1. Chapter 11 Mutual Funds as Institutional Investors Viewing recommendations for Windows: Use the Arial TrueType font and set your screen area to at least 800 by 600 pixels with Colors set to Hi Color (16 bit). Viewing recommendations for Macintosh: Use the Arial TrueType font and set your monitor resolution to at least 800 by 600 pixels with Color Depth set to thousands of colors

2. Copyright © Houghton Mifflin Company. All rights reserved. 11–1 Who Are Institutional Investors? Mutual funds Pension funds Bank trust departments Insurance companies Endowments of universities and foundations

3. Copyright © Houghton Mifflin Company. All rights reserved. 11–2 Institutional Ownership by Size of Company

4. Copyright © Houghton Mifflin Company. All rights reserved. 11–3 Some Differences Between Investors

5. Copyright © Houghton Mifflin Company. All rights reserved. 11–4 Legal Framework of Corporate Governance Stockholders only indirectly control the company’s policies or business strategies though a board of directors and periodic votes (ballots, proxies) Why institutional investors still generally follow the “Wall Street Rule” –They are legally constrained from controlling public companies –Their fees do not support the time and resources involved in takeover fights –They hold too many stocks to participate actively in corporate management –They are experts in making portfolio investments, not in operating companies

6. Copyright © Houghton Mifflin Company. All rights reserved. 11–5 Legal Framework of Corporate Governance (cont.) What happens if investors decide to battle for control? –Company’s charters and by-laws delineate scope of shareholder activity in areas such as voting power and information access (subject to applicable laws) –May have to deal with anti-takeover measures (e.g., poison pill) –Federal securities laws establish disclosure obligations and procedural ground rules to level the playing field for all parties; also rules by organizations such as SEC, NYSE, and NASD

7. Copyright © Houghton Mifflin Company. All rights reserved. 11–6 Poison Pill (Shareholder Rights Plan) Definition –Company plan giving shareholders more rights after a “trigger” event Example –Right of every shareholder (other than theacquirer) to buy 1,000 shares of companystock at one cent per share Trigger –Anyone acquires more than specified percent of company’s voting stock (e.g., 15%) without approval of company’s board

8. Copyright © Houghton Mifflin Company. All rights reserved. 11–7 Voting Procedures for Mutual Funds Government agencies –SEC: No formal rule on proxy voting for mutual funds –DOL: Extensive set of letters and interpretations on proxy voting for ERISA fiduciaries Independent directors –Typically have reviewed/approved a set of voting guidelines used by the investment adviser to the funds –Investment adviser provides directors with annual summary report of fund votes

9. Copyright © Houghton Mifflin Company. All rights reserved. 11–8 Voting Procedures for Mutual Funds (cont.) Investment adviser –Adviser may form a special group dedicated to evaluating proxy votes or may use a third-party vendor –Most proxies involve routine votes; non- routine votes handled by board guidelines or adviser’s officials

10. Copyright © Houghton Mifflin Company. All rights reserved. 11–9 Types of Shareholder Activism Goals of various groups seeking to implement corporate governance –Governance structure of company is improved –Price of company’s stock goes up –For green or socially responsible funds company improves its environmental approach or achieves targeted policies

11. Copyright © Houghton Mifflin Company. All rights reserved. 11–10 Benefits of Activism by Level Higher benefit/most likely to lead to higher stock price –Mergers –Tender offers Lower benefit/least likely to lead to higher stock price –Many procedural changes in corporate governance –Example: appointing an outside chairperson separate from the CEO In the middle: long-term benefits to shareholders –Restructuring executive compensation –Electing a majority of independent directors

12. Copyright © Houghton Mifflin Company. All rights reserved. 11–11 Cost of Strategies Higher cost strategies –Categories Tender offers Proxy fights Director nominations –Legal issues May require filing extensive documents with the SEC Exposure to potential lawsuits Lower cost strategies –Categories Shareholder resolutions Letters to outside directors Informal discussions with management –Legal issues Company must include shareholder resolutions, along with supporting statements in its proxy statement sent to all shareholders Shareholder must file form 13D with the SEC if deemed to be acting in concert with other shareholders holding 5% or more of company’s voting stock

13. Copyright © Houghton Mifflin Company. All rights reserved. 11–12 General Guidelines for Choosing Strategies Generally use low-cost strategies because it is difficult to predict benefits of activism If activist on an issue not involving stock price, use only lowest cost strategies If activist on an issue involving stock price, use higher cost strategies only in exceptional circumstances

14. Copyright © Houghton Mifflin Company. All rights reserved. 11–13 Strategies of Index Funds Index funds as passive shareholders –Extremely low management fees do not allow for large investment staff –Most benefits of activism will go to other shareholders of companies in the index –No relative benefit to fund’s performance Index funds as active shareholders –Well positioned because stakeholder in most important U.S. companies –Improving U.S. corporate governance can bring benefits to all companies in the index –Absolute benefit to fund’s performance

15. Copyright © Houghton Mifflin Company. All rights reserved. 11–14 Corporate Governance Outside the U.S. Institutional investors may face the following in corporate governance for stocks owned outside the U.S. –Dominant shareholder groups –Legal relationships between company board and shareholders that limit rights of minority shareholders –Inadequate proxy disclosure –Other operational and logistical challenges to exercising shareholder rights

16. Copyright © Houghton Mifflin Company. All rights reserved. 11–15 Corporate Governance Outside the U.S. (cont.) Recent improvements –In Europe, Euro zone has quickened pace of cross-border mergers and led to a more shareholder-friendly environment –Leaders in many countries have realized they must improve corporate governance process to attract equity capital and improve investment returns –Industry group and multilateral agencies are supporting improvements and adopting “best practices” codes