How Do Institutional Investor Rules Affect Local Corporate Governance in Different Countries, And What Is Their Impact? (India, USA and UK)
ABSTRACT
The article discusses institutional investor activism in a company’s corporate governance. Institutional investors are increasingly playing a crucial role in overseeing a company’s corporate governance. On the other hand, a few variables affect how activist investors are. In this paper, these factors have been examined. The United States and India are compared with respect to institutional investor activism. Despite criticism, this article seeks to make the case for institutional investor involvement. Additionally, it enumerates recommendations for enhancing institutional investor activity about corporate governance.
A significant portion of Indian companies’ funding comes from institutional investors. Foreign Direct Investment and Foreign Institutional Investment into India have increased as a result of recent government measures. Institutional investors are increasingly crucial to businesses. Although it is not as common in India, institutional investor activism is becoming more and more significant. In the corporate governance of American and British corporations, institutional investors take the initiative. They keep an eye on the Board’s decisions and support the establishment of strong corporate governance procedures within the company. Big institutional investors have the ability to share with other shareholders confidential information that they receive from management.
It has been observed that enterprises with stronger corporate governance practices have received loans from development financial institutions. Additionally, we discover that mutual funds have made investments in businesses with stronger records of corporate governance. By applying a simultaneous equation approach, we discover that this positive correlation results from the mutual funds’ (development financial institutions’) investments in businesses that have strong governance records as well as from their contribution to the businesses’ improved financial performance.
Introduction
A significant portion of Indian companies’ funding comes from institutional investors. Foreign Direct Investment and Foreign Institutional Investment into India have increased as a result of recent government measures. Institutional investors are increasingly crucial players in of businesses. Although it is not as common in India, activism among institutional investors is becoming more and more significant. In the corporate governance of USA and UK corporations, institutional investors take the initiative. They keep an eye on the Board’s decisions and support the establishment of strong corporate governance procedures within the company. Big institutional investors have the ability to share with other shareholders confidential information they get from management.
Institutional Investors and Corporate Governance
Corporate governance is the set of policies, procedures, and guidelines that control and direct an organisation to make sure it is managed and directed well. It involves the board of directors as the main body deciding on corporate governance, with an emphasis on values like accountability, fairness, transparency, and accounting. Protecting shareholder interests, controlling risks, improving business performance, gaining financing, gaining the trust of stakeholders, maintaining legal compliance, settling disputes, encouraging innovation, and encouraging flexibility all depend on effective corporate governance.
Large organisations known as institutional investors make financial investments on behalf of other people or entities, such shareholders, clients, or customers. Mutual funds, pension plans, insurance providers, hedge funds, foundations, commercial banks, and other organisations are among them. These investors are significant players in the stock market because they are regarded as smart and are well-known for purchasing and selling huge quantities of shares, bonds, or other securities.
The public trusts institutional investors with their money, and these investors hold the majority of family income. They hold public funds in trust and behave in a fiduciary manner. They have a responsibility to make choices that advance the company’s objectives and direct it towards acting morally.
Banks, insurance firms, development financial institutions, mutual funds, foreign institutional shareholders, provident funds, and suggested private fund managers are among the several categories of institutional investors. Certain institutional investors, such as Foreign Institutional Investors, are exempt from Indian regulations due to their incorporation outside of the country and the fact that their investors are either foreigners or non-resident Indians.
The World Bank suggested a corporate governance framework that would encourage participation from institutional investors in transparent, equitable decision-making as well as firm review and assessment.
Institutional investors and corporate governance of a corporation are mutually dependent. Determining the quantity and number of institutional investors interested in investing in a company is largely dependent on its corporate governance standards. According to a McKinsey poll conducted in 1996, institutional investors were prepared to pay an average of 11% extra for companies with sound governance practices. A second poll conducted in 1999–2000 found that the relative premium ranged from 20–27% in the Asian countries that were chosen, from 18–22% in Europe and the US, and from 21–28% in Latin America. Conversely, a corporation with a robust base of institutional investors would benefit from stronger oversight, which would improve corporate governance.
The majority of institutional investors who care about governance prefer to make investments in companies that already have established governance procedures. Investing in organisations with good corporate governance processes would result in lower monitoring expenses. Institutional investors won’t have to take the initiative to keep an eye on the business’s procedures.
Instead of actively participating in management, the majority of institutional shareholders sell their shares, which lowers stock prices and impacts the market. For smaller investors, becoming involved in the company’s corporate governance matters is not cost-effective. Investors in institutions can be divided into two categories: those who are responsive to pressure and those who are not. Investors who are sensitive to pressure tend to follow the opinions of the majority, whereas investors who are not sensitive to pressure express their own opinions and do not just vote in favour of the majority’s position.
Institutional investors have three options if they are unhappy with the Board: they can leave the company, express their displeasure, or remain devoted and keep their complaints to themselves. Hirschman has labelled these options as voice, loyalty, and escape. However, institutional investors need to be actively involved in the company’s management and operate independently to protect other shareholders’ interests.
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Institutional Investors and Corporate Governance in India
The amount that institutional investors are investing in Indian companies is increasing. The government’s policies have additionally contributed to the growth in FII and FDI into India. As a result, there are now greater numbers of institutional investors throughout India.
Institutional investment participation is not very common in India. They don’t really utilise their right to vote. They assess the expenses related to using their voting rights and conclude that they are excessive given the potential benefits. Therefore, it is more economical to take a back seat and avoid going to the work of gathering knowledge in order to meaningfully exercise one’s right to vote.
In India, corporate governance is determined by the Organisation for Economic Co-operation and Development. The governments are free to choose whether or not to embrace the OECD guidelines, which are not legally enforceable. Clause 49 of the Listing Agreement and rules published by the Ministry of Company Affairs and SEBI regulate the corporate governance of the majority of companies.
The right of investors and important ownership functions is one of the OECD’s fundamental principles. This implies that both the protection and facilitation of shareholders’ rights are necessary. However, despite a number of clauses in the Companies Act and SEBI regulations regarding to the protection of shareholders’ rights, investors have filed a number of complaints alleging wrongdoing. This is a result of the shareholders’ rights only ever being acknowledged on paper. The company’s shareholders do not participate in meetings or use their voting rights. In India, investor activism is rather minimal. Increased involvement from institutional investors is necessary to prevent further of these misdeeds.
A recent proposal has been made to amend the listing agreement to require institutional investors to remain independent (Clause 49).10 This would imply that they may independently exercise their right to vote and enhance the company’s corporate governance procedures.
The OECD guidelines have promoted greater investor participation in the company’s operations as well as greater knowledge among institutional shareholders. The N.S. Narayanamurthy Committee Report and the Kumaramangalam Birla Report are the two reports that have been published on corporate governance.
The Kuamaramangalam Birla Committee Report on Corporate Governance states that institutional investors must be presented with quarterly reports. This will enable institutional investors to properly exercise their right to vote by raising their awareness and understanding. The report of the Kumaramangalam Birla committee suggested that institutional investors become more involved in corporate governance. Nonetheless, they opposed these investors’ appointment to the company’s board of directors. The report of the Narayanamurthy committee supported this opinion.
Institutional investors should intentionally prioritise the interests of beneficiaries over those of asset managers, chief executive officers, and other stakeholders, and they should behave in a way that best serves the interests of shareholders, according to the World Bank’s draft report.
In order to promote improved corporate governance processes, prevent disasters like Satyam, and raise the bar for corporate governance in our nation, institutional investors should be heavily involved.
Institutional Investors and Corporate Governance in USA
In the United States of America, institutional investors are actively involved in corporate governance matters. Institutional investors hold a significant influence in the company’s decision-making process. This has aided the county in implementing the best corporate governance procedures.
However, the primary issue that the majority of businesses deal with is privatisation, mergers, or amalgamations between US-based and foreign-based businesses. The corporate governance standards observed in the United States diverge significantly from those observed in any other nation. Even if institutional investors are engaged in the US, it’s possible that they aren’t as interested in other nations’ corporate governance practices.
Determining the type of shareholder action is another crucial aspect. They could take the lead from the local shareholders in order to use their right to vote in any other country. Institutional investors’ capacity to exercise their right to vote is contingent upon the availability of information. Therefore, the institutional investor’s activism in a different nation would be contingent upon the cost and availability of company information. Institutional investors would need to do checks and balances to determine whether the advantages of the information obtained would outweigh the expenses associated with doing so. However, because obtaining information can be expensive, there are situations where investors fail to effectively use their voting rights.
There isn’t much of an impact of the US corporate governance model on corporate governance in other nations. Therefore, even while shareholder activism is practiced in the United States, it is not exported to other nations. Despite the activism of shareholders, there have been a number of scandals and instances of misconduct, like the Enron affair.
Many movements to establish institutional investor activism have surfaced recently. To voice shareholder unhappiness with the Board, campaigns like the just vote no campaign have been started. This consists more of an act of symbolic disapproval directed at the Board.
Following the corporate governance scandals of 2001 and 2002, institutional investors have increased their level of activity. Brent claims that an increasing number of mutual funds are launching shareholder proposals and voting proxies.
Even so, some institutional investors have a conflict between interest and their personal interests and the interests of the company’s shareholders, despite the fact that they actively participate in casting proxy votes. It is important to minimise conflicts of interest as these might give rise to issues such as insider trading and looting. The institutional investment base in the United States is active, but it must be utilised to prevent disasters like the Enron incident.
Institutional Investors and Corporate Governance in UK
It was uncommon in the past for institutional investors to have direct control over how the company they invested in was run. The majority of these large investors sold their shares of the companies they believed were underperforming. But as of late, the pattern has shifted. The short-term holdings of institutional investors have drawn criticism. The shift in the market’s tendency from short-term to long-term ownership can also be linked to institutional investor activism.
According to Principle E.2 of Section 2 (Institutional Shareholders) of the Combined Code, institutional shareholders ought to be prepared, whenever possible, to engage in communication with businesses on the basis of a shared understanding of goals. As a result, institutional investors have had a greater need to actively use their voting rights. In the United Kingdom, the majority of proxy votes support majority decisions, with only 4% of proxy votes voting in accordance with the designated proxy. The majority of votes support the Board’s recommendations. 15 Hardly any one disagrees with the decisions made by the majority.
Even while institutional investors are growing increasingly involved, their proxy votes almost never go against the Board’s decisions. To guarantee improved corporate governance procedures, they need to be encouraged to express their opinions.
Recommendations Involving Institutional Investor Activism for Improved Corporate Governance Practices
It is clear that institutional investors are necessary for a company to have effective corporate governance procedures. Institutional investors need to be more involved in keeping an eye on the company’s operations. These institutional investors need to take a proactive stance. Institutions are required to make public their corporate governance policies, explain how votes are made, and make sure that open procedures are followed. This would guarantee that a greater number of institutional investors participate actively in the operations of the business. It would promote better corporate governance procedures and the involvement of institutional investors.
Institutional investors should be required by SEBI to reveal their voting records; this would promote open voting among the investors. Institutional investors are required to make two different types of disclosures. Both main and secondary disclosures would apply. To give the public confidence that their money is in capable hands, institutional investors should make their primary disclosures. Another kind of disclosure should be made so that investors are aware of the investing philosophy, the choices being taken, etc.
Conclusion
Concluding whether or not investor activism benefits the company. Some believe that because investors lack the necessary knowledge to keep an eye on the corporation, they shouldn’t be given as much influence over corporate governance. They also believe that doing this would take their attention away from their primary business. Some, however, believe that institutional investors ought to be in the forefront of enhancing corporate governance procedures.
Before choosing to get actively involved in a company’s operations, an institutional investor takes a number of factors into account. To determine if the costs of gathering information to actively participate in the company’s activities and to keep an eye on those affairs would be less than the advantages that would come from such monitoring, they must perform a cost-benefit analysis. They would be actively involved in the company’s affairs if this were the case. If not, they wouldn’t.
Corporate activities are impacted by the legal framework that a nation has established. After adjusting for the impacts of legal origin, Palepu, Khanna, and Kogan (2002) propose that pairs of economically connected economies typically adopt identical corporate governance rules.19 If institutional investors actively participate in a company’s corporate operations, it is because of the nation’s evolved legal framework.
Better corporate governance procedures and monitoring are the result of institutional investors’ involvement in corporate governance. Therefore, institutional investors ought to be included more deeply in the company’s corporate governance procedures, and the laws that are in place ought to support this. To encourage institutional investor participation in corporate governance, SEBI must promulgate legislation.
This would make it easier to conduct fair and transparent commercial operations, protecting India from mishaps like the Satyam affair. If institutional investors were given a significant and fundamental role in a company’s decision-making process, Indian corporations would lead the world in corporate governance.
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