Essay on Institutional Investors’ Role in Corporate Governance

The literature on shareholder activism, proxy advisors, and the proxy voting process summarized in previous sections can be put into context with a case study on the recent DuPont (NYSE: DD) vs. Trian Fund Management Proxy Fight that occurred between 2014 – 2015. The DuPont vs. Trian Fund proxy fight, one of the largest proxy fights in history, will give insights into the influence and tactics of activist investors, the role of proxy advisors such as ISS and Glass Lewis, and mergers as a result of activist investors.

Corporate governance is a set of actions used to handle the relationship between stakeholders by determining and controlling the strategic direction and performance of the organization. Corporate governance major concern is making sure that the strategic decisions are effective and that it paves the way towards strategic competitiveness. (Hitt, Ireland, Hoskisson, 2017, p. 310). In today’s corporation, the primary objective of corporate governance is to align top-level manager’s and stakeholders interest. That is why corporate governance is involved when there is a conflict of interest between with the owners, managers, and members of the board of directors (Hitt, Ireland, Hoskisson, 2017, p. 310-311).

Corporate governance in itself has no single definition but common principles which it should follow. For example in 1994 the most agreed term for corporate governance was “the process of supervision and control intended to ensure that the company’s management acts in accordance with the interest of shareholders” (Parkinson, 1994)1. Corporate governance code is not a direct set of rules but a self-regulated framework which businesses choose to follow. This code has continued to change in the past 20 years in accordance with what is happening in the business world. For example the Enron scandal caused reform in corporate governance with the Higgs Report which corrected the issues which were necessary. Although it does not quickly fix problems, it gives a better framework to

Phenomenal growth of interest in corporate governance has emerged in recent years. The body of literature on the subject has grown markedly in response to successive waves of large corporate failures. Furthermore, there have been numerous attempts to define what constitutes ‘good corporate governance’ and to provide guidelines in order to enhance the quality of corporate governance.

Kluyver, C. (2013). A primer on corporate governance (2nd ed.). New York, NY: Business Expert Press.

Categorized by the natures, shareholders are recognized as the banks, trusts, insurance companies, private equity fund, public pension funds, religious groups, worker unions or a unique individual who is a natural person. They can be divided into the majority or minority shareholders, institutional or individual shareholder based on the group sizes and functions. The majority or institutional shareholders are continually believed to play an unprecedented role in corporate governance. King (2009) believes one of the major reasons for market failures connecting with governance is due to the absence of institutional shareholders. From the view of the sponsor’s motivations, the shareholders are financial activists who focus on the firm’s performance and social activists who pay more attention to corporate social responsibilities. Within the limit of this research, we differentiate the sponsors population into two distinct groups: the gadfly group that represent for all hyperactive individual shareholders and the other shareholder groups which include all other remain shareholder

In the aftermath of major scandals and bailouts in the United States, the world`s and the public’s confidence in public corporations, has been shaken. With the publicized scandals of Enron and other corporations in the United States, the faith in public corporations fell as fast as the stock market. Investors had no confidence in corporations or in their boards. Measures needed to be taken to form regulations to provide stronger accountability, to prevent these types of scandals from happening and to rebuild the confidence of investors. Corporate governance of publicly traded

“positive” change. There has been significant debate whether these activists are truly adding value to

Reforms have been created to close the gap of corporate governance and financial reporting in order to prevent the reoccurrence of corporate scandals. Congress created a federal bill named the Sarbanes-Oxley (SOX) Act in July 2002 in response to the Enron and WorldCom scandals that introduced major changes to the regulation of corporate governance and financial practice in order to protect the interest of investors and the public (“Sarbanes-Oxley Act Summary and Introduction,” 2003). The Act is extensive in corporate governance, which is a comprehensive theory concerned with the alignment of management and shareholders interest. The sections of the bill cover responsibilities of a public corporation’s board of directors, adds criminal penalties for certain misconduct, and requires the SEC to create regulations to define how public corporations are to comply with the law (Slater, 2002). The SEC has issued more than twenty rules implementing provisions of the Act pertaining to corporate governance, financial reporting, and audit functions. The SEC has worked with NYSE and NASDAQ to harmonize the new Corporate Governance Rules. Throughout the rest of this paper, the more detailed listing requirements of the NYSE and NASDAQ will be discussed. Since the reforms are extensive, these were selected for the discussion: the increased role of independent directors, independent audit committee, independent directors on the nominating/corporate governance committee, the

A general phenomenon about the corporations is that shareholders must accept majority rule in a company. Shareholders who own majority of the shares, feel that they have right to make majority of all decision because they have more at stake. Minority shareholder can also participate in company affairs by checking majority shareholders power, and promote transparency, ethical practices and good governance (OECD, 2004) but they are often regarded as an unnecessary burden a “dead weight” in corporation (Shkolnikov, 2006)

In recent years the issue of corporate governance has become a keenly debated topic in international finance. In developed countries, some of the biggest corporate collapses in history have brought about a change in focus. No longer are governments and lawmakers trying to deregulate and reduce the controls and disclosure requirements of corporations. The deregulation boom has ended, as regulation comes back into the picture.

Information asymmetry, moral hazard, difference in attitude towards risk and difference in interest between shareholders versus directors are common agency problems that would usually be at the expense of shareholders (Mallin, 2007; Rahman, & Salim, 2010). For example, directors may have a wider range of economic and social needs (such as to maximize compensation, security, status and to boost their own reputation), while shareholders are interested only in maximizing return on investments. Furthermore, as directors are usually contracted to the company on short term basis, they may be eager for short-run payoffs within their contract term, whereas shareholders’ interest would be based on long-term success.

1. This article focuses on the Gompers, Ishii, and Metrick (GIM, 2003) study which found that strong shareholder rights lead to higher stock price returns and thus value. This is a great indicator that good governance has a direct effect on the performance of the firm. The article finds that corporate governance has a positive impact on the firm / management / shareholders. However good governance is not always the correct metric of evaluation for firms and boards. The primary finding of the article is from an economic analysis defending the relation between corporate governance and performance. This article examines the relationships among corporate governance / corporate performance / capital structure / and corporate ownership structure. Many of the past studies have taken into consideration only one measure of governance, while this study focused on seven different governance measures. The article also looks at the performance of a firm and the relationship it has with management turnover or disciplinary actions required.

Another agency issue involves the stockholder-manager relationship. Because managers tend to be the primary decision makers of an organization, they may choose to make decisions in their best interest rather than in the best interest of the stockholders. With this, the principle of self-interested behavior comes in (Emery, et. al., 2007). Stockholders want to maximize their stockholder wealth while the goals of managers tend to be salary, power, status, and growth of the organization (Emery, et. al., 2007). This agency issue was apparent in the case study, “Level of Executive Pay.” In this case study, there was an investigation by the SEC into the New York Stock Exchange (NYSE) because of its excessive payments to the NYSE Chairman Richard Grasso (Eldenburg, 2005). The NYSE is a private organization with

FI’s with large shareholdings are better apt at influencing the performance of investee firms in their portfolios by being a quasi insider and creating knowledge advantage using private information gained through regular meetings (Holland, 1999). Through cooperative means FI’s are able to probe, monitor and direct the corporate strategies, management and financial performance without direct intervention. Private and informal influencing is favored to public interventions as it may affect reputation of all parties involved.