We believe that corporate governance activism is not an issue which should be regarded with concern but rather one which focuses the attention of corporate management on activities which promote improved corporate performance. -- Pension Investment Association of Canada (Issue 5:42)
In recent years, as pension funds and mutual funds have rapidly grown in value, there has been a concomitant increase in their ownership of the shares of Canadian companies. As a result, institutional investors are becoming more interested in corporate governance issues and in ensuring that adequate accountability mechanisms have been established in the companies in which they invest.(76)
A survey of Canadian institutional investors revealed that abuse of power by management or a majority shareholder was the most important incentive for them to become active in corporate governance. Additional incentives included fiduciary responsibility to clients and the size and nature of an institutions holdings.(77)
Other developments also have been identified as responsible for increasing institutional investor interest in corporate governance: (78)
- Strong growth in funds managed The value of funds managed by institutions has grown significantly as demographic trends support retirement saving and more and more savings are directed to professionally managed funds.
- Increasing institutional ownership of Canadian equities As institutions own an increasing percentage of the Canadian equity market, their liquidity decreases in that they are less able to sell their shares without adversely affecting the market.
- Fewer investment opportunities Restructurings and mergers have decreased the number of companies in which institutions can invest.
- The growth of index funds (79) When institutional investors index investments they essentially become long-term investors. They become locked into an investment because selling would be contrary to indexation, a principle that seeks to mimic the performance of a particular stock market index.
- More competition in fund management Competition has increased in fund management with respect to investment performance and the ability of the fiduciary to safeguard an investment.
- Regulatory changes Changes to the legal and regulatory environment have enhanced shareholder rights and provide more protection to minority shareholders.
Witnesses confirmed that a number of the above factors and developments have raised the level of institutional investor interest in corporate governance. The Pension Investment Association of Canada asserted that this new focus is attributable to the vast increase in institutional investors holdings in individual companies.(80)
You can understand the dilemma facing an institutional investor holding a large position in the share capital of a company. Not many years ago it was an easy decision for such investors. Dissatisfied with corporate performance, they simply sold the shares into a liquid market. Today, it is not always as simple as many pension funds find themselves in the position of working with the company in an effort to improve long-term corporate performance.(81)
OMERS, for example, told the Committee that, as a large shareholder selling a substantial block of shares, it could negatively affect the market value of the shares for some time. Furthermore, OMERS pointed out that it might be difficult to place the money it received from a sale elsewhere at an acceptable rate of return, given the relatively small number of Canadian companies in which OMERS and other large pension plans could make meaningful investments without taking control.(82)
One should not conclude from the foregoing, however, that it is now always difficult for institutional investors to sell their investments without driving prices down. Many such investors, particularly smaller ones, are still able to, and do, vote with their feet in response to flagging corporate performance.
The level of interest in corporate governance issues would also appear to depend to a large extent upon the attributes of the institutional investor. In both Canada and the United States, large public pension funds have been the most active institutional investors attempting to influence the governance of the firms in which they invest. Jeffrey MacIntosh suggests that there are structural reasons for this. Public pension funds have enormous assets; the largest Canadian funds, such as the Ontario Teachers Pension Plan Board, the Ontario Municipal Employees Retirement System and the Caisse de dépôt et placement du Quebec, invest billions of dollars in Canadian equities and own large numbers of shares of publicly traded companies. The amount of money and the holdings involved give them considerable economic leverage. In addition, pension money, by its nature, is long-term, so that pension fund managers are able to invest for a longer period than, say, mutual fund managers, whose perspective is shorter-term. Furthermore, Professor MacIntosh suggests that public pension fund managers are less vulnerable to co-option by corporate management (that is, simply "toeing the corporate line").(83)
Many private sector funds, in spite of a large asset base and a long-term perspective, are still not nearly as active as their public sector counterparts. Again, Jeffrey MacIntosh contends that susceptibility to being co-opted by corporate management seems to be the main reason for this. He also suggests that internal pension fund managers may have an implicit arrangement not to "rock the boat" at other corporations, in return for a similar behaviour from other pension fund managers.(84) PIAC, however, believes that co-option is less of an issue than anecdotal reports may suggest.
...PIAC has no evidence whatsoever that co-option has occurred and understands, from reports from its Members, that proxies are voted without duress. As for external managers, the influence of a corporate client on the managers ability to vote proxies of that company is secondary to an extant bias in favour of management arising from their selection of the stock in the first place. They bought the shares, thus they are not likely to vote against the management in whom they have expressed confidence.(85)
Thus, it would appear that larger plans are more active than smaller plans and public pension plans are more active than their private sector counterparts. PIAC, whose membership includes public and corporate-sponsored pension funds, stated that it would be inappropriate to attribute to the entire pension business the same interest and level of sophistication in governance issues as the large public pension plans(86). Furthermore, a recent survey of members of the Association of Canadian Pension Management (ACPM) revealed that proxy voting and influencing companies are primarily concerns of large plans; smaller plans tend to invest in pooled funds or delegate voting to external managers(87). When the ACPM asked pension plans if they had ever tried to influence the structure or behaviour of a company in which they had invested, 40% of the responding plans with assets of more than $1 billion said that they had. Only 15% of plans with assets of $100 $999 million responded in this way while none of the plans with assets below $100 million so responded.(88)
Jeffrey MacIntosh contends that there are structural and practical reasons to believe that mutual fund managers should not be active in corporate governance. He suggests that because such managers do a considerable amount of trading and are evaluated regularly, their interest is not sufficiently long-term. In addition, they may not be willing to spend the time and money required to become actively involved in corporate governance. Finally, a number of external mutual fund managers also manage pension fund assets; activism on their part might deter management from directing pension fund business towards them. (89)
One witness noted:
On the whole, and I am now generalizing, mutual fund managers are more passive than public pension fund managers and tend to vote with the management of corporations in which they own stock.
There are, however, some notable exceptions, more in the U.S. than in this country, but even here there are one or two examples where a few high-profile mutual fund managers speak out forcefully.(90)
When institutions become involved in the governance of investee corporations, it is generally in relation to a specific set of issues. This is largely confirmed by a 1997 survey of PIAC members, which found that the key governance issues reported by the respondents as being of concern to PIAC members are:
- Accountability of management to the board;
- Accountability of the board to shareholders;
- Private agreement exemptions;
- Golden parachutes ;(91)
- Independent directors on compensation and audit committees;
- Crown jewel defences ;(92)
- Executive compensation linked to performance;
- Director independence from management;
- Poison pills;
- Director independence from a controlling shareholder;
- Unequal or subordinate voting shares;
- Blank cheque preferreds ;(93)
- Greenmail ;(94)
- Excessive executive compensation;
- Detailed disclosure of executive compensation;
- Stock option plans;
- Lock-up arrangements;
- Self-assessment of corporate governance effectiveness.(95)
In order to assist its members in their consideration of contentious corporate governance issues, PIAC published corporate governance standards to codify the standards institutional investors believe Canadian corporations should follow.
The PIAC corporate governance standards deal with four principal areas: obligations of boards of directors, executive compensation, takeover protection and shareholder rights.(96)
The evidence indicates that institutional investor activity in corporate governance is based upon the principles of corporate accountability and improved shareholder value. PIAC contends that "the only reason pension funds encourage improved corporate governance is to realize improved corporate performance and the resultant improved shareholder value." (97)
Institutional investors were careful to note that the pursuit of these aims does not include involvement in running the companies in which they invest.
We are not interested in taking over companies. We are not interested in building empires. Our total goal, as shareholders, is to improve the return on our shares. (98)
The OTPPB pointed out that it does not want to run the companies in its investment portfolio. Its focus is rather on what a company is doing to create long-term shareholder value(99). Other pension plans expressed a similar view. For example, OMERS approach to large Canadian companies
is not to tell an operation how to run itself or to get involved in day-to-day management. Instead we are there to remind the management and directors of a public company that they represent their shareholders and that their fiduciary responsibilities are sacrosanct. Ultimately, we are there to insure that all shareholders are being treated with an equal hand.(100)
Mr. Jonathan Wellum, President and portfolio manager of the AIC Group of mutual funds, noted that becoming involved in the management of companies is not part of its mandate as a mutual fund manager.
We are a longer-term buy-and-hold investor.... However, we are caught, as we get into larger and larger positions as mutual fund managers, with this passive investor aspect. We must be passive at the same time as we take large positions in companies. ... We talk to management, and if things are not going the way we think they should be going we can make suggestions; but we are not activists in the sense of trying to get involved in management to enforce those issues.(101)
The traditional, and still important, way in which institutional investors interact with companies is through the proxy voting process; they view proxy voting rights as important assets. Indeed, it has been suggested that institutional investors have a responsibility to make considered use of their proxy votes(102). A number of institutional investors told the Committee that they routinely exercise their voting rights. As an index fund manager, Barclays Global Investors pointed out that they cannot simply sell a stock when they disagree with how a company is being run; they view voting as part of their duty to act in the best interests of their clients.(103)
The Ontario Public Service Employees Union Pension Trust, which manages the OPSEU Pension Plan, strongly supports the exercise of voting rights on behalf of pension plans.
Failure to vote would mean reducing the value of those shares purchased on behalf of plan members and pensioners. Responsible and effective participation in the investment market includes the right and, in the case of pension plans, the obligation to participate in corporate decisions through the exercise of voting rights.(104)
The OTPPB takes proxy voting seriously. In its brief to the Committee, the OTPPB outlined the procedures it employs for dealing with proxies.
We review all proxies as they come in and check them against out guidelines. Non-routine items are highlighted and then reviewed by our vice-president, equities. More obscure proxies are discussed with our managers and analysts. We also subscribe to the Fairvest proxy service which alerts us to controversial issues.
The most controversial or difficult proxies are discussed with the senior vice-president of investments and occasionally with the CEO. We also report annually to the board of directors on proxy voting.(105)
The OTPPB went on to note that in 1997, it had exercised proxies in 337 companies. Of those proxies, it had voted in favour of 127 routine items, such as non-contentious appointments of directors and auditors, and 84 non-routine items, including changes in general corporate by-laws. The OTPPB had voted against management 126 times on proposals that were contrary to its guidelines. (106)
OMERS told the Committee that its fiduciary duties require it to vote its proxies. Voting rights are the property of the pension fund and have a recognized market value. OMERS is asked to vote on more than 1,200 proxies each year, most of which are routine. Its uses its own internal researchers and a number of services to review proxies and alert it to major changes proposed by companies.(107)
Not all institutional investors, however, assign the same importance to proxy voting. A survey of PIAC members completed in 1997, revealed that though a significant number of respondents were notified of important corporate issues, 71% of them did not provide specific instructions to external managers on proxy issues(108). Of the respondents, 26% analyzed proxy material internally while 50% believed such material was analyzed by external managers.(109)
Institutional Investors such as OMERS, the OTPPB, and the Ontario Public Service Employees Union Pension Trust have developed their own proxy voting guidelines. These guidelines often contain general statements of policy on various aspects of corporate governance and specific recommendations on numerous issues. The PIAC survey revealed that 66% of respondents have a proxy voting policy(110). While allowing flexibility to judge each situation on an individual basis, the OMERS guidelines make a number of specific recommendations for voting. Under most circumstances, OMERS will direct its votes to be cast in the following manner:
- against stock option clauses that do not meet the criteria set forth in the guidelines;
- against "golden parachutes";
- against most "poison pills";
- against leveraged buyout proposals if OMERS believes that management or the board of directors have not adequately pursued shareholders interests;
- against unequal or subordinate voting shares;
- against "greenmail" transactions;
- against unlimited or excessive share issues, including unlimited "blank cheque" preferred shares.(111)
Noting that the right to vote possesses economic value, Ms. Glorianne Stromberg told the Committee that fund managers should clearly articulate their policy with respect to voting and explain in their annual and interim reports any deviations from it.(112)
Jeffrey MacIntosh believes that institutional investors have a useful role to play in supervising Canadian public corporations. He maintains that they are better overseers than retail investors because they have more at stake. Professor MacIntosh referred to empirical studies showing that institutional investor involvement improves corporate performance and produces higher returns on assets and equity(113). Purdy Crawford, former CEO of Imasco, agreed with these findings confirming that institutions have tended to create a higher return on assets and equity in Canadian companies in which they invest.(114)
Professor MacIntosh noted that institutional investors play a vital role in ensuring that corporate managers manage in a disciplined way. He suggests that this benefits not only institutional investors but also small retail investors, especially as markets become more efficient, making it increasingly difficult for small retail investors to use information in the media to beat the market. In addition, because institutional investors now do the bulk of trading in Canadian equity markets, the pricing efficiency in the portion of the market in which they are active is greater than the pricing efficiency in the portion where only retail investors are present.(115)
Witnesses who commented on institutional activism were generally of the view that this had increased and would likely continue to do so. They also had a positive view of the impact of such activism. William Dimma answered an unequivocal "yes" to the question of whether greater shareholder influence over a wider range of corporate governance issues is a good thing. However, he stated that it was important not to forget that the institutional investor is an agent of the shareholder, whose interests may not always coincide with those of the manager of a pension fund. While institutional investors have become the watchdogs in relation to potential abuses of corporate power, he wondered who would watch institutional investors to ensure that one type of abuse was not replaced by another.(116)
Michael Grandin, of CP, noted that institutional investors have had significant success in obtaining increased disclosure with respect to corporate governance practices, compensation and its link to performance and shareholder rights plans. (117)
Malcolm Hamilton, of William M. Mercer Limited, took a tempered view, noting that some activism improves corporate performance but activism taken to excess does not.(118)
Institutional investors who commented on activism suggested that it produces benefits for all shareholders. OMERS felt that this positive effect is manifested in two ways. First, by their vigilance, institutional investors are able to detect problems early and provide a means of provoking change that might not have been possible for small shareholders. Second, by demanding more information from public companies, institutional investors have increased the flow of information to all shareholders.(119)
For its part, the OTPPB believes that all shareholders, particularly the small investors, benefit from its quiet influence on corporations. PIAC pointed out that everyone, from small retail investors to other institutional investors, gains if an institutional investor improves shareholder value. (120)
Not all commentators agree that activism has a significant impact on company performance, however. Commenting on the activities of American institutional investors, Bernard S. Black argues that activism has not affected corporate performance to a large extent. (121)
Activism by large institutional shareholders has been part of the United States landscape for over a decade, long enough to begin to assess whether it affects firm performance. The evidence to date suggests that activism, American style, has had little effect on firm performance. The evidence on whether long-term "relational investing" by institutional investors correlates with improved firm performance is also mixed. Particular institutional investors may have the skill to improve the performance of their portfolio companies, but this skill may be scarce among institutional investors as a whole.(122)
Another commentator noted that institutional investor activism "demonstrates the validity of institutional funds" but went on to state that
Institutional investors are similar to a posse, actively pursuing increased returns. But shareholder activism also produces the occasional lone ranger, grandstanding on his own by attempting to mask personal social and political agendas in the guise of shareholder interest.(123)
Given the resources of institutional investors, their desire to monitor their investments closely and their access to companies senior management, it becomes important to know whether such investors are privy to company information that may not be available to other investors. The institutional investors and companies that commented were adamant that they did not have access to "inside" information.
Imasco Limited, for example, speaks regularly and directly to institutional investors in private meetings, but told the Committee that it is very careful to avoid disclosing information selectively. The President and CEO pointed out that preferred access and selective disclosure would be unfair and possibly illegal.
we are careful to ensure that we do not tell anybody anything. If the information is important enough for somebody to want to know it, then everybody should know it. Although we are under no legal obligation, occasionally we will issue a press release disclosing what is not, technically, a material fact. We do that because we want to ensure full disclosure. (124)
The Chairman of Sceptre Investments acknowledged that Sceptre has private meetings with companies in which it invests, but stressed that there is no exchange of privileged or inside information. (125)
OMERS talked about formal and informal information-gathering. It contends that there is a level playing field in formal information-gathering because "individual investors can pursue the same course of action as institutional investors if they are prepared to do the work or if they hire professional managers through a mutual fund or through a professional investment advisor service."(126) Any disparity between institutional and other investors in access to information, OMERS argues, is likely to arise as a result of informal information-gathering undertaken by large investors.
OMERS maintains that it engages in informal information-gathering because its fiduciary responsibilities require it to monitor the management of companies in which it invests and because the current corporate disclosure laws in Canada do not go far enough since they
require only certain amounts of information to be given out. Corporate lawyers and managers are often reluctant to discuss concerns in any form until they are forced to do so by law. So the law has created the option of omission, and omission in turn is the bottleneck that prevents information critical to shareholders all shareholders from being properly disseminated.(127)
The December 1995 report of the Committee on Corporate Disclosure of the Toronto Stock Exchange, Toward Corporate Disclosure(128) examined the issue of equality of access to corporate information.
The report noted that meetings between public corporations and analysts employed by institutional investors and those employed by investment dealers were "a regular and accepted feature" of capital markets(129). A survey of analysts conducted by the TSE and referred to in the report indicated that over three-quarters of the respondents relied on direct discussions with management of a company when making an investment decision. The majority of analysts at member firms indicated that they frequently obtained previously undisclosed information through discussions with management, while nearly half of analysts at the institutions felt that rarely obtained such information.(130)
The report also revealed that the Committee on Corporate Disclosure heard evidence that selective disclosure of material information takes place in meetings with analysts, conference telephone calls with analysts and private meetings between corporate executives and major institutional investors. The report went on to note:
The problem of selective disclosure stems largely from the fact that there is no clear line dividing material information from other information. Material information must be disclosed publicly and as widely as possible by media release in conformity with the dissemination requirements imposed by the TSE and other stock exchanges, and by SRAs. Timely disclosure policies focus on disclosure of the nature and substance of corporate news, and only require sufficient detail to enable investors and other market participants to understand and assess the news. Invariably, the purpose of private meetings is to flesh out the information provided in the news release by providing additional background and details, and managements opinions on the implications of the companys business. Of equal importance is the opportunity to ask questions of management. These sessions necessarily entail disclosure of information and comment that has not been publicly disclosed. (131)
Given the subjective definition of materiality, the report points out that room for interpretation of what news and details comprises material information adds to the public concern that material information is disclosed at such meetings. (132)
The report details the Committee on Corporate Disclosures concern that private meetings with analysts and professional investors have resulted in selective disclosure of information that should have been disclosed generally. While acknowledging that analysts meetings are a useful and legitimate component of the system by which information can be better understood, the report pointed to the relatively high risk associated with one-on-one meetings between management and analysts.
The report goes on to note that there is inequality of access to information between retail and institutional investors. To create a more level playing field between individual and professional investors, the report recommended, among other things, that retail investors should have access to group meetings of analysts through electronic or other means.(133)
The recent sell off of Northern Telecom Ltd. (Nortel) stock serves to highlight the problems faced by retail investors who do not have access to certain corporate information. Information with respect to revenue and earnings presented at a private meeting between company executives and analysts prompted a massive sell off of shares, driving the Nortels share value down from nearly $62.00 to about $48.00. Before retail investors became aware of the information, the value of their shares had plummeted. The incident also highlights the subjective aspect of the definition of material information.
OMERS has called for the law to be changed to provide for greater disclosure, along the lines suggested by various Canadian and American accounting organizations. Such changes, OMERS suggests, would eliminate the need for informal information gathering and as well as any gap in information between individual and institutional shareholders.
To the same end, Glorianne Stromberg urged the Committee to consider a regulatory system that focused on continuous disclosure, "where you have a system that requires, to the extent that you could ever require things of that nature to happen, all of the information that is material to be in the marketplace on a current basis so that everyone has access to it." (134)
One example of such disclosure was suggested in a Financial Post editorial of October 7, 1998, which recommended that the media should be permitted to listen to briefings by management following the release of a corporation's quarterly report.
Individual investors must have timely and equal access to information presented by companies to analysts and institutional investors. Dissemination through the Internet and 1-800 numbers would make information more widely and instantaneously available than it is now.
The Committee recommends that the media be invited to listen to, but not participate in, briefings of analysts by management following the release of each quarterly report.