Awakening giants? The politically contested modification of institutional investors

• DOI: https://doi.org/10.1108/CG-08-2015-0111
• Pages: 278-294
• Published date: 04 April 2016
• Date: 04 April 2016
• Author: Markus Kallifatides,Sophie Nachemson-Ekwall
• Subject Matter: Strategy,Corporate governance

Awakening giants? The politically

contested modification of institutional

investors

Markus Kallifatides and Sophie Nachemson-Ekwall

Markus Kallifatides is

Associate Professor at

the Department of

Management and

Organization, Stockholm

School of Economics,

Stockholm, Sweden.

Sophie Nachemson-

Ekwall is Research fellow

at the Centre for

Governance and

Management Studies,

Stockholm School of

Economics, Stockholm,

Sweden.

Abstract

Purpose –The purpose of this paper is to offer a political perspective on modifications in corporate

governance regulation. In the wake of the financial crisis, the investment rationale of institutional

investors is being pushed away from a focus on financial market liquidity and short-term trading. From

a political perspective, this modification entails consideration both of investment horizon and of the

definition of corporate value.

Design/methodology/approach –The paper narrates the historical policy debate on institutional

investors as corporate governors. Building on this point, a conceptual framework is developed to further

the understanding of the current shifts in policy debate of institutional investors as governors.

Findings –The authors find a strong policy impetus to move away from certain liberal market

assumptions of efficient financial markets and the positive effects of privatization, toward viewing

markets as institutionally embedded. Based on their knowledge of corporate governance regimes’

political economy, the authors argue that this shift brings intensified engagement of institutional

investors in corporate affairs. The reasons for why and how this might be politically contested are

specified. In conclusion, propositions regarding the outcome of such contestation in different national

corporate governance regimes are offered.

Originality/value –Pointing to the predominantly European stakeholder value versus shareholder

value discussion, the authors claim that the corporate governance policy debate related to intensified

engagement of institutional investors in corporate affairs is still in its infancy. Their political perspective,

including propositions for further elaboration, offers a contribution to further academic debate.

Keywords Regulation, Corporate governance, Institutional investors, Stakeholder value

Paper type Conceptual paper

1. Introduction: the politics of institutional investment

In most Western capital markets, domestic as well as foreign institutional investors own

50-60 per cent of the capital in listed companies (Çelik and Isaksson, 2013). This category

of investors includes pension funds, investment funds such as retail funds and

government-sponsored pension plans now representing a significant force in domestic

capital markets and as corporate governors. In the academic debate, these investors

generally have been treated as a group of uniformed, passive investors with a propensity

to use the “exit” option when discontent, rather than the options of loyalty and voice

(Thomsen, 2004; c.f. Hirschman, 1972, on these generic action strategies available to

minority stakeholders in large organizations). We contend that this is a rather simplified

image, as the rationale of institutional investors is shaped by, and part of, particular national

corporate governance regimes. As intermediaries, their operations have been complexly

regulated everywhere, and these regulations have been politically contested all over as

well. In recent decades, regulators have tended to prohibit active engagement in corporate

decision-making[1]. This resulted in an outcome of institutional investors taking the role of

predominantly passive minority shareholders in corporations all over the world.

Received 17 August 2015

Revised 23 November 2015

24 November 2015

Accepted 27 November 2015

PAGE 278 CORPORATE GOVERNANCE VOL. 16 NO. 2 2016, pp. 278-294, © Emerald Group Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-08-2015-0111

Following the 2008 financial crisis, there appears to be a shift in academic and political

discourse with regard to the role of the institutional investors in the governance of listed

companies. Many calls for “engaged” governance in the part of institutional investors are

made[2]. What has come into question is the foundational notions of efficient capital

markets and portfolio optimization models (Markowitz, 1952;Modigliani and Miller, 1958;

Fama, 1970), emblemized by awarding the 2013 “Nobel prize” in Economics to Robert

Schiller, figurehead of the behavioural finance movement and Eugene Fama, orthodox

financial economist.

On the basis of the political science and sociological theory, we argue that the rationales

of institutional investors are best understood as institutionally embedded, shaped by and

shaping economic, legal and cultural factors. As a result, the likelihood of a reconfiguration

of the institutional investor organizations from a passive minority shareholder rationale

toward active or “engaged” stakeholder rationale will be interconnected with the future

development of national corporate governance regimes. Based on the conceptual

frameworks of Aguilera and Jackson (2003) and Gourevitch and Shinn (2005), we point to

the centrality of the formation of alliances between involved constituents (i.e. institutional

investors, corporate management, labour and minority shareholders). In all probability, any

modification of institutional investor operations would entice domestically powerful interest

groups to contest such changes. We therefore suggest that what we term the political

“independence” and “clout” of institutional investors will be a decisive explanatory factor in

any overall modification.

By developing Roe’s (2003) influential theory of static political preferences explaining

corporate governance regimes in different parts of the world, political scientists Gourevitch

and Shinn (2005) direct our attention to the formation of (political) preferences as an

explanatory “variable” in comparative corporate governance. Focusing here on the

changing rationale of institutional investors as corporate governors in the post-financial

crisis era, we add the discipline of economics to the conversation – particularly, financial

economics and its current importance to the formation of political preferences – that is of

central importance to comparative corporate governance research. We argue that

corporate “performance”, along with the notions of “efficiency” or “optimality”, is a

value-laden concept with a “moral dimension” (Etzioni, 1961;Young and Thyil, 2008). We

thus turn attention to the continuing divide in corporate governance research between the

“stakeholder” and “shareholder” visions of the firm (Donaldson, 2012).

In a similar vein, Australian economist Quiggin (2010) dissects five interrelated “zombie”

ideas in economics: the supposed Great Moderation of the macroeconomy, dynamic

stochastic general equilibrium modelling, trickle-down economics, (the universal benefits

of) privatization and the efficient market hypothesis[3]. The term “zombie” that Quiggin

uses refers to the sociologically familiar phenomenon that some theoretical ideas remain

alive and well and are used as practical guides to political and regulatory action, even

though they have been shown to be outright wrong, incomplete or ontologically misleading

(“reified”) (Callon et al., 1998;Fligstein, 2001).

In this article, we highlight how institutional investors have been the primary carriers on a

global scale of at least two of these “undead” ideas for quite some time now. Across the

globe, these organizations have been significantly shaped by ideas of the value of

privatization and the truth value of the efficient market hypothesis. Hence, financial capital

has been primarily allocated to private rather than public investment and in a manner in

which the ultimate beneficiary (all citizens) has exercised weak influence upon the

investment, leaving institutional investors the mandate, as intermediaries, to freely acquire

and sell securities with the only purpose of making a financial profit (Coffee, 1991).

The rest of the text proceeds as follows: in Section 2, we present the theoretical building

blocks for a political understanding of the institutional investment modifications in the wake

of the crisis. In Section 3, we discuss the dominant operational rationality of the institutional

VOL. 16 NO. 2 2016 CORPORATE GOVERNANCE PAGE 279