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July 24, 2012
Institutional Investors: Part of the Problem or Part of the Solution?
    by Robert Kropp

Authors Ben Heineman and Stephen Davis argue in a working paper that many institutional investors lag behind corporations in transparency, and call for a national database on the behavior of institutions. Second of a two-part series.

Yesterday, reported on a recently published paper in the Harvard Business Review, entitled What Good Are Shareholders?. Authors Fox and Lorsch argue, among other points, that pressure on corporate managers to behave responsibly would be better served by a version of stakeholder capitalism, in which a wider circle of actors—including customers, employees, lenders, regulators, and nonprofit groups—is involved.

To support their argument that many institutional investors may in fact enable some occurrences of poor corporate governance, the authors refer to a working paper authored by Ben Heineman and Stephen Davis. Published last October, Are Institutional Investors Part of the Problem or Part of the Solution? reports that in the aftermath of the financial crisis, institutional investors were given increased powers with which to oversee the governance of corporations. Policymakers expected that such increased powers would curb excessive risk-taking and improve corporate disclosure on environmental, social, and corporate governance (ESG) issues.

The authors argue, however, that "with these shifts in market and legal powers have come questions about institutional investors which are similar to those raised in the recent past about the corporations in which they invest." Furthermore, "Policymakers who championed the transfer of enhanced powers to investors went well beyond available knowledge in crafting such a response to the financial crisis."

The authors define institutional investors as pension funds, mutual funds, hedge funds, sovereign wealth funds and nonprofit endowments. They question whether the trustees and executives of such institutions invest with the aim of advancing the goals of beneficiaries; whether investment managers hired by institutions contribute to short-termism; and whether the passivity displayed by institutions on many occasions raises questions about their ability to be effective stewards of corporations.

"We need to have as much understanding about investor entities as we do about investee companies," the authors state. Yet, even as disclosures by corporations increase in number and even quality, an equivalent transparency has yet to be taken up by many institutions. A solution espoused by the authors is the construction of a new national database on the governance and practices of institutional investors.

"Fixing dysfunction in capital markets has to involve institutional investors," Davis said. "But as our research demonstrates, policy makers in this area are operating in a knowledge vacuum. A national database on how investors behave would be a timely and critical aid in understanding how the market can meet social expectations for solid and sustainable growth."


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