Engaged versus Disengaged Ownership: The Case of Pension Funds in the UK

• Date: 01 March 2013
• Author: Anna Tilba,Terry McNulty
• Published date: 01 March 2013
• DOI: http://doi.org/10.1111/j.1467-8683.2012.00933.x

Engaged versus Disengaged Ownership: The

Case of Pension Funds in the UK

Anna Tilba* and Terry McNulty

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: This study examines how the practice of pension fund investment management informs the

ownership behavior of pension funds vis-à-vis investee corporations.

Research Findings/Insights: Using data from: 35 in-depth semi-structured interviews with pension fund trustees, execu-

tives, investment off‌icers and f‌inancial intermediaries; documentary analysis; and observations of four fund investment

meetings, we f‌ind a variation in pension fund behavior, where a very small number of well-resourced and internally

managed pension funds exhibit engaged ownership behavior. By contrast, the vast majority of pension funds operate at a

considerable distance from their investee corporations having delegated pension fund investment management to a chain

of external relationships involving actuaries, investment consultants,and fund managers. These relationships are laced with

divergent interests and inf‌luence dynamics, which explain why these pension funds give primary emphasis to fund

investment performance and display little concern for matters of ownership and corporate governance.

Theoretical/Academic Implications: The “New Financial Capitalism” is characterized by ownership concentration, yet at

the same time liquidity and a lack of institutional investor engagement with corporations. Findings suggest that the

principal-agent view of the relationship between institutional investors and corporate managers is more assumed than

demonstrated. This widely assumed theory of investor ownership and control is shown to be contingent upon the meanings

and practices that underpin investment fund management by institutions.

Practitioner/Policy Implications: Shareowner engagement is proposed as a solution to problems of corporate governance.

Findings about the relationships within the investment chain undermine the notions of pension funds behaving as owners

and upholding corporate governance and accountability. This raises skepticism about realizing aspirations for engaged

ownership and shareowner stewardship contained in institutional investors’ engagement codes such as the Stewardship

Code (2010) and contemporary policy debate in the UK and beyond.

Keywords: Corporate Governance, Institutional Shareholder, Pension Fund, Ownership, Stewardship

INTRODUCTION

Agency theory provides a rationale for why investors, as

owners of corporate equity, should engage with f‌irms

(Fama & Jensen, 1983; Jensen & Meckling, 1976; Leech &

Leahy, 1991; Maug, 1998; Shleifer & Vishny, 1986). The

underlying assumption is that the need to align the interests

of managers (the agents) with those of investors (the princi-

pals) provides investors with an incentive to participate in

the company’s strategic direction (Anabtawi, 2006; Gillian &

Starks, 2000), in short to act as engaged owners.

However, pointing to the present era of Financial Capital-

ism, Davis (2008, 2009) and Jackson (2008) observe an

ownership paradox related to institutional investors. The

paradox is that while institutional investors seem to be

increasing in size and also the concentration of their stakes,

which gives them potential inf‌luence over managers, their

use of equity is generally liquid and without commitment.

This ownership paradox motivates us to examine whether

institutional investors are actually able and/or willing to

engage as owners.

An apparent lack of investor engagement in corporate

governance is of major concern to not only scholars of cor-

porate governance but also to practitioners and policy

makers seeking to effect better corporate governance. Inves-

tor disengagement is a subject of wide debate and signif‌i-

cance beyond the realm of academe. In the US such concerns

are evidenced by Conference Board reports (e.g., Tonello,

2006), whilst in the UK the f‌inancial crisis has served to

heighten expectations of policy makers on institutional

investors to act as stewards and engaged owners of shares

*Address for correspondence: Dr. Anna Tilba, University of Liverpool Management

School, Chatham Street,Liverpool L69 7ZH, UK. Tel: 44 151 795 3717; E-mail: a.tilba@

liverpool.ac.uk

165

Corporate Governance: An International Review, 2013, 21(2): 165–182

© 2012 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2012.00933.x

(The Ownership Commission Report,2012; The Stewardship

Code, 2010). A UK government sponsored study in 2011–12

(The Kay Review, 2012) aspires to longer-term investment

behavior and equity markets that better serve fund benef‌i-

ciaries and corporations. The Ownership Commission

Report (2012) promotes the culture of “engaged ownership”

with better links between the interests of the ultimate

owners and the f‌irms they own.

Pension funds are a type of institutional investor often

associated with a potential to adopt a long-term perspective

on equity holding and management and they are therefore

seen as potential model investors for stewardship (Davis,

Lukomnik, & Pitt-Watson, 2006). Against this theoretical and

practical backdrop, this study examines how pension funds’

investment management practice informs the ownership

behavior of pension funds vis-à-vis investee corporations.

Consequently, through qualitative inquiry of actors and insti-

tutions involved on the capital side of the ownership and

control debate, this study reports a marked difference in

behavior of pension funds. On the one hand, a very small

number of well-resourced and internally managed pension

funds exhibit behavior of engaged owners. However, these

funds are an exception rather than the norm. By contrast,the

vast majority of pension funds operate at a considerable

distance from their investee corporations, having delegated

pension fund investment management to a chain of external

relationships involvingf‌inancial intermediaries such as actu-

aries, investment consultants, and fund managers. Further-

more, these relations of dependence along the investment

chain are laced with interests and inf‌luence which predispose

pension funds to give primary emphasis to fund investment

performance rather than an engaged approach to ownership.

Our study contributes to existing governance research in

several respects. Our analysis goes beyonda dyadic focus on

institutional investors and investee corporations as princi-

pals and agents respectively, to attend to a broader examina-

tion of a wider system of diverse actors and relationships

involved in the investment chain that links capital providers

to corporations. Attention to the detailed practice of fund

investment ref‌lects theoretical and methodological turns

within the f‌ields of organization studies and corporate gov-

ernance research that are inclined to the detailed study of

behavior and processes (Ahrens, Filatotchev, & Thomsen,

2011; Pettigrew, 1992). Using this approach allows us to

account for heterogeneity among pension funds which is

something that has been observed but not explained in the

literature (Cox, Brammer, & Millington, 2007; Del Guercio &

Hawkins, 1999; Monks & Minow, 1995; Ryan & Schneider,

2002). By puncturing the image of homogeneity that often

characterizes debates about institutional investors, this

study f‌inds that pension funds are not a monolithic category

of investor but vary according to fund type, size of assets,

maturity, internal investment management capabilities, and

liquidity requirements. These differences are critical to

explaining their investment practice and behavior vis-à-vis

corporate management, and why there are marked differ-

ences in engagement between pension funds.

Theoretically, the analysis serves not to overturn or rebut

agency theory and its view of institutional investors’ behav-

ior (indeed, there is some evidence to support this – scenario

A later in the paper), but it is a signif‌icant jolt to a widely

held theory and set of assumptions about relations of own-

ership and control. In keeping with qualitative inquiry being

a means to reconsider established theoretical ideas, this

research suggests that the principal-agent relationship as

applied to institutional investor and corporate relations is

more assumed than demonstrated in practice. Rather, the

applicability of the theory is much more contingent on the

features of investment funds as well as meanings and prac-

tices employed by those managing funds, including f‌inan-

cial intermediaries. The contingent nature of the practice of

investment management offers alternative explanations of

institutional investor behavior rooted in “trading” and

“exit” behavior rather than “owner” and “voice” behavior.

The structure of this paper is as follows. We f‌irst review

the literature on corporate ownership and control,highlight-

ing an apparent paradox of institutional share-ownership

concentration, which lacks the corresponding or desirable

investor engagement, vis-à-vis investee corporations

implied by agency theory. We then introduce UK pension

funds as the research context. Following a discussion of the

research design and methods, we draw on multi-method

qualitative inquiry involving: interviews with pension fund

trustees, executives, investment off‌icers, and f‌inancial inter-

mediaries; observation of pension fund investment meet-

ings; and documentary analysis to explain the practices at

work along the investment chain between pension funds

and investee corporations, to reveal whether pension funds

behave as owners. We conclude by considering the signif‌i-

cance of our f‌indings with respect to academic and current

policy debates, and offer some implications for further cor-

porate governance research.

CORPORATE OWNERSHIP AND CONTROL:

INSTITUTIONAL OWNERSHIP AS A

MECHANISM OF GOVERNANCE

Since Berle and Means (1932) examined the implications of

dispersed ownership using the separation of ownership and

control thesis, ownership behavior by institutional investors

has been considered an important governancemechanism of

control to help align the interests of shareowners (princi-

pals) and managers (agents) (Fama & Jensen, 1983; Jensen &

Meckling, 1976; Leech & Leahy,1991; Maug, 1998; Shleifer &

Vishny, 1986). Jensen and Meckling (1976) refer to agency

theory as “a theory of ownership” (p. 309) where equity-

holding institutional investors are seen as signif‌icant moni-

tors of managerial decisions (Anabtawi, 2006; David, Hitt, &

Gimeno, 2001;Gillian & Starks, 2000; Hoskisson, Hitt,

Johnson, & Grossman, 2002; Johnson, Schnatterly, Johnson,

& Chiu, 2010;Mallin, 1994).

A relationship between institutional investor equity own-

ership and corporate control has provided a theoretical plat-

form for a substantial body of research aimed at addressing

the fundamental agency problem involved in the separation

of corporate ownership and control. In his seminal work,

Hirschman (1970) has identif‌ied the investor/company rela-

tionship within the “exit” or “voice” framework, where

investors sell the shares, or “exit,” if they are dissatisf‌ied, or

express concerns to management though “voice.” Indeed,

the empirical evidence investigating this relationship is

166 CORPORATE GOVERNANCE

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