Institutional Investors’ Votes on Corporate Externalities

M. Brière (Amundi, Paris Dauphine University)S. Pouget (University of Toulouse 1 Capitole) L. Ureche-Rangau (University of Picardie Jules Verne)

European Commission, 9 Jan 2019, Brussels

Outline

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1. Motivation and research question

2. Data and methodology

3. Preliminary results

4. Conclusion and further developments

01Motivation and Research Question

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Motivation

⎯ Corporations impose externalities on society

⎯ Externalities refer to firms’ impact on society that is not priced efficiently : e.g. CO2 emissions, nuclear energy, excessive use of common resources, employee training or welfare…

⎯ Costs are significant

⎯ In 2008, the largest 3,000 publicly listed companies worldwide generated more than US$ 2.15 trillion as environmental externalities (on the 6.6 trillion generated by global human activity) (Mattison et al., 2011)

⎯ Projected to reach 28.6 trillion (18% of GDP) in 2050

⎯ GHG emissions, water use and air pollution would have the greatest effect on reducing environmental costs

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Motivation

⎯ Today, investment companies hold a significant portion of corporate shares

⎯ US investment companies hold 30% of US equity (IC fact book 2017)

⎯ Largest 20 institutional investors: mean ownership of 33% of largest 20 firms (Bebchuk et al., 2017)

⎯ Significant enough to affect corporate behavior

⎯ Voting at shareholder general meetings is a key tool to impacts corporate behavior

⎯ Sufficiently sizable positions to have an effect on the outcome of the votes

⎯ Empirical evidence that the institutional investors influences the way corporations are governed (Hartzell and Starks, 2003 on executive compensation ; Aghion et al., 2013 on innovation)

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Research Question

⎯ Do institutional investors engage companies on global externalities such as climate change, human rights, etc.?

⎯ If so why?

⎯ Theories based on narrowly-defined shareholder value predict they should not

⎯ We want to test two (non-exclusive) reasons why they should⎯ Universal ownership (Monks and Minow, 1995)

⎯ Delegated philanthropy (Benabou and Tirole, 2010)

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In a Perfect World

⎯ Classical theories of the firm (complete market settings with perfect competition):

⎯ Shareholders are unanimous in requesting the firm to maximize its value (Arrow-Debreu, Modigliani-Miller)

⎯ The firm’s behavior does not affect agents’ consumption plans (Fisher separation theorem)⎯ General meetings should reveal no disagreement

⎯ Narrowly-defined shareholder value

⎯ By definition, externalities do not affect firms’ profits

⎯ Friedman (1970)’s famous injunction: ‘The social responsibility of business is to increase its profits’

⎯ Shareholders should not favor policies designed to deal with externalities

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Hypotheses: Universal Ownership

⎯ Large institutional investors own a significant share in virtually all listed compani es and have a long horizon

⎯ Firms’ negative externalities can deteriorate the overall financial value of their portfolios (Monks and Minow, 1995, Hawley and Williams, 2000, Mattison et al, 2011)

⎯ For ex: economic impact of GHG emissions on other companies’ businesses through water, food, health or migration issues

⎯ Evidence that universal owners (“common” owners) increase the level of coordination among firms’ policies towards governance or competition policy (Benabou and Tirole, 2016 ; Azar et al., 2017)

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Hypotheses: Delegated Philanthropy

⎯ Institutional investors invest on behalf of clients / citizens who may have preferences regarding externalities that differ from firms’ managers

⎯ Pension funds, mutual funds, sovereign funds care about their reputation among clients or citizens

⎯ They might want to promote their values/preferences and induce management to choose the appropriate action (Heinkel et al., 2001, Benabou and Tirole, 2010, Gollier and Pouget, 2016)

⎯ Their engagement is less subject to the free-rider problem than individual shareholders (Morgan and Tumlinson, 2012)

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Related papers

⎯ Understanding institutional investors’ behavior at shareholder meetings

⎯ Bubb and Catan (2018), Bolton, Li, Ravina, Rosenthal (2018) on investor ideology with a political scientist approach

⎯ Contribution: economic approach

⎯ Understanding institutional investors’ motivation for ESG investin g

⎯ Climate risk perception of investors (Kruger, Sautner and Starks, 2018)

⎯ Political leaning of US mutual funds managers (Hong and Kostovetsky, 2012) ; US pension funds’ beneficiaries (Hoepner and Schopohl, 2018)

⎯ Contribution: impact of institutional investors’ CEO’s values on voting behavior

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02Data and Methodology

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General Assembly Meetings

⎯ General meetings (GM) provide shareholders with a corporate governance mechanism⎯ Exercise their voting rights, meet the management and challenge certain strategic decisions

⎯ Resolutions submitted at GM may be sponsored by management / shareholders ⎯ Financial, environmental (E), social (S), governance (G) issues

⎯ In the US, proposals can be filled by shareholders holding at least $2,000 or 1% of the company’s securities (SEC 14a8 rule), 5% in the UK or France, one single share in Germany or Nordic countries

⎯ Focus on shareholder resolutions on E&S⎯ Ex: GHG emissions, nuclear safety, GMOs, human rights, diversity - proxy for externality issues

⎯ Focus on climate change for a clear externality

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Two Archetypical Investors

⎯ Blackrock (BR): standard universal owner

⁃ Listed corporation directed by a professional CEO, fiduciary duty to represent its shareholdersand clients⁃ $5 trn total assets, $2.6 trn in equities (both passive and active)⁃ Broadest global blockholder in listed corporations (3,648 holdings above 3%)⁃ Corporate governance / voting team : 31 persons

⁃ “The trigger for engagement on a particular E&S concern is [its] assessment that there ispotential for material economic ramifications for shareholders.” (Global CorporateGovernance and Engagement Principles, 2017)

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Two Archetypical Investors

⎯ Norway Fund (NF): universal owner and responsible investor

⁃ SWF serving as long-term saving vehicle, monitored by the Ministry of Finance, itselfsupervised by the Norwegian parliament, fiduciary duty to the representatives of the Norwegianpeople

⁃ Over $1 trn total assets, 542 bn in equities

⁃ Average holding around 1%

⁃ Corporate governance team : 12 persons

⁃ Council of Ethics (ensure consistency between investment policy & ethical guidelines):“gather information to provide a basis for assessing the risk that the company may becontributing to the violation of ethical norms , either now or in the future” (Council on Ethics,2016)

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Test Strategy

⎯ Do institutional investors oppose management on externality issues?

⎯ Compare votes on shareholder resolutions on E and S issues to⎯ Shareholder resolutions on Governance issues

⎯ Management resolutions on G and Financial issues

⎯ Focus on investors’ opposition to management⎯ Management opposes all shareholder resolutions on E and S issues

⎯ Identical to studying support of investors for E and S negative externality mitigation policies

→ Probit model of investor’s opposition to management on a dummy variable for resolutions sponsored by shareholders on E&S (or climate) issues

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Test Strategy

⎯ If yes, why? Work in progress… ⎯ We are currently expanding our analysis to all US mutual funds

⎯ Test of universal ownership : investors should oppose more if they invest in a large number of well diversified companies

⎯ Test of delegated philanthropy : mutual funds’ “values” proxied by CEOs’ political contributions

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⎯ 35,382 resolutions voted by BR and NF in 2014 on 2,796 corporations across the world⎯ SEC Filings on Mutual Fund Proxy Voting Records for BR

⎯ Norway Fund votes from internet website (year 2014 only)

⎯ Firm characteristics⎯ Firms’ returns and characteristics from Factset (mkt cap, ROA…)

⎯ Firms’ dispersion in analysts’ forecasts from I/B/E/S

⎯ Firms’ extra-financial ratings from MSCI ESG STATS

⎯ Country ESG performance ⎯ E: 5 variables on air quality, CO2 emissions etc. from OECD, EDGAR, YCELP and CIESIN

⎯ S: Human Development Index and Gender Inequality Index

⎯ G: 6 World Bank governance indicators

⎯ Institutional investors’ holdings from Thomson-Reuters (13F)

⎯ Extension : All US mutual funds’ votes holdings from ISS

Data

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Data: Opposition to Management

⎯ All resolutions

⎯ BR disagrees with management for3% of the resolutions, NF 8%

⁃ BR disagrees for 7% of E&Sresolutions, 3% of G resolutions

⁃ NF disagrees for 31% of E&Sresolutions, 8% of G resolutions

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Data: Opposition on Shareholder Resolutions

- Shareholder resolutions

- BR supports 9% of shareholderresolutions, NF 34%

- NF supports equally E and Sresolutions (49%) and 36% of G

- BR supports 4% and 9% of Eand S, 12% of G

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03Preliminary Results

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Empirical Results

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(1) (2) (3)BR or NF

oppose BR opposes NF opposes

Shareholder proposal*resolution ES 1.867*** 1.028*** 1.818***

Management proposal*resolution ES 0,089 0.435** 0,146

Shareholder proposal*resolution G 1.594*** 1.220*** 1.507***

Management proposal*resolution G 0.327*** 0.238*** 0.296***

Country rating ES -2.768*** -5.334*** -2.195***

Country rating G 1.108*** 1.752*** 0.900***

Company rating ES -0,018 -0,026 -0,016

Company rating G -0.038*** -0.040*** -0.036***

Mktcap -0.048*** -0.056** -0.048***

ROA -0,011 -0.085* 0,009

Pricetobook 0,004 -0,010 0,003

Salesgrowth 0,015 -0,012 0,017

Assetturnover -0,026 -0,010 -0,028

Volatility -0.048** -0.091*** -0.037*

Analyst dispersion 0,001 -0,013 0,003

Industry fixed effect yes yes yes

Country fixed effect yes yes yes

Observations 35 382 35 367 35 382

Pseudo R2 0,062 0,085 0,058

Probit coefficients

Both investors oppose management more on E&S shareholder resolutions than on financial

Marginal effect: 13% for BR, 56% for NF

Only NF opposes management more for E&S shareholder resolutions than G

Empirical Results: Climate Resolutions

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Climate: clear externality

NF opposes management more on climate than otherexternalities and G

BR does not oppose more than on F, less than on G

Universal ownership: not enough to induceinstitutional investors to fight against negativeexternalities

⎯ Identical results with and without country fixed effects and with a bivariate analysis

⎯ Identical results when we focus on US firms for which we know the holdings of the two investors from SEC Filings 13F – 6,037 resolutions voted by both investors in 548 firms

Robustness Checks

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Extension to all US investment managers

⎯ Opposition to management on shareholder resolutions on E&S issues, 2013-2016

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Extension to all US investment managers

⎯ Opposition to management on shareholder E&S resolutions, 2013-2016

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VARIABLES ES E S

Universal owner (> 2000 stocks) -0.0254* -0.00637 -0.0191*

Contributes strongly to political party -0.0222 -0.00816 -0.0149

Strong Democrat or Republican 0.0458** 0.0198** 0.0266

Strong Democrat 0.0182 0.00155 0.0181

Churn rate 0.0298** 0.0152*** 0.0157

Number of stocks (ln) 0.00775** 0.00372*** 0.00414*

Total assets (ln) -0.00896*** -0.00193** -0.00752***

% equity funds -0.0204 -0.00161 -0.0179

% retail funds -0.017 -0.0109*** -0.00675

% ISR funds 0.187*** 0.0879*** 0.120***

% index funds 0.021 0.00864 0.0124

Age of asset manager 0.00015 -6.56E-05 0.000249*

Average expense ratio 1.462 0.46 1.036

Idiosyncratic risk of asset manager -1.642 1.282 -3.005*

Year FE Yes Yes Yes

Observations 780 780 780

R-squared 0.096 0.099 0.092

Universal ownership logic does not hold

Other explanations?

Political engagement of investment management companies CEOs

Extension to all US investment managers

⎯ Opposition to management on shareholder E&S resolutions, 2013-2016

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Climate GHG Nuclear Energy Human Rights Discrimination

Universal owner (> 2000 stocks) -0.00165 -0.000246 -0.000215*** -0.000811 -0.00141 -0.00235

Contributes strongly to political party -0.00353 -0.00112 -9.23E-06 -0.0012 -0.00116 0.000568

Strong Democrat or Republican 0.0107** 0.00456 3.40E-05 0.00322** 0.00451*** 0.00215

Strong Democrat -0.00143 -0.00223 0.000187** 0.000567 -0.00184 0.00119

Asset manager churn rate 0.00477 0.00363* -3.54E-05 0.00117 0.00218** -0.000125

Number of stocks (ln) 0.000943 0.000872* 5.94e-05*** 0.000452** 0.000456** 0.000496

Total assets (ln) -0.000649 -0.000703** -3.10E-06 -0.000387*** -0.000224* -0.000874***

% equity funds -0.00239 -0.000881 -3.02E-05 -0.000824 0.00124 0.000862

% retail funds -0.00582*** -0.00161 4.99E-05 -0.00159** -0.00120* -0.00152

% ISR funds 0.0159* 0.00621 0.00314*** 0.0207*** 0.0164*** 0.0146***

% index funds 0.00408 0.00292 7.73E-05 0.000868 8.79E-05 0.000148

Age of asset manager -2.83E-05 -4.48E-06 -9.08E-08 3.42E-07 -1.02E-05 6.24e-05***

Average expense ratio 0.131 0.399*** -0.00315 0.0185 0.1 0.177*

Idiosyncratic risk of asset manager 2.134*** 0.0871 -0.00304 -0.323** -0.281* -0.284

Observations 780 780 780 780 780 780

R-squared 0.076 0.047 0.326 0.128 0.095 0.07

Conclusion and Future extensions

⎯ BR and NF comparison⎯ BR & NF oppose management more on E&S shareholder resolutions than on financial

⎯ Support for negative externality reduction is stronger for NF than BR

→ Delegated philanthropy stronger than universal ownership in fightingagainst negative externalities via institutional investors’ engagement

⎯ Cross-sectional test on all US mutual funds

⁃ Universal owner dummy, % of SRI funds, values of the CEOs

→ Universal Ownership hypothesis does not hold

→ Delegated philanthropy logic (% of SRI funds, values of the CEOs) betterexplains opposition to firm’s management on externalities

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Conclusion and Future extensions

⎯ Policy impllications

⎯ Corporations are not likely to be disciplined by institutional investors only because these investors hold well-diversified portfolios

⎯ Their engagement should also reflect the values of their clients

⎯ Need to measure the clients’ values on the main externalities ? Design of pass-through votingprocess?

⎯ Work in Progress… Comments welcome!

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