II, CORPORATE GOVERNANCE

Question 1

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure?
Pajuste, Anete, and Anna Toniolo, 2022

Why is stakeholderism important?

Answer 1

It is believed that to maximise shareholders’ value, it is vital to focus on stakeholders’ interests (opinions vary, some believe that stakeholders’ should be taken to consideration regardless shareholders’ value).

Question 2

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure?
Pajuste, Anete, and Anna Toniolo, 2022

How did stock market react to companies’ choice to leave Russia?

Answer 2

Stock market seemed to reward companies who left Russia, and penalized ones who stayed.

Question 3

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure?
Pajuste, Anete, and Anna Toniolo, 2022

What were the sanctions towards Russia implied by firms?

Answer 3

1.Banning imports of Russian key strategic products
2. Setting embargoes on certain Russian exports
3. Closing airspace to Russian airlines
4. Removing several banks from the SWIFT system
5. Freezing assets owned by the Russian state and by individuals closely affiliated with it

Question 4

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure?
Pajuste, Anete, and Anna Toniolo, 2022

What was a response from social media?

Answer 4

Public support translated into political pressure; social media activity punished companies that remained in Russia

Question 5

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure?
Pajuste, Anete, and Anna Toniolo, 2022

Empirically speaking, how did companies respond to public pressure regarding operations in Russia?

Answer 5

Corporate leaders tend to prioritize social objectives when they believe it maximizes returns, and not obtaining the said social objectives (JP Morgan said they withdrew and continued trading debt).

Question 6

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure?
Pajuste, Anete, and Anna Toniolo, 2022

What role did Twitter play in cutting ties with Russia?

Answer 6

Stakeholder pressure is an effective instrument to promote responsible management (but only as a compliment).

Question 7

Corporate Response to the War in Ukraine: Stakeholder Governance or Stakeholder Pressure?
Pajuste, Anete, and Anna Toniolo, 2022

Is the company’s size important in this? How?

Answer 7

Smaller companies are left free to operate without the important managerial constraint from stakeholder pressure. (important because small companies can be just as harmful as big companies if they conduct a significant portion of business in Russia).

Question 8

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

The authors of “Active Ownership” find four important determinants of successful ESG engagements. Name two of these determinants and explain why they could lead to higher chances of success in ESG engagements.

Answer 8

exam q

Question 9

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

Nowadays, socially responsible investing (SRI) is attracting more and more attention, focusing on not only financial, but social benefits generated for the shareholders as well – investors incorporate Environmental, Social and Corporate Governance (ESG) concerns in the decision where to invest. The term “activism” in the context of investing has taken on a broader meaning, including not only shareholders, but stakeholders as well. An asset manager is in charge of creating an ESG-inclusive investment strategy. Before finalizing it, the manager of company is considering collaborating with other activists. Considering the
available parties and initiatives:
What are the types of collaborations the asset manager may engage in?
Which type of collaboration is more likely to have a higher success rate? Why?

Answer 9

exam q

Question 10

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

Why major institutional investors nowadays are called “universal owners”?

Answer 10

They have very diversified holdings and have significant ownerships.

Question 11

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

How does active engagement by universal owners on ESG issues differ in motivation from traditional shareholder activism and hedge fund activism?

Answer 11

Typically focuses 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.

Question 12

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

Which firms do active owners engage with?

Answer 12

Firms are more likely to be engaged with if:
1. they are in the late stage of business maturity
2. have a suboptimal performance.
3. the asset manager and other socially conscious institutional investors (such as pension activists and SRI funds) have high shareholdings in the firm.
4. Reputation - 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.

Question 13

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

How are these engagements executed?

Answer 13

1. 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.
2. 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.

Question 14

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

In this article, the implementation of the changes suggested by the asset manager is referred to as
successful engagements. When are these successful engagements more likely?

Answer 14

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)

Question 15

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

What are the channels through which the firm enhances its value by engaging in ESG activism?

Answer 15

1. More socially conscious consumers have greater customer loyalty, and increased product differentiation supports premium pricing
2. Firms with high employee satisfaction tend to outperform the market
3. More virtuous companies attract a broader clientele than “sinful” companies and political leanings, which attract particular stockholder clienteles
4. Successful investor interventions signal future governance improvements (signaling that the engaged firms may be induced to look for improvements in other areas.

Question 16

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

What is the reaction of the market to investors’ engagements with corporate?

Answer 16

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.
= The existence of a threshold for success to be pursued and achieved for both types of engagements.

Question 17

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

What effect on ROA and employee loyalty does the engagement have?

Answer 17

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.

Question 18

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

What impact on the shareholding does the engagement have?

Answer 18

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 (a change in share price due to corporate decision-making that triggers investors’ reactions) among shareholders.

Question 19

Active Ownership
Dimson, Elroy, Oğuzhan Karakaş, and Xi Li, 2015

How does governance quality change when engaging in ESG practices?

Answer 19

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

Question 20

Do Institutional Investors Drive Corporate Social Responsibility? International Evidence
Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019

In an ESG-conscious world, institutional investors are starting to pay more attention to whether or not firms like KLM are engaging in ES activities. Firm KLM is in its late stage of business maturity, and an asset manager has proposed engagement in ESG activism as a tool to help improve its performance. An individual institutional investor based in the US is considering influencing the ES performance of firm KLM. Will the impact be evident? Why?

Answer 20

Investors are motivated by social returns, and foreign
institutional investors impact firms’ E&S performance only when these investors are from countries where social norms reveal a greater demand (above median demand) for E&S performance, there is an improvement in the firm’s ESG performance.
Only European institutional investors were shown to impact firms’ E&S performance. No other region investors having an impact on the firm’s E&S performance.
There is an exception, where no matter the country there is an element that is capable of influencing firm’s E&S performance- pension plans. Pension plans consistently influence firms to strengthen E&S performance no matter the country they’re in.

Question 21

Do Institutional Investors Drive Corporate Social Responsibility? International Evidence
Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019

A different institutional investor from Slovenia sees suboptimal ES performance in firm KLM. What are possible the mechanisms in the article that the institutional investor can use to demand change?

Answer 21

1. Exit and selection (use negative screening to exclude poor E&S performers or positive screening to buy only firms above certain E&S thresholds). It remains unclear how popular this method is among investors, however, the authors find that this method does not account for broad, large-scale changes.
2. Voice (voicing their concerns to the management). As exit and selection has not been prevalent, the authors state their assumption that voice will prevail as the more important mechanism for demanding change. The research finds that it is not the dominant mechanism, as shareholder proposals are rather scarce and the shareholder proposals are rarely voted on.

Question 22

Do Institutional Investors Drive Corporate Social Responsibility? International Evidence
Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019

Is E&S performance beneficial for an average shareholder?

Answer 22

Whether E&S performance is beneficial to the average shareholder remains controversial, but it is clear that outsiders with no financial stake do not bear the costs of E&S activities and will press for improvements.

Question 23

Do Institutional Investors Drive Corporate Social Responsibility? International Evidence
Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019

What motivates investors to address firms’ E&S performance?

Answer 23

Investors around the world are motivated by both financial and social returns.

Question 24

Do Institutional Investors Drive Corporate Social Responsibility? International Evidence
Dyck, Alexander, Karl V. Lins, Lukas Roth, and Hannes F. Wagner, 2019

What is the role of social norms when talking about addressing firms’ E&G developments?

Answer 24

Strong enough social norms can overcome market pressures to focus primarily on financial returns – social norms matter when considering E&S developments in companies globally, but the strength of the norms matters greatly.

Question 25

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, Joseph A., Sautner, Z., Starks L.T., 2016

The article looks at the interaction between institutional investors and their portfolio companies. The authors argue that the threat of exit can be as effective as the exit itself. Discuss the four factors that make the threat of exit more credible/effective.

Answer 25

Shareholders can collect private information on the fundamental value of a firm, which is then impounded to the price they offer in case of an exit. If a firm is not doing well, but the public does not know it yet, managers are strongly incentivized to increase firm’s value to avoid exit by informed shareholders. Threat of exit is empirically unobservable; survey results are the only data.
1. Multiple informed shareholders, their trading incorporates more information on firm’s fundamentals = more threat to firm’s value in case of the exit.
2. If managers own equity in the company, exit threat is even more convincing.
3. The size of the equity stake should be significant for the threat to be effective.

Question 26

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, Joseph A., Sautner, Z., Starks L.T., 2016

There is little knowledge how institutional investors engage with their portfolio companies, because most of the interactions occur behind the scenes. What are the two activities that institutional investors conduct when they are unhappy with company’s performance?

Answer 26

1. Voice: engaging with management to try to initiate changes.
2. Exit: leave the firm by selling shares.

Question 27

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, Joseph A., Sautner, Z., Starks L.T., 2016

What encourages shareholder activism?

Answer 27

1. fraud
2. inadequate corporate governance and excessive compensation
3. disagreement with a firm’s strategy
4. specifically large mergers and acquisitions
5. contributions to politicians.

Question 28

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, Joseph A., Sautner, Z., Starks L.T., 2016

What discourages shareholder activism?

Answer 28

1. “Free rider” problem, inadequate legal rules do affect activism: diversification requirements for mutual funds can prevent them from taking stakes necessary for effective voice strategy
2. Weak disclosure requirements limit the amount of information that shareholders get, providing less opportunities for activism
3. Conflicts of interest, as investors might be concerned that aggressive engagement might affect their future relations with firms (private costs).
4. Fund managers might not bother engaging if they are not sufficiently rewarded for activism (compensation problems).

Question 29

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, Joseph A., Sautner, Z., Starks L.T., 2016

Can voice and exit strategies be used complementary?

Answer 29

Voice and exit strategies are complements. Managers tend to take discussions with shareholders more seriously in the face of a threat to exit.
They might be substitutes (used separately, one or the other) as well: some investors might lack the expertise of intervention and thus rely solely on the exit strategy. Investors might face capital gains costs when exiting, which makes the option of voice more attractive.

The paper finds robust positive correlation between the two variables, suggesting that they are complements!

Question 30

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, Joseph A., Sautner, Z., Starks L.T., 2016

The authors explain that even though liquidity and investment horizon can have both positive and
negative relationships with voice intensity, their survey results point to one-way relationships. Explain how liquidity and investment horizon can affect voice intensity both positively and negatively and state the survey results regarding the two determinants.

Answer 30

1. Liquidity. Theory isn’t in an agreement: Higher liquidity of shares held encourages investors not to bother with activism and liquidate. On the other hand, higher liquidity makes it easier to sell at increased price that reflects engagement efforts. The paper indicates negative relationship between liquidity and voice: the more liquid shares institutional investors hold, the less they intervene.
2. Investment Horizon. Theory isn’t in an agreement: Long-term shareholders might be incentivized to intervene, because they can reap the long-term benefits. Contrary to this, hedge funds (short-term mostly) sometimes push for actions that are profitable in the short run, but detrimental in the long run. The paper shows positive relationship between horizon and voice: longterm orientation provides more incentives to monitor and intervene.
3. Size. The paper does no find significant relationship between the size of stake and voice. Agency problems of institutional investors? Larger share of company means more absolute payoff for intervention, encourages more activism. Larger funds might also have more resources to engage.

Question 31

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, Joseph A., Sautner, Z., Starks L.T., 2016

According to the authors, what is the role of proxy advisors? What are the two issues that surround the use of proxy advisors? What do the authors find out from the survey regarding the use of proxy advisors and those issues?

Answer 31

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.
Proxy advisors merely complement individual judgement and do not imply that investors take passive
governance role (60% of respondents use at least one proxy). Recommendations of proxy advisers can be too standardized and ignoring firm-specific cases. As profit seeking organizations, they are incentivized to conduct low-cost analyses only. Some proxy advisors serve as corporate governance advisory firms and make recommendations on voting at the same time. Conflict of interest might arise.

Question 32

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, Joseph A., Sautner, Z., Starks L.T., 2016

SoftBank Group Corp. is a Japanese conglomerate holding company founded by Masayoshi Son. Son has a greater than 25% stake in the conglomerate. The second largest shareholding group owns only 5.3% of the shares. Other shareholders are mostly institutional investors. Last week, the activist hedge fund Elliott Management disclosed a $2.5bn stake in SoftBank. Assume that Elliot Management has already called for governance changes in SoftBank. What are the three possible determinants of the hedge fund’s voicing strategy and what does the evidence suggest about the possibility of their prevalence in Elliot Management’s case?

Answer 32

Liquidity (the more liquid the shares, the less they are likely to intervene), size (the larger the stake, the more benefits from intervention) and investment horizon (hedge funds push their views and strategies, which are profitable in a short-run) .

Question 33

Behind the Scenes: The Corporate Governance Preferences of Institutional Investors
McCahery, Joseph A., Sautner, Z., Starks L.T., 2016

Imagine that management wants and has the corporate authority to buy a sketchy startup promising to increase the efficiency of the company’s solar panels. However, none of the shareholders like the idea – they believe that the investment is far too risky and might lead to a decrease in the firm’s value. What are the two ways in which the shareholders might influence the decisions of the management? Please provide a short explanation of these ways.

Answer 33

Voice or (threat of) exit.