THE ROLE OF INSTITUTIONAL INVESTORS IN CORPORATE GOVERNANCE

ABSTRACT

Institutional Investors are central to the evolution of corporate governance, wielding significant influence due to their substantial ownership stakes and fiduciary responsibilities. Their role extends beyond passive shareholders to active stewards of governance, monitoring managing performance, advocating for accountability and promoting sustainable long term value creation. This study explores the multifaceted contributions of institutional investors, focusing on their engagement strategies, including proxy voting, shareholder activism and direct dialogues with management. Additionally, it examines their impact on board composition, executive compensation and environmental, social and governance (ESG) initiatives. Despite their growing influence, challenges such as conflicts of interest, short-term pressures and regulatory constraints persist. This research provides comprehensive analysis of institutional investors’ role in corporate governance, emphasizing their potential to drive meaningful change and enhance governance standards globally. It can also be said that institutional investors play a transformative role in corporate governance by leveraging their substantial shareholdings to influence corporate decision-making and thus promoting accountability. They are seemed as stewards of significant financial assets, thus are uniquely positioned to drive accountability, transparency and better growth in corporations. They have a direct engagement with corporate boards to promote governance practises that align with the significant and long-term interests of shareholders and stakeholders.

KEYWORDS

Institutional Investors, Corporate Governance, Shareholder activism, Managerial oversight, Board Diversity, Corporate Accountability, Executive Compensation, ESG, Stewardship.

INTRODUCTION

Corporate governance is the framework through which companies are directed and controlled, ensuring accountability, fairness and transparency in the process of decision-making. It has gained increasing importance in recent years as stakeholders demand higher standards of governance, ethical practises and value creation in long-term. It is eminent that institutional investors have been emerged as the most important players of shaping corporate governance. Their significant ownership stakes and fiduciary duty to their clients or beneficiaries enable them to influence corporate policies and practises in profound ways. Institutional investors such as pension funds, mutual funds, sovereign wealth funds and insurance companies hold substantial portions of equity in public trading companies. This ownership concentration gives them the power to act as stewards of governance by monitoring managerial performance, voting on critical issues and engaging directly with corporate boards. Their role extends to addressing key governance concerns, such as board composition, executive compensation and sustainability. Particularly this research devolves into the role played by investors in the governance of corporate world. The study also highlights the challenges they face, such as conflicts of interest, short-termism and regulatory complexities. Their impact on company and its corporate governance is high like in cases where board is not effectively managing its fund, then this can be checked by institutional investors etc. Their involvement in corporate governance extends beyond passive investment, as they often work to ensure transparency, ethical practices, and strategic direction that benefits both the company and its stakeholders. Institutional investors can exert pressure on corporate boards to adopt better governance practices, improve financial performance, and implement policies that address environmental, social, and governance (ESG) factors.

Given their ability to influence company operations, institutional investors are increasingly seen as key players in shaping corporate behaviour, particularly when it comes to aligning corporate strategies with shareholder interests and promoting sustainable business practices. This role has evolved, with institutional investors now being more vocal in demanding changes in corporate structures, executive compensation, and corporate social responsibility. Also, institutional investors act as a guidance to corporate governance as they bring a level of scrutiny, accountability, and strategic guidance that can drive companies toward sustainable growth and ethical practices. Their influence on corporate boards and management is crucial in fostering good governance and improving overall company performance.

Furthermore, this research also aims to underscore the critical role of institutional investors in shaping governance frameworks that align with the interests of shareholders and stakeholders. It emphasizes the need for continued dialogue, engagement and innovation to ensure that institutional investors contribute to sustainable and responsible corporate governance practises and works. Institutional Investors gained prominent status everywhere.

INSTITUTIONAL INVESTORS CONTRIBUTION TO CORPORATE GOVERNANCE

Active ownership and stewardship: The ownership rights exercised by institutional investors is by actively participating in shareholder meetings, voting on resolutions considered to be of vital importance as well as engaging with company management and boards. By greater engagement and promotion practises, they provide valuable inputs on strategic decisions, and other governance-related matters.
Engagement and dialogue: Institutional Investors engage in constructive dialogue with company management and boards to address necessary concerns of governance, frameworks and also to advocate for vital changes that are needed. Moreover, the institutional investors have dedicated teams that undertake thorough research and analysis for the purpose of undertaking investment decisions. This well-laid out mechanism serves as a way for the institutions to stay up-to date on the latest developments in the industry.
Disclosure and transparency: Institutional investors encourage companies to foster and enhance disclosure and transparency practises by advocating for clear and accurate reporting of financial and non-financial information, including ESG factors. Through their standard efforts, vital information and frameworks of the organisations is shared with the investors thereby enabling theme to make informed decisions and assess the governance practises and risks associated with their investments and monetary contributions.
Market Confidence and Long-term Focus: Other than retail investors, institutional investors often adopt a long-term investment horizon thus encouraging companies to focus on sustainable growth through strategies aimed at broader societal and environmental goals rather than short-term profits. Institutional Investors help enhance confidence in the financial markets through their mechanisms relate to transparency and accountability.

ROLE OF INSTITUTIONAL INVESTORS IN CORPORATE GOVERNANCE IN INDIA

In India, there is a rise in the amounts invested by institutional investors in companies. The government policies also facilitated the increase of flow of FDI and FII in India. The Institutional investors do not exercise their voting rights meaningfully. They evaluate the associated costs with exercising their voting rights and finds the costs associated with their voting rights as being too high. In most Indian Companies, the monitoring role played by institutional investors is either missing or marginally visible in some way. No monitoring role is played by institutional investors in smaller companies.

For determining corporate governance in India, the Organisation for Economic Co-operation and Development [OECD] plays a major role. The principles of OECD are not considered binding and governments are free to decide whether they want to adopt these or not. The Corporate governance of most companies is done by Clause 49 of the Listing Argument along with regulations which are issued by the Ministry of Corporate Affairs as well as SEBI {Securities and Exchange Board of India}. One foremost principle which is mentioned in OECD principles is the key ownership functions and right of shareholders. It said the rights of shareholders must be protected and facilitated in a proper way. Despite the various provisions in the Companies Act along with the regulations issued by SEBI, there have been still cases relating to complaints of malpractices filed by the investors. This is because shareholders rights are not really executed and are shadowed in paper only. They are also not involved in the meetings of the company and voting rights are not performed by them. Thus, Investor activism is significantly reduced in India. Institutional Investors should be more fostered and encouraged to avoid such malpractices.

According to the Kuamaramangalam Birla Committee Report in governance of corporate sector, presentations of quarterly reports are to be made to the investors. This would encourage increased wisdom and awareness among the investors to better exercise their rights of voting. This view is also endorsed by Narayanmurthy committee report.

According to the World Banks Draft paper, the interests of beneficiaries should be put before the interests of the Asset Managers and the Chief Executive Officers by the institutional investors. They should also act in a manner which best serves the interests of the shareholders.

In conclusion, it is said that the institutional investors in India are not playing an activist role and hence are not improving the corporate governance standards in India. It is therefore encouraged that investors should engage in improving the corporate governance standards of our country and should also ensure better corporate governance frameworks, practices and policies.

ROLE OF INSTITUTIONAL INVESTORS IN CORPORATE GOVERNANCE IN USA

There is a proactive role played by institutional investors in the United States of America for corporate governance. They play a significant role in the decision-making process of the company in the country. The practices related to corporate governance followed in the USA are very different from practices which are in any other country.

An important point to be look at is the kind of shareholder activism. For exercising the voting rights in any other country, the lead of the local shareholders might be followed by them. Information availability is a primary requisite to exercise voting rights by the institutional investor. To decide whether there would be more benefits derived form the information procured than the cost involved in the procuring of information, institutional investors would have to conduct checks and balances.

The Securities and Exchange Commission regulate play a role in regulating institutional investor activism and corporate governance in the United States of America. There have been some campaigns launched to assert institutional investor activism. Campaign such as vote no campaign to express shareholder dissatisfaction of the Board. Institutional investors have become more active because of the scandals in corporate governance in 2001 and 2002.

Despite certain institutional investors are active in exercising their proxy votes, some of them face conflict of interest between the interests of shareholders and their own interests. USA must avoid fiascos such as the Enron Scandal as they have an institutional investor base.

LEGAL PRECEDENTS

Dodge Vs Ford Motor Co. (1919)[1]

The, Dodge brothers, minority shareholders in Ford Motor Company, sued Henry Ford, alleging that his decision to reduce dividends and reinvest profits for employee and community benefits was not in the shareholders’ best interest. The Michigan Supreme Court held that a corporation’s primary duty is to maximize shareholder wealth. Thus, Institutional investors should ensure corporate policies align with shareholder interests.

Unocal Corp. Vs. Mesa Petroleum Co. (1985)[2]

Mesa Petroleum attempted a hostile takeover of Unocal, which adopted defensive measures to thwart the bid. The Delaware Supreme Court upheld the board’s right to defend against hostile takeovers but required actions to be reasonable and proportional.

CALPERS Vs AFSCME (2008)[3]

The California Public Employees’ Retirement System (CalPERS) proposed a bylaw amendment requiring staggered board elections, which conflicted with corporate bylaws. The Delaware Supreme Court ruled that shareholder proposals must not conflict with existing laws. Thus, the case emphasizes the importance of aligning shareholder proposals with corporate governance frameworks.

Citigroup Inc. Shareholder Derivative Litigation (2009)[4]

In this, the court dismissed the case, highlighting the difficulty of proving board negligence under the business judgment rule. The case emphasizes on the challenges that institutional investors face in holding boards accountable for risk management.

Staples, Inc. Proxy Contest Case (2016)[5]

In this, Institutional Investors challenged Staples’ merger with Office Depot, arguing it undervalued shareholder interests. The merger faced significant opposition, highlighting the influence of institutional investors in shaping corporate actions. This case illustrates the growing role of institutional investors in advocating for fair value during mergers and acquisitions.

Trinity Wall Street Vs Walmart Stores, Inc. (2015)[6]

In this case, a shareholder proposed restricting Walmart’s sales of firearms, citing social responsibility concerns. Walmart argued the proposal interfered with ordinary business operations. The court sided with Walmart, ruling that such proposals were inappropriate for shareholder considerations. Thus, this case highlights the limits of institutional investors in addressing social issues through corporate governance.

CONCLUSION

Institutional Investors have become indispensable actors in the global governance landscape, fundamentally reshaping the way corporations are monitored, managed and held accountable. By leveraging their substantial ownership stakes and fiduciary responsibilities, they serve as stewards of corporate accountability, promoting transparency, sustainability and long-term value creation. Their active engagement through proxy voting, shareholder activism and direct board-level dialogues has enhanced oversight in key areas such as board composition, executive compensation, risk management and environmental, social and governance initiatives. Institutional investors act as a vital counterbalance to managerial authority, ensuring that corporations prioritize shareholder interests while increasingly addressing broader societal concerns. Despite their significant contributions, institutional investors face challenges, including potential conflicts of interest, short-term performance pressures and diverse stakeholder expectations. Regulatory frameworks and ethical standards are crucial to addressing these challenges, ensuring their activities align with long-term governance objectives and stakeholder interests.

As the custodians of vast financial assets, institutional investors have the potential to drive transformative changes in corporate governance, fostering more ethical, transparent and inclusive corporate practices. However, their influence must be wielded responsibly, with a focus on balancing profitability with sustainability and ethical accountability. Through their continued agreement and advocacy, institutional investors can not only enhance corporate governance standards but also contribute meaningfully to broader societal and economic progress.

REFERENCES

SSRN, Role of Institutional Investors in Corporate Governance by Manya Srivardhan. https://papers.ssr.com January 7, 2025.
PRIME Database, Role of Institutional Investors in Ensuring Better Corporate Governance by Atul Sobti. https://primedatabase.com January 7, 2025.
Law Brigade Publishers, Role of Institutional Investors in Corporate Governance by Dr Parula Choudhary & Deepika Kulhari. https://thelawbrigade.com January 8, 2025.
Vanderbilt University, The Evolving Role of Institutional Investors in Corporate Governance and Corporate Litigation by Randall S. Thomas. https://scholarship.law.vanderbilt.edu January 10, 2025.

[1] Dodge vs Ford Motor Company (1919) 204 Mich. 459

[2] Unocal Corp. vs Mesa Petroleum Co. (1985) 493 A.2d 946

[3] CalPERS vs AFSCME (2008) 953 A.2d 227

[4] Citigroup Inc. Shareholder Derivative Litigation (2009) 964 A.2d 106

[5] Staples, Inc. Proxy Contest case (2016) 190 F. Supp. 3d 100

[6] Trinity Wall Street vs Walmart Stores, Inc (2015) 792 F.3d 323

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