Financial Reporting Council (FRC) of UK has initiated consultation for developing a stewardship code for institutional investors. The reference point is the ‘Code on the responsibilities of institutional investors’ issued by the Institutional Shareholders’ Committee (ISC). The undertone of the ISC document is that institutional investors should intervene in the management of investee companies regularly. It also requires disclosure of the policy in this regard and disclosure on the use of the voting right (e.g. whether they have voted for the management in a particular resolution or voted against it) and how they have managed situations of conflict of interests.
The Cadbury Committee in its report (December 1992) delineated the role of institutional investors in improving corporate governance. The report observes that: institutional investors should establish regular engagement with senior executive level to exchange views and information on strategy, performance, board membership and quality of management; they should make positive use of their voting rights; and they should take positive interest in the composition of board of directors.
Stewardship role
Institutional investors are expected to manage wealth of beneficiaries entrusted to them. They carry out that responsibility by careful and responsible management of portfolios of securities. They seldom actively intervene in the management of investee companies. Private agencies evaluate fund managers indirectly by evaluating fund performance and publishing rankings based on such evaluation. Thus, fund managers are evaluated indirectly in their stewardship role. This market based evaluation motivates fund managers to improve rankings of their funds. It is debatable whether regular intervention in the management of investee companies is necessary to carry out the stewardship function.
Engagement with senior management
Relationship investment may not be the right strategy for all institutional investors. Pension funds and insurance companies can take a long term view and can thus create wealth for beneficiaries by improving the performance of inve-stee companies through regular intervention. Some pension funds (e.g. California Public Employees’ Retirement System, popularly known as CalPERS) follow a strategy to buy shares of underperforming companies cheap and then actively intervene to improving their performance to create wealth for beneficiaries.
Mutual funds, as a strategy, cannot resort to relationship investment because they cannot take a long term position like insurance companies or pension funds. They have to manage NAV on a daily basis. In general, the effective engagement is difficult for two reasons: investing companies do not like regular intervention and therefore, do not encourage and facilitate engagement with senior management; and it is practically impossible for an institutional investor to effectively engage with large number of investee companies. Even if an environment is created to encourage direct intervention by institutional investors, unless a mechanism is established to enable institutional investors to collectively engage with senior management of listed companies, such a proposition cannot be implemented.
Voting right
Institutional investors find it very costly to attend general meetings and exercise voting rights. The present system of proxy voting is a very ineffective mechanism. A proxy cannot participate in discussion and can vote only in a poll. As per the current corporate practice, voting is by show of hands unless a poll is demanded. Therefore, in most situat-ions a proxy cannot exercise the voting right. Therefore, in order to enable institutional investors to exercise voting rights the law must change. It should be mandatory for listed companies to introduce electronic voting and to conduct poll on every resolution placed before the general meeting.
Conclusion
With increase in the sharehol-ding by institutional investors in listed companies, they collectively can play an important role in improving the enterprise governance of listed companies. Therefore, we need to debate the question whether India should introduce a stewardship code for institutional investors? Introduction of a stewardship code will definitely increase the administrative cost of institutional investors but incremental benefit to beneficiaries may not be significant. While we debate on the stewardship code, the government should amend the Companies Act and take other necessary steps to encourage and facilitate direct intervention by institutional investors in the management of listed companies on a regular basis. This will strengthen shareholder activism, which is essential to improve enterprise governance.
E Mail: asish.bhattacharyya@gmail.com