This blog looks at the influence of institutional investors, and the role of collaboration, partly by reviewing emerging literature on social network analysis as a theory to analyse investor influence on companies.
The role of institutional investors in public equity markets has increased significantly. A report for the OECD on the matter shows how they have become the single largest category of investors in public equity markets, with three times the amount invested by public sector owners and six times that of strategic individuals.
According to the report (published in 2019), institutional investors held 41% of global market capitalisation, and have become significant owners in individual companies in advanced economies. For example, in the United States, the average combined ownership held by a company’s ten largest institutional investors was 43%. More, in terms of foreign ownership, this has increased significantly over several decades to reach an average of at least 30% of public equity investments in domestic markets.
With ownership comes responsibility
Investors of all types have grown increasingly informed and engaged in their portfolio companies. Guided by their fiduciary duty, they are expected to act as universal owners focused on protecting and developing the long-term value of diversified portfolios.
Using voice and ownership rights is central to such stewardship efforts, for which collaboration (under the right circumstances) can provide a powerful mechanism to pool knowledge, resources, and information. However, while investor-corporate engagement looks promising on paper, research tells us it needs to become more effective to truly help address the issues and opportunities facing companies and the societies in which they operate.
Social network analysis
Speaking of effectiveness, from a theoretical perspective, institutional investors’ influence can be considered in the context of social network analysis (SNA). Building on the widely-accepted principle that the position within a network creates different status or reputation, this theory has been used to analyse stakeholder influence on companies and in sustainability transitions.
Researchers Bajo, Croci and Marinelli (2020) found the level of active institutional investor centrality to have a strong and positive effect on firm value. To establish the centrality of each actor, the authors overlapped block-holding positions with other institutional owners to assess the number of connections, effectively creating a degree of connectedness. The position of each institutional block holder then served as a proxy for its relative influence, prominence and prestige in the entire network.
Using similar network theory to uncover the structures of ownership in the fossil fuel industry, Dordi et al (2022), identified 918 distinct (direct and indirect) shareholders with greater than 1% ownership in at least one of the fossil fuel firms in their sample (the Carbon Underground 200). Ranking the most prevalent shareholders based on emissions potential and network centrality, nine of the top twenty shareholders were asset managers (investment advisors in the report). Furthermore, this investor type generally followed with a higher degree score in comparison to the other types, indicating that they, through their numerous holdings, are more central to the network. The main finding was therefore the significant influence of these shareholders on the net zero transition, with the top ten “owning” 49.5% of the emissions potential.
The inference from these studies is that while size and scale matter, investors should consider the points of intervention suitable for them by considering aspects such as investor type, geographical and sectoral exposures, location, and expertise. Through combining resources, collaboration can then help investors to reach beyond the amount of “paper” they individually own, increasing both their power and legitimacy.
1+1=3
The market still has lengths to go to truly democratise active ownership. While there is a tradition of equality of treatment for shareholders and strong minority rights, differential treatment is still persistent. In part, this is due to issues in the market infrastructure and intermediary chain, which for companies, is resulting in agency issues, and partial information problems. The latter is something Fisch and Sepe (2020) have found more costly. Based on the economics of information, the authors show how collaboration can work as an antidote, effectively helping to reduce both of these issues by promoting the production and aggregation of information from insiders and shareholders, adding value that is otherwise lost under unilateral decision-making.
Fundamentally, enhanced collaboration helps spread resources and costs associated with research, tasks, and responsibilities. It reduces duplication, streamlines information dissemination, and democratises engagement access for smaller, resource-constrained investors. However, there are challenges to it as well, such as how to manage coordination costs, competitive aspects, and individual preferences, while staying clear of regulatory hurdles around acting in concert rules.
Constructive activism has changed in nature
Today, it’s not just an investment strategy, but a behaviour of mainstream investors. Collaboration offers a particularly powerful tool to help align the interests of investors, companies, and their stakeholders. In turn, empowering investors to stay true to their commitments through the Principles for Responsible Investing: to be active owners and work together in the furthering of the principles.
Author: Rickard Nilsson, Director Strategy & Growth at Esgaia.
With years of experience in the field of responsible investing, Rickard focuses on industry- and regulatory developments, market and academic research, and more. He has particular experience in investment stewardship and how engagement can help advance sustainability practices.