Shareholder Activism: The Suspicious Shareholder

The European Commission sees active institutional ownership as an important corporate governance mechanism, and several regulatory initiatives have been taken to enhance shareholder activism by improving shareholders’ rights and facilitating shareholder monitoring. In the light of the fact that most institutional shareholders still remain passive, in its 2011 Green Paper on the EU corporate governance framework the Commission again addresses the question of how to promote active ownership. The Commission is facing major challenges. Not only is it hard in itself to make institutional investors vote, but active ownership as an effective corporate governance mechanism is challenged by a changed shareholder landscape and the innovation of financial instruments. The effectiveness of active ownership as a corporate governance mechanism builds on for example the assumptions of shareholders having economic ownership and having identical interests in increasing firm value. But today shareholders are a heterogeneous group with different interests. For example Sovereign Wealth Funds are accused of having political-strategic interests in their investments. In addition, the innovation of financial instruments has made it possible to decouple voting rights from economic ownership and risk. There is thus a risk of shareholders such as hedge funds using their influence not to improve the overall performance of the company, but to profit at the expense of the company and other shareholders. This development in the financial market leads to a risk of conflict of interest and shareholder opportunism, and it can undermine the effectiveness of active ownership as a corporate governance mechanism. This article will identify some of the challenges facing active ownership as an effective corporate governance mechanism, when shareholders’ primary interests may not be to increase firm value. If some shareholders have a different goal for their investments than increasing share value, and if they use their influence to promote these goals, this not only leads to conflicts of interest between shareholders, it rocks the very fundament of active ownership as an effective corporate governance mechanism. This presents the Commission with the question of whether this amounts to a serious market failure requiring regulatory measures, and if so what measures should be taken. This requires the weighing of the various risks of influence against each other, and a close examination of any harmful economic consequences of such regulation. If it is found that there is a need for regulation, it must be proportionate, in other words it must be suitable for engendering the required behavior, without going further than necessary. It seems that the current debate to a great extent to favor regulation. Both within the EU and among legal theorists there is an intense debate about different possible regulatory measures, aimed at ensuring long-term responsible ownership. The article gives a review of a number of the different mechanisms that have been proposed for dealing with the problem of short termism, conflicts of interest and shareholder opportunism. A choice has to be made between seeking to solve the problem by various measures affecting voting rights, or to couple the greater shareholder powers given under the EU directives with greater shareholder responsibility. At this point European considerations seem to point in the direction of intervening in voting rights, and the pendulum, which for a long time swung towards breaking down barriers to the exercise of voting rights and the OSOV principle, now seems to be swinging back towards establishing certain barriers and the introduction of CEMs in order to curb unwanted activism. Some of these proposed solutions strike deep into the heart of the power structures of companies and may have unforeseen and harmful effects and raises the question whether there is a need to make haste more slowly when it comes to new regulatory measures.