The New Wave of Activists

A small group of institutional investors has taken on an outsized role in corporate governance, according to new research from the University of Edinburgh.

The increasing concentration of assets that they oversee has resulted in “an institutional investor community that is both more powerful and compelled to be more involved in corporate strategy,” Patrick Jahnke, a PhD candidate at the university’s graduate school of social and political science, wrote in a paper posted this week on electronic research library SSRN.

Due in part to the rise of passive indexes and exchange-traded funds, institutional asset managers more than tripled their stock holdings between 1965 and 2010 to about two-thirds of all corporate equities. At the end of last year, a smaller group of mega shareholders — including BlackRock, Vanguard Group, State Street Corp., Fidelity Investments, Bank of New York Mellon Corp. and Capital Group Companies — had amassed about a quarter of the $56.3 trillion of assets under management globally, according to the paper.

“The largest institutions tend to own larger shares than they have before,” said Pat McGurn, special counsel for proxy voting firm ISS. “It’s really empowered the whole process of shareholder engagement and made it possible to see reforms adopted on a more expedited basis.”

Traditionally, McGurn said that shareholders unhappy with a company’s performance have had two options: sell their stake, or engage with the firm’s management — a difficult undertaking in the years before ETFs, when stakes were more diluted. “Exit tended to be favored over sticking around and fighting for change,” he said.

With today’s greater shareholder concentration, Jahnke argued that selling has become a less viable option. Either equities are held in passive funds, which as a rule do not buy and sell individual stocks, or institutional owners are limited from selling because of transaction costs or a lack of liquidity.

Jahnke estimated half of the U.S. stock market is tied up in passive funds and active managers who are “closet indexers.”

“In a world in which ownership concentration has reduced the ability to sell the shares of underperforming companies, institutional investors have no other choice than to become active stewards of the companies they invest in if they are to fulfill their fiduciary duties toward their clients,” Jahnke wrote.

The proportion of S&P 500 companies reporting investor engagement on corporate governance issues soared to 66 percent in June 2016, from just 6 percent in 2010, according to the paper, which cited data from consulting firm Ernst & Young. 

Vanguard, for example, reported a 67 percent increase in corporate engagement over the three years ending in June 2016, while State Street Global Advisors has recently stepped up its shareholder involvement to address issues like gender diversity on boards.

[II Deep Dive: How State Street Global Advisors Became an Unlikely Activist]

At ISS, McGurn said he has seen the pace of governance reform grow at an “exponential” rate, pointing to recent examples such as ExxonMobil’s May shareholder vote on climate change reporting.

“The passive investors tend to be more or less permanent capital; they couldn’t sell even if they wanted to,” he said. “They have to develop long-term engagement with the companies in which they invest.”