“Behind the Scenes: The Corporate Governance Preferences of Institutional Investors” 7. McCahery, Joseph A., Sautner, Z., Starks L.T

Question 1

What is the main idea?

Answer 1

Asking how people make portfolio companies behave (by threatening exit or telling them what to do)

Question 2

Who are institutional investors?

Answer 2

An entity which pools money to purchase securities, real property, and other investment assets or originate loans. Institutional investors include banks, insurance companies, hedge funds, investment advisors, endowments, and mutual funds.

Question 3

What are the choices available to institutional investors when they are unhappy with a portfolio firm?

Answer 3

1. Voice: engaging with management to try to initiate changes.
   (63% of investors have engaged directly with the management and 45% have had private discussions with the board in the past 5 years)
2. Exit: leave the firm by selling shares (can also serve as a disciplinary action).
   (50% of investors have used exit as a viable strategy, 42% believe threat of exit is effective)
   Threat of exit is unobservable – if threat is credible, exit doesn’t happen

Only when private discussions and negotiations fail to achieve the goal, investors tend to take public measures. Aggressive public measures are also used: 15% have used legal actions, 13% have used public criticism.

Question 4

What affects the effectiveness of exit threats?

Answer 4

• The investor’s equity stake’s size
• Whether other investors also exit for the same reason
• If managers own equity in the company
• Whether other shareholders are also present

Question 5

What determines the intensity of the voice?

Answer 5

• Liquidity (The more liquid shares institutional investors hold, the less they intervene)
• Investment Horizon (Long- term orientation provides more incentives to monitor and intervene)
• Size (no sign. relationship)

Question 6

What encourages shareholder activism?

Answer 6

In general, shareholders tend to engage more over long-run strategic issues.

Main drivers of activism:
Fraud;
Inadequate corporate governance and excessive compensation;
Disagreement with a firm’s strategy, specifically large mergers and acquisitions;
Contributions to politicians

Question 7

What discourages shareholder activism?

Answer 7

*Free rider problem;
*Inadequate legal rules;
*Diversification requirements for mutual funds;
*Weak disclosure requirement (less info for shareholders, less opportunities)
*Conflicts of interest (fear that aggressive engagement might affect future relations with firms – private costs);
*Compensation problems

Question 8

Are voice and exit substitutes or complements?

Answer 8

Complements, because managers tend to take discussions with shareholders more seriously in the face of a threat to exit.

Paper finds supporting evidence.

Question 9

What are proxy advisors?

Answer 9

Proxy advisory firms provide institutional investors with research, data, and recommendations on management and shareholder proxy proposals.

It reduces the costs of being informed by monitoring, collecting information and using professional judgment in recommendations.

Question 10

What are the problems of proxy advisors?

Answer 10

o Quality of their voting advice (conflicting evidence – reliable source, reduce costs vs too standardised advice, do low cost research)

o Conflicts of interest (possible that they’re advising both sides at the same time, firm have structurally separated the sides) (50% agree)

Question 11

Are proxy advisors and intervention substitutes or complements?

Answer 11

Investors who employ proxy advisors use voice more intensively – direct intervention & proxy advisors are complements