on those
involved:
Hard collaborations include the partnership of the asset manager with activist investors, such as SRI
funds, pension funds, asset managers, financial institutions, union funds, etc.
Soft collaborations refer to asset managers who benefit from the ESG principles and initiatives
established by investment bodies, nonprofit organizations, or the industry in which the firm operates.
= Research concludes that cooperation with hard collaborators, compared with soft collaborators
leads to a higher success rate, as the former are activist investors, whereas the latter are passive
principals (this exists for ES engagements and not CG)
Do active owners compete or collaborate with other
shareholders, and with what effect?
The asset manager’s ownership plays a less important role in relation to ES engagements than to CG
engagements, and reputational concerns are a more important determinant of engagement with
firms on ES themes:
These findings indicate the importance of potential collaborations with other stakeholders and of
customer opinion and loyalty (stronger in customer-facing industries)
What determines the success of these engagements?
In this article, the implementation of the changes suggested by the asset manager is referred to as
successful engagements.
Success is more likely if:
1. The target firm has reputational concerns, a capacity to implement change, economies of
scale, and headroom for improvement.
2. There has been successful prior engagement experience with the same target firm (increases the
likelihood of subsequent engagements being successful)
3. Collaborations among the asset manager and other active investors and/or stakeholders to
contribute positively to the success of engagements (especially for ES, ES requires more
convincing and efforts to change than CG)
Many engagements are actually triggered by public events (46.6% of the cases analyzed in this
research are preceded by public news)
Enhancement of firm value through ESG activism:
THE 4 CHANNELS
- More socially conscious consumers have greater customer loyalty, and increased product
differentiation supports premium pricing - Firms with high employee satisfaction tend to outperform the market
- More virtuous companies attract a broader clientele than “sinful” companies and political
leanings, which attract particular stockholder clienteles - Successful investor interventions signal future governance improvements (signaling that the
engaged firms may be induced to look for improvements in other areas.
How does the market react to engagements?
ESG engagements create a cumulative size-adjusted abnormal return of +2.3% over the year
following the engagement. The abnormal returns are higher for successful engagements (+7.1%), but
they gradually flatten out after a year, when the objective is accomplished. This effect is most
pronounced for CG and climate change themes: the cumulative abnormal return of an additional
successful engagement over a year after the initial engagement averages +8.6% and +10.3%,
respectively.
There is no market reaction to unsuccessful engagements. The abnormal return patterns and
magnitudes are similar for the subsamples of CG and ES engagements.
= This suggests the existence of a threshold for success to be pursued and achieved for both
types of engagements.
How do ESG activities affect firm performance?
- Particularly focusing on the ES and CG subsamples, the research finds that ROA and the ratio of
sales to the number of employees improve significantly one year after successful ES engagements
(more pronounced results for the ES subsample).
= Successful ES initiatives enhance customer and employee loyalty. - There is an increase in shareholdings by the asset manager, pension activists, and SRI funds
one year after successful ES engagements (near to no effects for the CG subsample).
= ES initiatives generate a clientele effect (the clientele effect is a change in share price due to
corporate decision-making that triggers investors’ reactions) among shareholders. - There are notable improvements in the corporate governance structure of targeted firms,
(measured by the entrenchment index), two years after successful engagements on all ESG issues.
= Good ESG practices signal improving governance quality.
REMARKS
On average, these ESG activities give rise to a positive size-adjusted abnormal return of +2.3% over
the year after initial engagement, but no effects are seen for non-ESG companies.
Older companies with suboptimal performance, inferior governance structure, greater
reputational concerns and higher shareholding from the asset manager are more likely to be
targeted for engaging in ESG activities. Engagements are more likely to be successful in achieving
the activist’s objectives if the target firm is more concerned about its reputation, and has higher
capacity to implement.
ESG activities attract socially conscious customers and investors, and the authors find that, after
successful engagements, particularly for those on ES issues, engaged companies experience
improvements in their operating performance, profitability, efficiency, shareholding, and
governance.
