The Institutional Investor Stewardship Myth in a Dutch Context

The concept of institutional investor stewardship is based on the notion that in publicly listed companies responsibility for corporate governance is shared. The primary responsibility lies with the board, which oversees the actions of its management. Institutional investors in the company are assumed to play an important role in holding the board to account for fulfilling its responsibilities. According to the UK Stewardship Code (2010), effective stewardship is about well-chosen engagement. This means that institutional investors monitor and engage with companies on matters such as strategy, performance, risk, capital structure, and corporate governance, including culture and remuneration. Engagement means having a purposeful dialogue with companies on these matters as well as on issues that are the immediate subject of votes at general meetings.

Since the publication of the UK Stewardship Code, the debate between practitioners, regulators and policymakers worldwide about the role of institutional investors in corporate governance has intensified, and the concept of “institutional investor stewardship” became an important theme in the search for solutions for some of the failures of corporate governance at listed companies during the preceding decades. Although the importance attributed to institutional investor stewardship is high, the call on institutional investors to act responsibly has led Heineman and Davis (2011) to question “if policymakers went well beyond available knowledge in crafting a response to the financial crisis by transferring enhanced powers to investors, and [taking] a bet that investor institutions can and will exercise their rights responsibly and that such behavior will make markets more sustainable”. Heineman and Davis stressed that the increasingly important role of institutional investors requires substantial new intellectual attention. In 2012, the OECD stated that “the increased presence of large institutional investors in the last decade fostered the expectation that a new breed of highly skilled and well resourced professional shareholders would make informed use of their rights, promoting good corporate governance in companies in which they invest”. “[H]owever, institutional investors are not like other shareholders […]. Accordingly, they have not always behaved as desired” (OECD (2012)).

Daniëlle A.M. Melis Ph.D. (Nyenrode Business University, The Netherlands), researched if institutional investor stewardship as prescribed by corporate governance codes is a “myth”—a widely held, but false belief or idea—created by regulators and policymakers? In other words: is institutional investor stewardship as prescribed by corporate governance codes (such as for example the Dutch Corporate Governance Code) a realistic and well-considered concept that is supported by prevailing economic theories, by regulatory frameworks in which the world’s largest institutional investors operate on a global basis, and by various institutional investors’ practices? In answering this question, Melis refers to a concept called “teleopathy”. Philosopher Kenneth Goodpaster (2004) describes teleopathy as “the unbalanced pursuit of purpose in either individuals or organizations”. The principal symptoms of teleopathy are fixation, rationalization, and detachment. Fixation refers to a strong interest in something that prevents us from paying attention to something else (Sorenson (2011)). Rationalization refers to the behavior being rationalized by subtle distortions of judgment stemming from our views of ourselves, others, and the world around us. It describes the attempt to ignore signals from the environment that are in conflict with the fixation, by providing reasonable or self-justifying explanations (Sorenson (2011)). According to Goodpaster, “fixation calls for rationalization, and the iteration of these two symptoms eventually leads to detachment”.

Based on Goodpaster’s thoughts, one could question if prescribed institutional investor stewardship suffers from teleopathic symptoms, such as the fixation on the agency theory as the dominant theoretical paradigm, a fixation on prescribing institutional investor stewardship in specific (local) legal frameworks, a fixation on homogeneous institutional investors’ practices, and a rationalization of prescribing stewardship referring to high levels of compliance to the best practice provisions in corporate governance codes. The dissertation of Melis (2014) provides for an extensive analysis of the questions:

• 1. Do prevailing economic theories about corporate behavior support the likelihood of institutional investor stewardship?
• 2. Does the prevailing legal framework within which institutional investors operate support the likelihood of institutional stewardship in respect of investee companies?
• 3. Do institutional investors’ practices support the likelihood of institutional investor stewardship?
• 4. Does institutional investor stewardship in respect of Dutch listed companies as prescribed by the Dutch Corporate Governance Code currently exist in the Netherlands in form, as well as in substance?

In the conclusions of her dissertation, Melis (2014) refers to Stout (2012) who challenged the doctrine of shareholder value maximization using three perspectives: theory, the law, and empiricism. Stout argued that shareholder primacy is an ideology, not a legal requirement, nor a practical necessity of modern businesses and states that the shareholder primacy ideology is inconsistent with the real economic structure of public corporations, inconsistent with corporate law, and inconsistent with empirical evidence. The study of Melis (2014) into institutional investor stewardship is based on a comparable trilogy. Melis (2014) concludes that a triple paradigm shift is needed from—on the one hand—institutional investors being prescribed what their shareholder responsibilities are to be, (i) for which purposes those institutional investors’ practices are assumed to be homogeneous, (ii) the differences in prevailing legal frameworks are ignored, and (iii) from a theoretical perspective it is assumed that institutional investors are free to act in their self-interest, towards—on the other hand—ceasing to prescribe institutional investors what their responsibilities are, but instead (i) assume such responsibilities to be the result of individual agreements, mandates and fiduciary duties between institutional investors and their clients, (ii) acknowledge the fact that institutional investors’ practices are heterogeneous and driven by explicit choices and contractual agreements between institutional investors and their clients, (iii) facilitate institutional investors in the execution of their legal rights in different jurisdictions should they wish to do so, thereby assuming that institutional investors (or at least some of them) are willing and able to act as stewards and are driven by mutual beliefs and congruent interests (instead of self-interest) and not by the prescription of such institutional investor stewardship in a corporate governance code.

The dissertation is available for download here.