As institutional investors have engaged in various forms of corporate governance activity for more than 15 years, the question of whether such activities add value is increasingly being asked. A persuasive argument in favor of taking active ownership positions emerges from collected empirical research on corporate governance and other forms of ownership activity.
Consider any one of the following events: A large public pension fund adds a firm to its list of underperformers. A firm announces the adoption of a poison pill. Management, employees, and directors all increase their ownership stakes in a firm. A majority of outside directors is elected to a corporate board. Institutional investors declare that they refuse to sell a firm's stock. Dissident shareholders announce an upcoming proxy contest.
Which of these activities is the beginning of a decline in a firm's stock price? Which signal a potential increase? Does ownership activity--by a firm's management, employees, or shareholders--add value? The Council of Institutional Investors, an association of public, corporate, and Taft-Hartley pension funds, has released the first summary of its kind to address these questions. "Does Ownership Add Value?" collects and summarizes 100 empirical studies which illustrate how topics ranging from dual-class voting structures to institutional investor monitoring of management affect a firm's investment potential.
The overwhelming majority of the studies present a strong case for the value of ownership activity, except where a firm appears to be insulating itself from market forces. The findings of nearly half of the 100 studies demonstrate a strong association between ownership activity and significant value gains, including stock price appreciation and increased financial performance. Numerous studies indicate that institutional investor monitoring of management, director, management and employee stock ownership, and proxy contests are associated with added value. Having independent directors on a board or eliminating dual classes of stock appears to add value as well.
Conversely, antitakeover amendments and legislation, the issuance of dual classes of equity, the presence of poison pills, any attempts to restrict shareholder rights, and other corporate defenses are associated, in many cases, with value losses.
Set forth below are some highlights from the studies which support the idea that ownership activity adds value. Please note that, as findings of academic empirical studies, these conclusions are conditioned to some degree on the sample size, reliability and accuracy of the performance measure, time period, methodology, and other factors.
Monitoring of Management by Institutional Investors and Outside Directors
1. Thirteen companies, which were identified by the California Public Employees' Retirement System (CalPERS) as taking positive management steps as a result of shareholder monitoring, underperform the S&P 500 by 63.5 percent in the five years prior to CalPERS involvement, and outperform the index by 89.1 percent in the five years after involvement (for companies where a five-year history is available).
2. Excess returns (the difference between company returns and S&P 500 returns) for 42 CalPERS targets are -66.4 percent for five years prior to CalPERS' involvement, and 41.3 percent for the five years after (for companies where a five-year history is available). Similar results are found over the six month period before and after CalPERS participated in shareholder proposals at 27 companies. Average excess returns are -9.3 percent prior to a proposal announcement and 3 percent following the initiative.
3. In Japanese firms, prior poor firm performance stabilizes and improves modestly after outside director appointments.
4. Non-negotiated investments designed to change a corporate policy or board representation, but not to take over the firm, are associated with a 30 percent net-of-market return relative to the S&P 500 and a 39 percent excess return relative to the Wilshire 5000.
5. Where dissidents defeat antitakeover campaigns in a countersolicitation proxy fight, share prices rise by 5 percent on average; where they lose and the amendment passes, share prices fall by 7 percent on average.
Employee, Management, and Director Stock Ownership
1. Companies with 10 percent or more employee shareholdings in an employee stock ownership plan (ESOP) had above-market returns each year from 1991-1993. The average stock price increases of 400 companies with ESOPs versus the S&P 500 were: 35.9 percent vs. 26.3 percent in 1991; 22.9 percent vs. 4.5 percent in 1992; 20.2 percent vs. 7.1 percent in 1993.
2. Managerial ownership of stock is significantly related to above-market returns of 23.4 percent in successful takeovers.
3. Out of the 1,000 largest U.S. companies (according to Covenant Investment Management, Inc., Chicago), those with the highest ownership stakes for officers and directors outperform the average returns for all companies by more than 300 basis points. Companies with the lowest ownership stakes for officers and directors underperform the average by 364 basis points.
4. There is a link between heightened equity ownership by outside directors and more effective executive compensation oversight. The greater the value of outside director holdings, the more likely it is that a company has <169>reasonable<170> compensation packages, according to a survey of 500 large firms' pay practices.
5. Higher managerial stock ownership reduces the likelihood that a firm will be the target of a control contest.
6. Firm efficiency rises as board ownership increases from 0 percent to 5 percent. At ownership levels above 25 percent, efficiency continues to rise, although more slowly.
Independent/Outside Director Presence
1. Over the year prior to the replacement of a CEO, firms dominated by insiders perform about 10 percent worse than firms with a majority of outsiders.
2. The appointment of an outside director is accompanied, on average, by statistically significant net-of-market returns (up to .7% for an outside director with financial experience).
3. Firms with a higher percentage of independent directors in the early part of the 1970s end up, on average, with superior performance measures later in the decade (relative to industry).
4. The two-year stock performance of U.K. companies without independent audit committees is 10 percent worse than the market average.
1. Stockholder wealth increases 4.9 percent when measured from the day before to the day after a Wall Street Journal report of dissident proxy activity; 18.8 percent when measured over the 40 days prior to and including the first public report of dissident activity; and 6.0 percent when recorded from the 40 days prior to the initiation of action until the contest outcome.
2. Positive share price performance is associated with election contests for board seats.
3. In proxy contests where dissidents lose a board seat, the stock performance of target firms improves relative to prior underperformance.
Dual Classes of Stock
1. Firms whose managers are protected by poison pill plans and dual-class voting structures perform worse than their industries--by 4.7 and 5 percentage points, respectively.
2. There is a statistically significant negative price effect of .82 percent surrounding the announcement of dual-class recapitalizations.
3. A decline of 14.6 percent occurs in the 60 days following the issuance of dual classes of common shares. These declines are attributable almost entirely to the restricted voting shares.
1. Firms with more restrictive corporate governance structures (poison pills, unequal voting rights plans, classified board plans and seven others) are significantly less likely to exhibit outstanding long-term performance relative to industry peers with less restrictive governance structures.
2. There is a negative (1 percent) effect on a firm's stock price surrounding the announcement of poison pill adoptions. Share values of firms with poison pills are lower, on average, than those of firms without pills.
3. Firms choosing to adopt poison pills experience significant negative returns (-.92 percent) relative to the market on the day the pill is announced. Firms that abandon plans to adopt a pill experience significant positive average net-of-market returns.
4. Firms with poison pills and blank check preferred stock are associated with negative performance on return on assets (a measure of current performance) and market-book ratio (an estimate of future performance), relative to other firms in their industries.
Antitakeover Amendments and Legislation
1. There is a negative 1 percent wealth effect for a sample of firms that adopt antitakeover amendments.
2. Announcements of state takeover legislation are associated with statistically significant decreases in participating firms' stock prices (-.29 percent for incorporated firms and -.24 percent for headquartered firms).
3. The market places a 25 percent lower market value on firms opting into the 1989 Pennsylvania takeover law.
4. For a sample of firms, there is an average loss of 1.25 percent around the announcement of various antitakeover amendments, including supermajority, authorization-of-preferred-stock, and classified board amendments.
5. In a sample of 126 firms, efforts to restrict cumulative voting are associated with negative stock price reactions (-.9 percent average returns). Eliminating cumulative voting is associated with -1.6 percent reduction in share price, and classifying the board is associated with a -1.3 percent reduction.
For further information or to obtain a copy of the complete summary for $25, contact the Council of Institutional Investors, 1730 Rhode Island Avenue, N.W., Washington, D.C. 20036 Phone (202-822-0800), Fax (202-822-0801), or the Council at