Wall Street Stampede: Exit as Governance with Interacting Blockholders, 1994-2011

The asset management industry's growth has led to firms often having multiple institutional blockholders, which has a significant impact on corporate governance through exit strategies. A model has been proposed to illuminate this dynamic, emphasizing the role of open-ended institutional investors like mutual funds in enhancing corporate governance when informed blockholders exit. This model introduces a novel perspective on the influence of mutual funds in shaping corporate governance. Empirical evidence consistent with this framework is presented by examining mutual fund trading around exits by activist hedge funds. The empirical analysis centers on a dataset of 399 firms that underwent activist campaigns ending in exit between 1994 and 2011. Findings support the model's predictions, even after adjusting for unobservable firm-level variations and broader economic conditions. Following exits by activist hedge funds, mutual funds driven by fund flows significantly reduce their holdings in the target company compared to other institutional investors. This divergence in trading behavior is more pronounced when activists exit at a financial loss, campaigns show no clear success, or market reactions suggest liquidity concerns weren't the main driver. To conduct this analysis, data on activist campaigns is merged with institutional holdings information from the Thomson Reuters 13F database and the Morningstar Open-end Mutual Fund portfolio holdings dataset. The activist campaign data is based on Schedule 13D filings and aligns with the data collection methods of previous studies. Trading behavior of other blockholders is tracked using quarterly 13F filings, a requirement for institutional investors managing $100 million or more. The S34 dataset (13F filings) from Thomson Reuters is combined with the Morningstar Open End Mutual Funds database to classify mutual funds throughout the 1994–2013 period.

In the research programme outlined in this grant proposal, we shall study corporate governance in economies with intermediated equity ownership. When public corporations are characterised by dispersed equity ownership, blockholders - holders of non-trivial percentages of a company's shares - are key to good governance. In contrast to small shareholders, who have neither the incentive nor the capacity to effectively monitor management, blockholders are able to govern firms to the benefit of all. The governance role of blockholders must be viewed in the backdrop of the large-scale intermediation of equity ownership in recent decades. Fifty years ago households directly owned around 70% (55%) of US (UK) equity. Today direct ownership accounts for only around 20% (10%) of US (UK) equity. The rest is indirectly owned via institutional investors such as pension funds, mutual funds, and hedge funds. Thus, a majority of blockholders in public corporations in the US and the UK today are money managers. In other words, modern-day corporate governance is intermediated: Funds that manage other people's money must monitor company executives who make business choices funded by external investors, a case of agents watching agents. Several questions arise immediately. What are the consequences of myopia induced by asset management contracts on the nature of governance? Intermediation of equity ownership increases the distance between ultimate owners and ultimate decision makers while ownership chains also fragment equity holdings: how does this affect coordinated shareholder engagement and corporate decision making? Are there systemic stability concerns that arise from the predominance of asset managers as monitors of firms? In the aftermath of the financial crisis, prominent policy reviews have highlighted several such questions. Yet, the academic literature is yet to engage comprehensively with these issues. We propose to fill this gap. By a combination of theoretical and empirical methods, we shall develop a comprehensive analysis of several key facets of intermediated corporate governance that are of interest to policy makers. The work will be carried out via seven, interrelated, projects. The emphasis throughout will be on the incentives of asset managers and how these impact the nature of corporate governance in firms in which they hold blocks. We shall document the landscape and legal environment of intermediated ownership around the world, delineating how incentives vary along the ownership chain (Project 1). We shall examine theoretically and empirically how such incentives affect the nature of coordinated engagement in settings with multiple small blockholders (Projects 2 and 3), engender long ownership chains (Project 4), and provide commitment mechanisms for monitoring (Project 5). We shall also examine whether the ways in which such incentives induce asset managers to govern firms foster new channels for systemic risk (Projects 6 and 7). Our research approach will be positive: in other words, the projects will develop conceptual frameworks backed up by empirical analysis to provide a basis for understanding intermediated governance as it exists today. It is only by gaining such understanding that we can carefully evaluate the normative proposals in the policy reviews for what intermediated governance should be. We shall facilitate knowledge exchange between the academic and policy communities. By engaging carefully with issues highlighted by policy reviews, we shall enhance awareness of policy-relevant questions amongst academic researchers. By providing thorough theoretical and empirical analyses of issues of direct interest to policy makers, we shall facilitate the development of informed and effective policy to regulate the role of institutional investors in corporate governance.

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