The Untold Power of Investor Cliques

Investing is a relationship game — and researchers are beginning to find out how powerful those networks truly are.

Simon Dawson/Bloomberg

Simon Dawson/Bloomberg

Targeted by an activist hedge fund? Try calling in the influencers.

A new study of institutional investor relationships found that how shareholders vote — and if they vote — is deeply impacted by who they know. Among major investors, networks move markets.

Oxford University corporate law professor Luca Enriques teamed up with Yale University researcher Alessandro Romano to puzzle out why institutional investors exercise their votes at all. Economic theory suggests that corporate governance would be plagued by “rational apathy,” or the free-rider phenomenon. Why put in the effort to reach informed positions on myriad pay packages and merger proposals when, presumably, everyone else is going to do that as well?

One answer is that investors take action because their peers do, Romano and Enriques concluded.

The authors compared the community of major allocators and asset managers to an opera audience. After a performance, individuals choose to give a standing ovation or not based on signals from the rest of the group as much, or more so, than on their own view of the opera’s quality. Likewise for, say, approving Elon Musk’s $2.6 billion compensation package at a Telsa shareholder meeting.


“Institutional investors are embedded in a network formed by various agents, while also being connected among each other through a complex web of co-ownership, formal, and geographical ties,” the researchers wrote in their working paper, “Institutional Investor Voting Behavior: A Network Theory Perspective,” published April 9 by the European Corporate Governance Institute.

The study applied established network theory to this complex web and the unique dynamics present among institutional shareholders.

For instance, career competition inside and among fund management groups may motivate individuals to engage in corporate governance beyond what’s even optimal for their employer. “Discussing ideas on how to handle a given controversial issue at an informal meeting appears to be a good opportunity for an employee to impress potential employers,” Romano and Enriques wrote.

This self-motivated research tends to spread outside of an organization’s walls and through professional networks. “Institutional investors’ voting decisions can be affected also by the behavior of other institutional investors’ employees,” the paper noted, “and not only by large and visible sources of information such as proxy advisors.”

Industry players are beginning to get wise to the power of shareholder networks.

“Perhaps coincidentally, perhaps not, but yesterday we received an email from a prominent shareholder services firm,” Eriques told Institutional Investor during a phone interview. “They said they had sent our paper to their offices around the world. They’re thinking about what we wrote to see if they can make predictions about how shareholders will vote based on networks.”

Likewise, activist hedge funds’ success is linked to their networks of institutional asset managers and owners, according to Melissa Sawyer, a mergers and acquisitions attorney with Sullivan & Cromwell.

[II Deep Dive: The Investors Aiding Activist Hedge Funds Can Also Help Fend Them Off]

“Well-known activists often develop relationships with significant institutional holders because they have communicated with these investors in prior activist campaigns and maintain a regular dialogue,” Sawyer wrote earlier this month in a posting on Harvard Law School’s website. She has recently advised the Canada Public Pension Plan Investment Board, AT&T, and Nike on deals.

This dynamic, which tends to help institutional investors circulate information more freely, hinders corporations that lack those cozy connections to voters.

In contrast to hedge funds, corporate executives and directors may have more limited ties to institutional shareholders, especially passive asset managers and voting teams at active firms. “While many issuers have engaged in significantly more outreach to the largest institutions as part of an increasingly proactive and routinized shareholder engagement calendar,” Sawyer wrote, “they are not always successful in reaching their audience.”

Judging by Enriques and Romano’s research, they ought to keep trying.