The Role of Institutional Investors in Voting

The following post comes to us from Reena Aggarwal, Professor of Finance at Georgetown University; Pedro Saffi of the Cambridge Judge Business School at the University of Cambridge; and Jason Sturgess of the Department of Finance at Georgetown University.

In the paper, The Role of Institutional Investors in Voting: Evidence from the Securities Lending Market, which was recently made publicly available on SSRN, we use a unique setting to examine if institutional investors influence firm-level corporate governance through proxy voting. Understanding institutional investor preferences regarding corporate governance is important for firms trying to attract new investors as well as policy makers considering the regulation of different governance mechanisms. The activities of institutional investors in the securities lending market provide one of the few opportunities to directly examine the behavior of institutional investors in influencing firm-level governance.

To study the securities lending market for U.S. firms during the period 2007-2009, we use a proprietary data set comprising shares available to lend (supply), shares borrowed (demand), and loan fees. The data covers more than 85% of the securities lending activity for these firms and allows for a comprehensive analysis during a period of tremendous growth in that market. In the past, understanding the securities lending market has been limited partly due to the lack of transparency in this fragmented market. We find that on average, 22.48% of a firm’s market capitalization is available for lending, 3.44% is actually borrowed, and the annualized loan fee is 35 basis points. The supply of lendable shares shows great variation, with minimum and maximum values of 0.01% and 74.38% of market capitalization. We find that more lending supply is available for firms with larger institutional ownership and strong corporate governance. There is considerable interest in some stocks and almost 100% of the available supply of such stocks is actually borrowed and on loan. The annual fee can be quite high, with the maximum at 745 bps. During 2007-2009, 10% of the stocks were very expensive to borrow and had a fee greater than 100 basis points. 2007 was the peak year for the securities lending market, with activity dropping off after the financial crisis.

We analyze the supply of lendable shares around the time of a proxy vote to examine the role of institutional investors in the voting process. Just prior to the proxy record date there is a significant reduction in the supply of lendable shares, because institutions restrict or call back their loaned shares prior to a vote. The reduction in securities lending by institutions around the time of a vote is direct evidence that to bring about changes at companies, institutions play a role in the voting process. The reduction in the supply of lendable shares is most pronounced when there are contentious proposals on the ballot, for example, proxy contests, when management supports the proposals but ISS recommends voting against the proposal, and for firms with weak corporate governance. We find that the recommendations of proxy advisors have a strong influence on the securities lending market around proxy voting.

We find that the recall in equity lending supply is positively associated with the subsequent vote outcome. Votes cast against management’s recommendation and votes cast against a proposal are positively related to a recall in lending supply. If proposals are sponsored by shareholders or proposals that are opposed by ISS, then we find they are likely to get fewer FOR votes. The outcome of the result is more likely to be close when lending supply is recalled and ISS opposes the proposal. The results show that beneficial owners of securities recall lending supply ahead of the proxy record date in order to exercise their vote. In doing so, institutional investors reveal both that corporate governance is important and that the proxy process is an important channel for corporate governance.

In contrast to the activity around a proxy vote’s record date, we find that the large increase in loan fees around the time of the ex-dividend record date is driven by an increase in borrowing demand for cash flow reasons. During the financial crisis of 2008, activity in the securities lending market decreased as demand for borrowing decreased and institutions cut back on their lending programs. Lending fees also experienced large reductions during the financial crisis. Our results suggest policy makers should address several issues related to proxy voting, including the need for investors to learn about proxy items before the record date so that they can decide whether to lend their shares or not.

The full paper is available for download here.

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