Craig Doidge is Professor of Finance at the University of Toronto. This post is based on an article authored by Professor Doidge; Alexander Dyck, Professor of Finance at the University of Toronto; Hamed Mahmudi, Assistant Professor of Finance at the University of Oklahoma; and Aazam Virani, Assistant Professor of Finance at the University of Arizona.
In our paper, Can Institutional Investors Improve Corporate Governance Through Collective Action?, which was recently made publicly available on SSRN, we examine whether a collective action organization of institutional investors can significantly influence firms’ governance choices. Growth in institutional investor ownership over the last few decades puts these investors in the position to have significant influence, particularly if they can work collectively and coordinate their efforts. But we have very limited evidence whether institutional investors are able to overcome the obstacles to collective action. We focus on the Canadian Coalition for Good Governance (CCGG), an organization of institutional investors whose mandate is to promote good governance. We use proprietary data on its private communications and find that its private engagements between owners and independent directors influenced firms’ adoption of majority voting and say-on-pay advisory votes, improved compensation structure and disclosure, and influenced CEO incentive intensity.
The CCGG was formed in 2003, following legal reforms that made it easier for investors to work collectively. It has become a focal point for institutional investor activism and its members use the CCGG rather than shareholder proposals or proxy fights to advance their agenda. It has about 50 members that collectively manage about $3 trillion in assets and own an average stake of 14% in firms included in the leading index. Rather than focusing on just one type of investor, the organization seeks to bring together all of the large Canadian institutional investors. In that respect, it has been successful, bringing into the organization investors traditionally viewed as “passive” because of potential conflicts of interest. The resulting size and importance of its members, along with the broad representation of institutional investor types, gives the CCGG influence with firms it engages and a strong claim as “the voice of the shareholder.”
The CCGG’s strategic agenda includes working in the policy arena, developing and broadcasting best practices and guidelines, and directly engaging with firms’ boards to promote good corporate governance policies and practices. Our empirical analysis focuses on the engagements. These engagements were done privately and information about them was not made public. The CCGG engages firms through letter writing campaigns, phone calls, and meetings between the top executives of its owner-members and independent directors. During our sample period, it engaged firms on three main governance issues: majority voting, say-on-pay, and compensation structure and disclosure. Several factors explain which firms the CCGG chose to engage, but its members’ total dollar stakes in a firm is the most important. Measures of expected influence, such as percentage ownership stakes, do not explain engagements.
When we examine the extent to which CCGG engagements resulted in subsequent governance changes, we consistently find that they are associated with a statistically and economically significant increase in the likelihood of an improvement in governance. These results hold after controlling for internal factors that could influence governance as well as other external influences. Where possible, we also control for unobservable differences between engaged and non-engaged firms that could lead engaged firms to adopt the governance changes. Spillovers from engaged firms to non-engaged firms through board interlocks and informal regulation through definition and dissemination of performance relative to best practices, suggest a broader impact.
Do these specific governance changes matter? The fact that CCGG members devoted financial resources and scarce management time to engage firms on these issues indicates their importance and the evidence is consistent with this view. We examine abnormal returns around the date when the formation of the CCGG was first announced and find higher abnormal returns for firms in which CCGG members held larger stakes, i.e., those firms that were more likely to be subsequently engaged by the CCGG. We also find that engagements focused on compensation were followed by changes in performance-based incentives: the CEO’s equity pay ratio (EPR) and pay-for-performance sensitivity (PPS) increased, but with no change in total pay. Finally, evidence from other countries provides further support that these governance changes are valued by shareholders.
Our evidence suggests that a collective action organization can have an impact on governance through activism. The decision to seek large investors as members, regardless of type, ensured that the CCGG had a substantial stake in many firms. The coalition of different types of large investors also mitigated the concern that its requests were not representative of a firm’s investor base. The choice to focus much of its effort on engagement meetings with independent directors was also important because insiders who might oppose such changes were not part of the conversation. In addition to economic incentives, the CCGG leveraged social incentives to encourage firms to adopt governance changes. These efforts include repeat engagements with the same firms and restricting membership to Canadian-domiciled investors. Both decisions created a higher likelihood of repeated face-to-face contact that created reputational and social penalties for directors that did not respond to CCGG requests.
This form of activism is both a substitute and complement to other interventions to address governance concerns. The CCGG focuses on firms in which its members have significant dollar stakes, mainly large, widely-held firms, and it had a significant impact on their governance choices. For these firms and the governance issues the CCGG engaged them on, it appears to be a substitute. In other firms, the CCGG has had less influence. The CCGG also restricts its focus to issues that do not require significant firm-specific information or analysis and on which its members can reach consensus. In contrast, activist hedge funds typically engage individual firms on specific issues such as business strategy, financial policy, or leadership. Compared to proxy advisors, the CCGG is proactive rather than reactive on the issues we examine but it focuses on a narrower range of issues and firms.
The full paper is available for download here.