Download Chapter 11 - Widener University

Chapter 11
Mutual Funds
as Institutional
Investors
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Who Are
Institutional Investors?
• Mutual funds
• Pension funds
• Bank trust departments
• Insurance companies
• Endowments of universities and
foundations
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11–1
Institutional Ownership by Size
of Company
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11–2
Some Differences
Between Investors
Mutual
Fund
Corporate
Insurgent
Venture
Capitalist
Motivation?
Diversify
portfolio
Acquire
company
Hold large
positions
Goal?
Not seeking
control
Seeking
control
Seeking
management
participation
Holdings assets?
Need liquid
positions
May hold or
sell positions
May hold
illiquid
How paid?
On % of
assets
managed
On company
profits or sale
of company
assets
Base fee plus
20% profit
participation
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11–3
Legal Framework of
Corporate Governance
• Stockholders only indirectly control the company’s policies or
business strategies though a board of directors and periodic
votes (ballots, proxies)
• Why institutional investors still generally follow the “Wall Street
Rule”
– They are legally constrained from controlling public companies
– Their fees do not support the time and resources involved in
takeover fights
– They hold too many stocks to participate actively in corporate
management
– They are experts in making portfolio investments, not in operating
companies
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11–4
Legal Framework of
Corporate Governance (cont.)
• What happens if investors decide to battle for
control?
– Company’s charters and by-laws delineate scope of
shareholder activity in areas such as voting power and
information access (subject to applicable laws)
– May have to deal with anti-takeover measures (e.g., poison
pill)
– Federal securities laws establish disclosure obligations and
procedural ground rules to level the playing field for all
parties; also rules by organizations such as SEC, NYSE, and
NASD
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11–5
Poison Pill
(Shareholder Rights Plan)
• Definition
– Company plan giving shareholders more rights after a
“trigger” event
• Example
– Right of every shareholder (other than the acquirer) to buy
1,000 shares of company stock at one cent per share
• Trigger
– Anyone acquires more than specified percent of company’s
voting stock (e.g., 15%) without approval of company’s
board
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11–6
Voting Procedures for
Mutual Funds
• Government agencies
– SEC: No formal rule on proxy voting for mutual funds
– DOL: Extensive set of letters and interpretations on proxy
voting for ERISA fiduciaries
• Independent directors
– Typically have reviewed/approved a set of voting guidelines
used by the investment adviser to the funds
– Investment adviser provides directors with annual summary
report of fund votes
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11–7
Voting Procedures for
Mutual Funds (cont.)
• Investment adviser
– Adviser may form a special group
dedicated to evaluating
proxy votes or may use a third-party
vendor
– Most proxies involve routine votes; nonroutine votes handled by board guidelines
or adviser’s officials
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11–8
Types of Shareholder Activism
• Goals of various groups seeking to
implement corporate governance
– Governance structure of company is
improved
– Price of company’s stock goes up
– For green or socially responsible funds
company improves its environmental
approach or achieves targeted policies
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11–9
Benefits of Activism by Level
• Higher benefit/most likely to lead to higher stock price
– Mergers
– Tender offers
• Lower benefit/least likely to lead to higher stock price
– Many procedural changes in corporate governance
– Example: appointing an outside chairperson separate from
the CEO
• In the middle: long-term benefits to shareholders
– Restructuring executive compensation
– Electing a majority of independent directors
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11–10
Cost of Strategies
• Higher cost strategies
– Categories
• Tender offers
• Proxy fights
• Director nominations
– Legal issues
• May require filing extensive
documents with the SEC
• Exposure to potential
lawsuits
• Lower cost strategies
– Categories
• Shareholder resolutions
• Letters to outside directors
• Informal discussions with management
– Legal issues
• Company must include shareholder
resolutions, along with supporting
statements in its proxy statement sent
to all shareholders
• Shareholder must file form 13D with
the SEC if deemed to be acting in
concert with other shareholders holding
5% or more of company’s voting stock
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11–11
General Guidelines for
Choosing Strategies
• Generally use low-cost strategies
because it is difficult to predict benefits
of activism
• If activist on an issue not involving stock
price, use only lowest cost strategies
• If activist on an issue involving stock
price, use higher cost strategies only in
exceptional circumstances
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11–12
Strategies of Index Funds
• Index funds as passive shareholders
– Extremely low management fees do not allow for large
investment staff
– Most benefits of activism will go to other shareholders of
companies in the index
– No relative benefit to fund’s performance
• Index funds as active shareholders
– Well positioned because stakeholder in most important U.S.
companies
– Improving U.S. corporate governance can bring benefits to
all companies in the index
– Absolute benefit to fund’s performance
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11–13
Corporate Governance
Outside the U.S.
• Institutional investors may face the following
in corporate governance for stocks owned
outside the U.S.
– Dominant shareholder groups
– Legal relationships between company board and
shareholders that limit rights of minority
shareholders
– Inadequate proxy disclosure
– Other operational and logistical challenges to
exercising shareholder rights
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11–14
Corporate Governance
Outside the U.S. (cont.)
• Recent improvements
– In Europe, Euro zone has quickened pace of
cross-border mergers and led to a more
shareholder-friendly environment
– Leaders in many countries have realized they
must improve corporate governance process to
attract equity capital and improve investment
returns
– Industry group and multilateral agencies are
supporting improvements and adopting “best
practices” codes
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11–15