Common stock ownership in the United States has increasingly passed into the hands of financial institutions. It is estimated that institutional ownership of public corporations' common stock grew from 6 percent of the total in 1950 to 47 percent by the end of 1996. Institutions now hold nearly 60 percent of the stock of the 1,000 largest U.S. corporations, and they collectively hold more than 50 percent of the stock in two-thirds of these corporations. In only 12.5 percent of these same corporations do institutional holdings account for less than 30 percent.
The increase in institutional holdings clearly creates the potential for financial institutions to play a greater role in corporate governance. Some, arguing from the American populist political tradition, see this as a potentially dangerous aggregation of power in the hands of concentrated financial interests, The Financial Economists Roundtable views increased institutional ownership of common stock as a favorable development because because of its potential for mitigating the problems associated with the separation of ownership from control in large corporations.
Shareholder ownership carries with it voting rights, but in public corporations such voting rights provide a less effective mechanism for oversight of management the more diffuse ownership becomes. As recognized by Adolph Berle and Gardiner Means more than sixty years ago, the resulting separation of ownership from control can afford management the latitude to entrench itself and to pursue objectives that may be inconsistent with shareholders' best interests. Increased institutional stock ownership has the potential to overcome problems that can render ineffective the oversight exerted by individual shareholders. First, the larger the ownership position held by any one entity, the greater is its incentive to oversee management actively. Because larger owners more fully capture the economic benefits stemming from their activism, they are more likely to perceive oversight activities as cost effective. Second, larger ownership positions can reduce the costs of coordinating management oversight activities with other owners. Third, as institutional ownership positions become larger, institutions may find it more difficult and costly to sell their positions in large blocks of shares of companies in which they feel managers are not maximizing shareholder value.
The Financial Economists Roundtable recognizes that institutional ownership poses its own incentive conflicts, since the ownership of stock in institutional portfolios is separated from the management of those portfolios. Institutional portfolio managers represent their shareholders or beneficiaries. It is important that they pursue objectives that are consistent with the interests of such shareholders or beneficiaries.
The Appropriate Role for Institutions in Corporate Governance
The Roundtable encourages institutional owners to take a proactive
role in corporate governance. Specifically, the institutions we are referring
to include mutual funds, bank trust departments, defined contribution pension
funds, and variable annuities. By taking a proactive role, the Financial
Economists Roundtable means: (1) thoughtfully and responsibly voting their
shares, (2) communicating with management, the press, and, to the extent
allowed by law, other shareholders and (3) introducing proxy resolutions.
The Objective of Institutional Participation in Corporate Governance
The primary objective of institutional participation in corporate governance
should be to maximize economic value for the institutions' shareholders
and beneficiaries. Institutional shareowners should pursue governance initiatives
that will maximize the market value of their portfolios. They should not
pursue initiatives intended to further the interests of other corporate
stakeholders, such as suppliers, customers or employees, to the detriment
of shareholders. This also excludes the pursuit of social or political
objectives that will not be economically beneficial to shareholders.
While we strongly encourage institutional owners to be governed by the general principle of enhancing economic value, we recognize that in some cases institutions and their beneficiaries will wish to pursue noneconomic objectives. These might stem from shared religious beliefs, as in the case of a retirement fund managed on behalf of a religious order. In other cases, a majority of beneficiaries may wish to see their fund invested so as to promote such goals as social equality or environmental improvement.
The pursuit of these alternative goals should be constrained by two conditions. First, any noneconomic objective should be clearly and fully disclosed to all shareholders and beneficiaries. Second, with the possible exception of funds managed for religious groups (in which membership is voluntary and based on shared noneconomic values), a viable alternative should be made available to any shareholder or beneficiary who does not wish to participate in the pursuit of a noneconomic objective. Such an alternative could consist of the right to withdraw one's funds entirely and without penalty, as in the case of open-end mutual funds. The availability of an alternative investment fund that pursues only value maximization would also satisfy this requirement. We believe that the burden should be on institutional fund managers to show that viable alternative investment opportunities exist for shareholders and beneficiaries.
Public Policy Issues
It should be a public policy objective to make corporate governance
by institutional owners as effective as possible. The Roundtable therefore
opposes any legal or regulatory constraints on the ability of fund managers
to vote or communicate with management of portfolio companies. The Financial
Economists Roundtable also urges a thorough legislative review of existing
restrictions on institutional ownership positions and or other legal impediments
to effective governance by institutional owners. The review would seek
to determine what changes might either reduce the costs associated with
institutions' exercise of ownership powers or increase the incentives of
institutional fund managers to take an active role in corporate governance.
Conclusions
Institutional stock ownership has grown steadily in the post-World
War II period, and financial institutions are now major shareholders in
U.S. corporations.
• Rashad Abdel-Khalik, University of Florida
• Edward I. Altman, New York University
• George J. Benston, Emory University
• Gerald O. Bierwag, Florida International University
• Marshall E. Blume, University of Pennsylvania
• Richard Brealey, London Business School (U.K.)
• Willard T. Carleton, University of Arizona
• Andrew Chen, Southern Methodist University
• George Constantindes, University of Chicago
• Elroy Dimson, London Business School
• Franklin R. Edwards, Columbia University
• Robert Eisenbeis, Federal Reserve Bank of Atlanta
• Lawrence Fisher, Rutgers University
• Martin J. Gruber, New York University
• Elroy Hakansson, University of California at Berkeley
• Edward J. Kane, Boston College
• George G. Kaufman, Loyola University Chicago
• Alan Kraus, University of British Columbia
• Dennis E. Logue, Dartmouth College
• John J. McConnel, Purdue University
• Franco Modigliani, Massachusettes Institue of Technology
• Stewart C. Myers, Massachusetts Institute of Technology
• Anthony M. Santomero, University of Pennsylvania
• Kenneth E. Scott, Stanford University
• William F. Sharpe, Stanford University
• Seymour Smidt, Cornell University
• Robert A. Taggart, Boston College
• Seha Tiniç, Koç University (Turkey)
• James Van Horne, Stanford University
• Ingo Walter, New York University
• Roman L. Weil, University of Chicago
• Richard West, New York University
• J. Fred Weston, University of California at Los Angeles
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http://www.luc.edu/orgs/finroundtable/statement98.html