Guiding Seminar III Flashcards
THE AGENCY PROBLEMS OF INSTITUTIONAL INVESTORS Bebchuk, Lucian A., Alma Cohen, and Scott Hirst, 2017
Main idea: There is not enough stewardship because for institutional investors it costs a lot to be active towards their portfolio
More institutional investors than before (from 6% to 60%). By aggregating the assets of investors, institutional investors hold substantial stakes in corporations to have nonnegligible effect when voting.
Investment managers of index funds bear full costs of stewardship, yet capture only a fraction of benefits created, because compensation is based on fixed % of assets under management. No incentive fees on the change of portfolio value- the manager is not incentivized to make the portfolio grow more.
Most of the active funds are “closet indexers” whose holdings highly overlap with the benchmark index, differing only by under- and over- weighting some stocks
Hedge funds offer services to sophisticated investors; thus, their regulations are more lenient. More risky positions, more leverage, more activism. Hedge fund limitations: managers spend on stewardship only when the resulting value increase are high enough to still give investors a reasonable return after higher fees is charged. Opportunities giving smaller returns are ignored.
Agency problems of institutional investors prevent the full realization of the potential benefits of the increased concentration of shareholders. Modern corporations suffer from too little shareholder intervention.
Possible systematic improvements:
- Adopting disclosure regulations (e.g., on how voting takes place) that would enable beneficial investors identify and assess agency problems themselves (e.g., business ties)
- Adopting incentive-based compensation for mutual fund managers.
PRIVATE BENEFITS OF CONTROL: AN INTERNATIONAL COMPARISON
Main idea: PBOCs are explained and measured as the difference between the controlling stake and market value of the shares.
PBOC measurement: 1. Control premium: the difference between the price per share of the control block and the market price per share. Drawbacks: Sales of control blocks are rather rare; delay in incorporating public information to the market price. 2. Price difference between shares in a dual-class system. Extra voting rights as a proxy for corporate control. Drawback: dual class shares are not allowed in every country.
In countries showing high PBOC, entrepreneurs are reluctant to make their companies public because investors do not factor in the control value (less IPOs). Selling control in private negotiation is more profitable than in the market with dispersed buyers buying many noncontrolling stakes.
Three implications apply to countries with high PBOC: 1. Fewer companies are public; the equity markets are underdeveloped which hinders firm financing. 2. Afraid of ending up in the minority position, incumbents seek to retain control after going public, thus there should be less widely held companies. 3. To maximize profit, governments should sell companies privately rather than in public offerings.
What helps to curb PBOC: 1. The legal environment. 2. Disclosure. 3. Enforcement. 1. Product market competition. 2. Public opinion pressure. 3. Better tax enforcement
Concluding: more PBOC = less stock market, less competition, weaker institutions.
EXTREME GOVERNANCE: AN ANALYSIS OF DUAL-CLASS COMPANIES IN THE UNITED STATES
Main idea: The research summarizes dual-class firms in the US, provides reasons for their existence and insights about the valuation of such companies. different strength of shareholder rights translates to different performance of firms and economies at large.
Strong protection of shareholder rights = low PBOC = shareholders expect to get a proper return. More takeover defenses = less rights for the shareholders.
Dual class shares provide insiders (those with superior shares) with a majority of votes despite much lower cash flow rights in their possession. Insiders of dual-class firms have effective control over all corporate decisions. It makes them virtually immune to hostile takeovers.
Compared to single-class, dual-class firms are: Bigger on median terms, more levered, older. No abnormal returns by dual-class companies are documented.
What predicts larger size of PBOC and thus dual-class status? 1. If the company is named after a founder. 2. Control of a media company (e.g., newspaper, TV network) 3. If the firm is young and the founder is still active, PBOC and also dual-class structure is more likely. 4. The less firms there are in firm’s metropolitan area, the more likely the firm is a major employer are “the only game in town”
Firm value is positively associated with insiders’ cash-flow rights. Firm value is negatively associated with insiders voting rights. Firm value is negatively associated with the wedge between the two
DO INVESTORS VALUE SUSTAINABILITY? A NATURAL EXPERIMENT EXAMINING RANKING AND FUND FLOWS
Main idea: Investors believe that higher sustainability ratings are worth investing in, although there is no proof of better performance of the companies.
Why do investors value sustainability? 1. Institutional constraints = Institutional investors are often obliged to hold high sustainability stocks or constrained not to hold low sustainability stocks. 2. If investors believe sustainable funds will outperform the market, funds will flow to high sustainable funds. Actual evidence: inverse relation or no relation between ESG ratings and returns. 3. They simply had nonmonetary preference for holding more sustainable mutual funds
Concl: The sustainability ratings of stocks do not prove to represent the financial performance of the company, however, many investors still choose to invest in them. In the situation of an economic downturn, stocks with a good ESG rating experience less volatility. The reasons for choosing stocks with a good ESG standing is most likely explained by irrational behavior and non-monetary motives.
THE BONDING HYPOTHESIS OF TAKEOVER DEFENSES: EVIDENCE FROM IPO FIRMS
Main idea: Anti-Takeover defenses remain one of the most controversial corporate governance mechanisms.
Arguments for Takeover defenses: they commit the firm to a prearranged business strategy whose reversal is complicated and costly. They can be used to defend a mutually beneficial relationship.
Takeover defenses are valuable due to the existence of business ties that can be exploited by the firm for its own benefit. More takeover defenses are used in the presence of the following counterparties: 1. Large customer 2.Dependent supplier 3.Strategic alliance
The number of takeover defenses is positively related to four additional measures of the business relationship’s value to the large customer: 1. Social links. 2.Pre-IPO relationship length 3. Long-term contracts. 4. % of customer’s COGS.
The use of defenses results in higher ROA as well as higher valuation of the IPO firm!
Firm’s business partners are encouraged to make further relation-specific investments that are mutually beneficial. The closer the business relationship, the more takeover defenses are employed for its protection. Antitakeover defenses economize on having to build new contracts of business relationships from scratch, increasing net gains from trade.
