Institutional investors and growth

Institutional investors should act to curb corporate short-termism, according to influential US think tank, the Brookings Institution.

Brookings recently published an article by Robert C. Pozen, a senior lecturer at Harvard, MIT Sloan and senior fellow at Brookings, about the role institutional investors can play in limit corporate short-termism.

In the US, activist investments and interventions, particularly by hedge funds, are growing more commonplace and the outcome of these events is often that executives focus more on quarterly earnings than sustainable growth. Although large institutional investors are the majority owners of publicly traded companies, they rarely participate in proxy fights initiated by players with a smaller investment position.

Pozen speculates that the institutional investors’ main reasons for staying on the sidelines may be their reticence to use resources and management time to fight a proxy battle, or in the case of index-oriented funds such as Index Mutual Fund and Exchange Traded Fund (which hold about 30 per cent of US stock under management), a potential shortage of analysts with in-depth individual stock expertise to evaluate the activist’s proposal. He comments on the dangers of inaction by the institutional investors and cites a recent letter by Laurence Fink, chief executive officer of BlackRock, where he warned US companies may be harming long-term value creation by capitulating to pressure from activist hedge funds to increase dividends and stock buybacks.

The solution to this issue, Pozen contends, is for securities regulators and other relevant parties to “encourage” institutional investors to take a “decisive role” in determining the outcome of an activist raid on a company in which they are the major shareholder. To this end, he asserts the institutional investor should evaluate the proposal carefully and model its impact on the medium-term growth of the company. This would need to take into account the type of company, its industry segment and its expectations of financial return.

If the outcome of the evaluation is that the proposal is not complementary to the promotion of sustainable growth of the company then the institutional investor must participate vigorously in the activist’s intervention to protect the company position. Similarly, he supports institutional investors rejecting executive remuneration plans if they promote short-term results.

Given the low growth and softening trading results of companies around the globe and here in Australia, Pozen’s article shows that there is a role for institutional investors to be more active in protecting corporate value in the companies in which they have significant investment.

For more information, read the full article ‘The role of institutional investors in curbing corporate short-termism’.