Institutional Investors as Minority Shareholders

In the paper, Institutional Investors as Minority Shareholders, which was recently made publicly available on SSRN, my co-author, Yishay Yafeh, and I study the role of institutional investors in markets where concentrated ownership and business groups are prevalent. Whereas investors in dispersedly-owned firms are primarily concerned with disciplining managers, investors in firms with a controlling shareholder are concerned with self-dealing and “tunneling.” Institutional investors, however, can effectively use voting to discipline corporate insiders only when the law empowers minority shareholders to influence vote outcomes. Moreover, the presence of powerful families who control many public companies through business groups creates new potential conflicts for institutional investors.

Using hand-collected data on voting by institutional investors in Israel, we find that (i) legal intervention (rather than minority voting rights) plays an important role in driving institutional investors’ activism. Most notably, institutional investors do not vote on director elections even when the law grants minority shareholders the power to influence board composition; (ii) institutional investors are most likely to object to firms’ compensation-related proposals (and not tunneling transactions), but even when their votes do not matter; (iii) institutional investors with other business activities (e.g. underwriting) and those affiliated with a public company or business group are more likely to support insider-sponsored proposals than “pure-play,” stand-alone investors. Again, this tendency persists even when outside investors’ votes are unlikely to matter; and (iv) large firms tend to enjoy a more favorable treatment from institutional investors, whereas firm performance has virtually no impact on voting.

Our findings lead to several conclusions. First, legal measures to empower minority shareholders may not be sufficient to induce institutional investors to play an active role in corporate governance. Second, our findings call for more research on the connection between executive compensation and minority expropriation. Third, conflicts of interests arising from business ties and ownership affect voting. However, we find no evidence that insider pressure on specific votes is the channel through which conflicts affect voting.

The full paper is available for download here.