For some time it has seemed to me that our thinking about corporate governance has become blindered by the existingframework and playerswe have created, which have becomeself-sustaining and assumed to be immutablenomatter howimperfectthey are.This is the first of a series of ideas and suggestions that I hope will provoke productive discussion unhindered by such assumptions.
Suggestion:Globally, require all large beneficial owners of shares in everyexchange-tradedcompany to do the following if those owners are financial institutions of any form orhave any form offiduciary duty (implied or explicit)to another beneficiary:(a)on a quarterly basis, publicly disclose their identity and number of shares held; and (b) after each shareholders' meeting, publicly disclose how they voted their shares.For instance,insurance companies, investment banks, mutual funds,asset managers, or hedge fundsholdingmore than .25% of the outstanding shares of each company (aggregating all accounts, etc.), might come under the application of such rules.
Reasons: Right now, we have a global investment system that separates legal title from beneficial title for purposes of convenience of and efficiency (including economies of scale)for reporting about holdings to beneficiaries, voting, and administration. This is fine. But one outcome of this system is that large investors can hide their identify to some parties, selectively reveal it to others, and do not necessarily have to take full responsibility forvoting and exercise of othergovernance rights.This significantly reduces the efficency of mechanismsfor both pricing and governance.
Suppose you were a real estate investor and you were offeredshares in a private company – say, a private REIT – that owned a number of large hotel properties. Before you made a decision to buy such shares, most likely you would want to know, who are the other investors in this REIT? What percent does each of them own, and are they the sort of owners who are likely to hold for the long term and exercise their voting rights wisely, or are they short-term holders and individuals whose motives and time horizonsyou cannot speculate about?The composition of shareholders would alter your view of the value of the shares on offer. It would reflectyour perceptions of thequality of the investment,your expectationsthat (for instance)many shareholders might sell their shares over the short-medium term if the economy weakens, and the chances of the company's obtaining additional financing (and the likelyterms of such financing) from the market in the future.
If full data on all large holders were available on a quarterly basis, share values could be analyzed in this way. But as things stand now,only a handful of large investment banks and securities firmshave a rough ideawhether the shareholder composition of a company seems to bechanging for the worse, e.g.over the past six months. They (and perhaps their best customers), but not the general public, can use this information. If they tell the company, insiders can use this information, but not the market of general investors.
Similarly, the market for corporate control is presently rendered less effective because withoutmore transparency about ultimate beneficial holder who make sell decisions,it is difficult forwould-be acquirors to confirm what premium level will be deemed suficient. This contributes to a tendency to overpay for acquisitions.
On the flip side of the coin, if voting records for a wider group than the US definition of investment advisor were made public, virtually all large investors would be subject togreater scrutiny by shareholder, beneficiaries and the general public. Institutionaland hedge fund investors alike would have to live by their records,rather thanhiding behind a curtain of legal title.
We often talk about the fact that large institutional holders should engage in more responsible investing and voting practices, withoutconsidering that ourassumed immutablesystem separating legal title from beneficial title, which creates billions of dollars of profit for arelatively small number of custodian banks each year, results in alack of transparency that makes it extremely easyto engage in investing practices that are less than fully responsible in sense of ESG and voting practices. We oftencomplainabout the need for greater attention tofiduciary duty with respect to thevoting of shares, without noting that our very system to administer the ownership of those shares, makes it easy to be lax in that regard.
If the market could track information on both sides of the coin (who are the large holders? – and how do they vote?), it could not only price securities more efficiently, but there would arise third-party advisors to analyzeand rate(a) companies withregard to the quality of their shareholder base;and (b) investing institutions and funds with respect to the quality and type of their voting practices, with specific examples.
In this day and age of virtually limitless computing power, and considering that anot-so-largenumber of custodian banks already have all this information on their computers, the aforementioned suggeston would not seem at all impossible to implement.
But whenever I have suggested anything like this to a friend atan investing institution, I have almost had my head chopped off. I thnk there arethree predictiblereasonsfor this. First, custodian banks make huge money from their de factorole of hiding the identity of large holders. Second, institutions do not like anyone to know the details of how they voted if they can avoid it. (They talk about accountability by management, but cannot see that this is a case of the exact same accountability.) Third, index funds would face even larger burdens if they were forced to be even more careful with regard to the voting of shares.
This last reason is the only possibly justifiable one, and requires some thought; all the more so becausethe proportion of indexed funds is set to increase over the next few decades. On the one hand, one can imagine that each company might have a separate class of non-voting shares, in which only indexed funds were eligible to invest. But this would unnecessarily inject instability into markets,because the number of voting shares mightdecline to the point where changes of control requiredmuch smallerfunding.It would seem better to continue to requireindex fund managers to vote all their sharesresponsibly,using the incentive of transparency as describe above.
I am interested in what others think about these ideas.