Research depicts potential of stewardship codes as shareholder engagement booster

The introduction of stewardship codes could empower shareholders by emphasising their roles as stewards of companies and contribute to the creation of an adequate environment for engagement, academic research published this month has found.

The study – Institutional Investor Engagement: How to Create a Stewardship Culture – is a comparative analysis of 16 jurisdictions conducted by Mark Fenwick, Professor of Law at Japan’s Kyushu University and Erik Vermeulen, Professor of Business and Financial Law at Tilburg University in the Netherlands.

The paper, which examines the effect of regulation on institutional investor behaviour, argues that regulation in a “less formal mode – via a process of spotlighting – can play a crucial role in fostering” such a stewardship culture.

The authors use a framework of four types of regulatory measures to categorise institutional investor engagement.

First, measures that “enable” engagement (e.g. general and special shareholder rights); second, measures that “support” engagement (e.g. company disclosure and investor coordination); third, measures that “require” engagement (e.g. board composition and remuneration); and fourth, measures that “encourage” engagement (e.g. voting policies and codes).

Regarding voting policies, the study differentiates between three types. First: private guidelines adopted by institutional investors themselves.

Second: voting guidelines developed by industry bodies. For example, Binding Standard No13 of the Australian Financial Services Council which prohibits its members to adopt a “no engagement” approach.Third: additional requirements by law or regulations. The authors offer the example of Israel, where institutional investors have a duty to participate in AGMs and to allocate adequate resources to monitor companies in which they invest as part of their fiduciary duty to earn the highest possible returns.

When it comes to stewardship codes, they are described as measures that target investors’ own governance that represent an “attempt to create more responsible and purposeful investor engagement” and can “assist in detecting blind spots in strategy” of companies.

Similarly, the authors distinguish between the codes that are the result of private initiatives at industry level, and those that were drafted by regulators (such as the ones in the UK, Japan and Korea). The former are more numerous, such as the 2017 Principles of the Investor Stewardship Group in the US.

According to Fenwick and Vermeulen, regulator-drafted codes present several advantages: in addition to economies of scale, they suggest, the publicity of the drafting process reduces the information costs for potential users of the guidelines.

They argue that “a proliferation of codes is likely to further stimulate discussion and feedback leading to the cross-fertilization and refinement in the practice of “stewardship engagement”.

However, they recommend a careful approach to “sanctioning ‘non-compliance’ at this stage.

Fenwick and Vermeulen conclude: “A mandatory application of the codes’ provisions and best practices could have the counter-productive effect of stimulating more ‘reactive engagement’ (instead of encouraging ‘stewardship engagement’).”