In the paper, The Role of Institutional Investors in Voting: Evidence from the Securities Lending Market, which was recently made publicly available on SSRN, we use a unique setting to examine if institutional investors influence firm-level corporate governance through proxy voting. Understanding institutional investor preferences regarding corporate governance is important for firms trying to attract new investors as well as policy makers considering the regulation of different governance mechanisms. The activities of institutional investors in the securities lending market provide one of the few opportunities to directly examine the behavior of institutional investors in influencing firm-level governance.

To study the securities lending market for U.S. firms during the period 2007-2009, we use a proprietary data set comprising shares available to lend (supply), shares borrowed (demand), and loan fees. The data covers more than 85% of the securities lending activity for these firms and allows for a comprehensive analysis during a period of tremendous growth in that market. In the past, understanding the securities lending market has been limited partly due to the lack of transparency in this fragmented market. We find that on average, 22.48% of a firm’s market capitalization is available for lending, 3.44% is actually borrowed, and the annualized loan fee is 35 basis points. The supply of lendable shares shows great variation, with minimum and maximum values of 0.01% and 74.38% of market capitalization. We find that more lending supply is available for firms with larger institutional ownership and strong corporate governance. There is considerable interest in some stocks and almost 100% of the available supply of such stocks is actually borrowed and on loan. The annual fee can be quite high, with the maximum at 745 bps. During 2007-2009, 10% of the stocks were very expensive to borrow and had a fee greater than 100 basis points. 2007 was the peak year for the securities lending market, with activity dropping off after the financial crisis.

…continue reading: The Role of Institutional Investors in Voting

In the past few years, hedge funds have moved into the mainstream of the U.S. economy. Once restricted to a small number of super-wealthy “sophisticated investors,” they now receive hundreds of billions of dollars from public and private pension plans acting as fiduciaries for school teachers, truck drivers, construction workers, first responders and others whom we have lately come to call “the 99 percent,” who share little in common with fund managers stocking the Forbes 400 list. Surfing upon this incoming tide of money, some individual funds now manage enough assets to exert significant influence in the markets.

But the widespread acceptance of hedge funds among institutional investors has not been matched by commensurate improvements in their level of transparency, accountability and corporate governance. In recent months, we’ve witnessed the dismal result: a parade of inside-trading scandals evoking the fraud-riddled implosions of Worldcom, Tyco, Enron and Global Crossing that rocked corporate America a decade ago. It’s time for hedge funds to be brought into the 21st century and reflect their new broader role and fiduciary responsibilities. This means the legal regime that sets the rules for hedge funds must change.

Without question, the profile of the average hedge fund investor has changed in the past few years. Battered by the financial crisis that erased billions of dollars in stock market value just a few years before the first baby boomers were scheduled to retire, many pension funds started investing with hedge funds in the hope of making up lost ground by taking advantage of their customized, often quant-driven investing strategies and promises of “absolute returns” regardless of the markets’ direction.

…continue reading: Hedge Funds Need More Accountability

In our paper, Equity-Holding Institutional Lenders: Do They Receive Better Terms?, which was recently made publicly available on SSRN, we evaluate the way in which institutional equity holders are involved in the lending process. Participation by equity-holding institutions has become a major part of the syndicated loan market. In our sample of 11,137 institutional “leveraged” loan tranches between 1997 and 2007 from the DealScan database, 2,008 (18%) have participation by a “dual holder” institution that owns at least 0.1% of the borrowing firm’s equity. Lending to firms in which one has an equity position goes against the principle of diversification, since it exposes the investor to firm-specific shocks through both its equity and debt ownership. To justify dual holding, the investor must receive compensation of some sort, either through the improvements in the value of its equity holdings, or by above market rates of return on the loan.

We estimate the abnormal return a dual holder receives by comparing spreads on dual holder tranches to those on observationally equivalent tranches that do not have a dual holder. Our estimates indicate, holding all else equal, that loan tranches with dual holder participation receive a 13 basis-point higher spread than otherwise similar tranches without an equity holder’s participation in the lending syndicate. The positive spread is statistically and economically significant for revolvers as well as term loans and for loans to borrowers of different ratings and to unrated borrowers as well.

…continue reading: Equity-Holding Institutional Lenders

It is well known that the separation of ownership and control in public firms causes tension between investors and managers. These so-called “agency problems” are particularly pronounced in the use of corporate cash holdings because it is both easy for managers to misuse cash and hard for investors to evaluate the appropriateness of mangers’ use of cash. Moreover, cash holdings account for a substantial proportion of corporate assets (about 25% of total assets in recent years). Therefore, since firms with better internal corporate governance tend to use their cash holdings more for the benefit of their investors rather than their managers, it is not surprising that investors are willing to pay a higher price for them.

In the paper, Investor Horizons and Corporate Cash Holdings, which was recently made publicly available on SSRN, we study how the investment horizons of a firm’s institutional investors affect the agency costs of corporate cash holdings. It is widely recognized that monitoring by institutional investors of managers increases firm value. However, not all institutional investors are created equal, and, one important way in which they differ is their investment horizons. Differences in investment horizons arise, for example, because of differences in investment strategies (e.g., short-term hedge funds) and/or differences in the maturity of liabilities (e.g., long-term pension funds).

…continue reading: Investor Horizons and Corporate Cash Holdings

Hedge fund activism has received a lot of attention in the legal and financial communities since the middle of the last decade, and has been identified as a major threat to U.S. public companies. Some of the early literature suggested that hedge funds avoid companies with high levels of R&D (such as technology and life science companies), in part because their businesses are more complicated and it takes longer for efforts of the hedge funds to be appreciated by the investment community and to generate returns. There has also been an assumption among legal practitioners that many technology and life science companies are dependent on the skills of their founders, and thus a hedge fund campaign faces the risk that the main assets of the company may walk out the door. However, a review of campaigns of 33 hedge funds from 2005 through the end of 2011 indicates that hedge fund activism is not only a significant risk that technology and life science companies face, but one that may disproportionately target them relative to companies in other industries. This Commentary summarizes some of the findings regarding the funds involved and their campaigns, and makes recommendations to technology and life science companies on how to address the risks.

…continue reading: Hedge Fund Activism in Technology and Life Science Companies

Fiscal year 2011 witnessed the SBA’s shift from domestic and foreign asset classes, to a combined global equity portfolio, with a heavier international equity weighting and a more balanced U.S. exposure. With the recent structural changes, the proportion of SBA assets invested in foreign equity markets will continue to rise, and a significant proportion may be managed internally. In 1998, for foreign equities was 7.6 percent, rising to 12.7 percent by 2003, and 18.8 percent by the end of fiscal year 2010. Upon completion of the transition to a combined global equity asset class, foreign equities composed 33 percent of FRS assets as of October 2011. As a percent of the equity asset class, foreign shares account for 56 percent and U.S. shares for 44 percent.

Coinciding with this shift, the SBA realigned its international proxy voting practices, bringing foreign voting decisions ”in-house” to match domestic SBA voting practices.

Previously, external asset managers were responsible for voting international proxies associated with SBA shares held in their funds. Since the SBA assumed this responsibility, votes are now cast by SBA staff—based on our own Corporate Governance Principles & Proxy Voting Guidelines and meeting specific research from our proxy research providers.

…continue reading: Analyzing Global Proxy Voting Practices

This column looks at four circumstances having special impact on the governance of executive pay today and then focuses on one of them, proxy advisers (with particular attention to the largest one, Institutional Shareholder Services (ISS)). It concludes with suggestions as to steps that might be taken to better regulate proxy advisers.

Four Influential Factors

Increasing Complexity of the Executive Pay Discussion. Discussions of executive pay in proxy statements are often extremely complex and lengthy (frequently 30 to 40 pages of narrative and tables). Many companies are putting into the Compensation Discussion and Analysis (CD&A) their own tables (most especially their own competing version of the Summary Compensation Table) in order to express their own views on the correct way to explain and justify executive pay at the issuer. It has become a challenge to understand any one company’s executive pay arrangements and an even greater challenge to understand how that company’s executive pay arrangements relate to those at competitor companies.

Institutional Shareholders. Institutional shareholders represent an overwhelming proportion of the vote at publicly traded companies. (They own approximately 75 percent of the market value of exchange- traded companies.) These institutional shareholders owe a fiduciary duty to the persons who own their shares or are beneficiaries of the trust funds managed by them. This duty includes understanding how the companies in which they have invested are managed, including management of executive pay. The explosion of data noted in the preceding paragraph has meant a challenge to these institutional shareholders in trying to understand the executive pay practices at thousands of companies that they (collectively) are investing in.

…continue reading: Say on Pay: Who Is Watching the Watchmen?

The Harvard Law School Shareholder Rights Project (SRP) is a clinical program at Harvard Law School through which faculty, staff and students assist public pension funds and charitable organizations to improve corporate governance at publicly traded companies in which they are shareowners. Below are links to joint press releases issued earlier this week by the SRP with each of five institutional investors – the Illinois State Board of Investment, the Los Angeles County Employees Retirement Association, the Nathan Cummings Foundation, the North Carolina State Treasurer, and the Ohio Public Employees Retirement System.

During the 2011-2012 proxy season, the SRP has been representing and advising these institutional investors in connection with the submission of shareholder proposals to more than eighty S&P 500 companies that have staggered boards. The proposals urge a move to annual elections, which are widely viewed as corporate governance best practice.

Through active engagement with companies receiving declassification proposals, the SRP and the institutional investors working with the SRP have been able to reach negotiated outcomes with forty-two of the companies receiving such proposals. These forty-two companies have entered into agreements committing them to bring management proposals to declassify their boards of directors.

The forty-two companies that have entered into agreements to bring management declassification proposals represent about one-third of the S&P 500 companies that had staggered boards at the beginning of this proxy season. A list of twenty-five companies that have entered into such agreements is available here. The list includes only companies that, after they entered into such agreements, issued a public filing disclosing the planned management proposal. The list will be updated periodically as more companies disclose management proposals brought pursuant to such agreements.

The press releases providing more information about the work described above are available at the following links:

…continue reading: Repealing Classified Boards in S&P 500 Companies

Investors and companies are both increasingly interested in sustainability issues. These issues typically revolve around environmental and social factors that have real but potentially long-term or contingent impacts on corporate financial value. This, in turn, makes traditional accounting metrics less valuable in assessing sustainability issues than in analysis of many other business issues. Therefore, both investors and companies – as well as groups that service or monitor and regulate them – have a growing interest in receiving meaningful corporate environmental, social, and governance (ESG) information on an ongoing basis. Despite this shared interest, investors often complain about the difficulty of gathering and truly understanding corporate ESG data, while company representatives may express concerns about “survey fatigue,” or the amount of time and resources it takes to supply the requested data to various investors and ESG research firms.

…continue reading: Finding Common Ground on Environmental and Social Metrics

In the paper, The Effectiveness of Institutional Investors in Evaluating Analysts, which was recently made publicly available on SSRN, we examine the effectiveness of institutional investors in evaluating analysts by comparing the performance of recommendations made by AAs—star analysts elected by institutional investors—with those made by other analysts.

We ask four related questions. First, does the AA status at least partially reflect analyst skill? That is, if AAs make more valuable recommendations, is it because of skill, or other factors such as luck, market influence, or access to management? If investors are effective in evaluating analysts, we expect the AA status to be indicative of skill. Second and closely related to the first question, does the AA status contain information about the analyst that is not entirely captured by other observable characteristics? The answer should be affirmative if institutional investors uncover unique information about analysts. Third, can institutional investors and the AA election process adapt to major changes brought to the industry by regulations and labor market movements? And finally, who benefits the most from the elected star analysts’ views?

…continue reading: The Effectiveness of Institutional Investors in Evaluating Analysts