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Institutional investors are organisations like mutual funds, pension funds, insurance companies and foreign institutional investors (FIIs), that pool large sums of money for investing in companies. This gives them inter alia the power to influence the corporate governance practices.

Corporate governance refers to the processes that direct companies, facilitates transparency, checks accountability of management and their ethical conduct. It strives to create a balance between the varied interests of all stakeholders such as – shareholders, customers and employees. Over time, institutional investors have attained considerable influence over companies owing to their shareholding in such companies. And as with great power comes greater responsibility, it is their duty to actively oversee and shape corporate governance practices in the investee company, while simultaneously ensuring long-term growth and sustainability. Additionally, they must take the responsibility of managing investments in the best interests of all the shareholders. .

Apart from owning significant stakes in the investee companies, another vital role played by the institutional investors includes voting at general meetings, and asking relevant questions. This helps in ensuring that the decisions taken at the Board meetings align with the best interests of the company and other stakeholders. They must do so to promote shareholder democracy.

Role of Institutional Investors in Corporate Governance

Institutional investors play a vital role in moulding corporate governance by proactively collaborating with companies. By using their abundant financial resources, expertise and long-term investment outlook, they can structure the company’s strategy and promote practices that encourage sustainable growth.

1. Strengthen Board Accountability and Independence: One of the major responsibilities of the institutional investors is to help strengthen the Board accountability and its independence. They are the ones who can push for transparent Board nominations, and suggest skillsets to ensure that Boards are capable, responsive and always work towards the betterment of the shareholders.
2. Advocating Ethical Practices and Resolving ESG Issues : Institutional investors play an important role in fostering ethical business practices and incorporating ESG factors into corporate governance practices. By interacting with the companies, they can support corporate culture, ensure effective risk management and sustainability practices. They can also help with ensuring that long-term value is created in line with the global standards and the expectations of the society.
3. Enabling Shareholder Management and Activism: Institutional investors have a significant impact on shareholder democracy. They have the power to ask relevant questions, speak for shareholders’ rights and demand accountability from management. Their interactions result in transparency and accountability, which ensures that the shareholders’ interests is upheld. Active involvement of institutional investors has led to them being able to influence corporate governance. They act as activist investors who advocate for strategy improvement, leadership development and better fund allocation for the betterment of the company.
4. Promoting Long-Term Value Creation : Since the institutional investors are in for a long haul, they would always prefer long-term value creation by promoting sustainable growth strategies, paying attention to capital allocation, executives pay and corporate planning. With their relatively long-term investment strategies, they can collaborate with Boards to make decisions that would work in the best interests of the company and its stakeholders.
5. Managing Power and Aligning Interests: Institutional investors have a significant role to play in creating a balance of authority between the management and the shareholders. With their resources, they are at times better equipped to analyse resolutions. This ensures that management is not working against the shareholders’ interests.
6. Fostering transparency and Accountability : Institutional investors promote transparency in financial reporting. They can exert pressure on companies to meet the regulatory disclosure requirements and hold them responsible in cases of issues like related party transactions, executive remuneration or any kind of mismanagement. They can also interact with the companies to seek clarifications and enquire about the financial policies and other important decisions to support transparency. Their careful monitoring results in improving corporate accountability, safeguarding shareholders’ interests and other transparent business practices.

Additionally, the institutional investors may also end up securing a Board seat, allowing them to play a more influential role in governance. After becoming a Director, the nominee can play a significant part in shaping corporate policies and processes and in holding management accountable. The more the degree of involvement, the more their ability to bring change.

The Stewardship Code: A Key Instrument for Institutional Investors

The Stewardship Code is one of the key frameworks that defines the role of institutional investors in corporate governance in India. It is a set of rules that have been designed to encourage the institutional investors to prioritize the welfare of the companies they invest in.

In 2020, the Securities and Exchange Board of India (‘SEBI’) introduced the Stewardship Code to promote the role of institutional investors in strengthening corporate governance and aligning their actions with sustainable, long-term value creation. The Code focuses on transparency, active participation with companies and monitoring the investments constantly.

Apart from this Code by SEBI, other regulatory authorities in India, such as Insurance Regulatory and Development Authority of India (‘IRDAI’) and Pension Fund Regulatory and Development Authority (‘PFRDA’) have also initiated their segment specific stewardship-related guidelines.

Impact of such Stewardship Codes

The impact of Stewardship Codes in India is phenomenal. They advocate active interaction among institutional investors and investee companies. The Codes also promote responsible voting rights and demand transparent practices via disclosure of voting and investment policies.

Challenges and the Road Ahead

There are a number of challenges that institutional investors face in their role as influential players in corporate governance. Some of them include

1. Stewardship Code Implementation – Although the Stewardship Code has been mandated by Regulators in India, its complete implementation is still under process.
2. Striking a balance between ESG and Financial Goals – The incorporation of the ESG strategies in investment strategies would require a great amount of balance. Not all investors are capable of assessing long-term ESG risks and opportunities. This becomes more prominent when the companies show their reluctance to adopt ESG practices. Engagement with companies, to make them understand the importance of ESG, is a way out.
3. No Transparency – One of the major roadblocks of access to information is the lack of transparency by some companies. Quality of disclosures has to be improved.
4. Complicated Global Regulations : Where the institutional investors possess a diverse portfolio, they can come across various challenges while managing compliance across various regulations in different countries. Bigger investors have big teams to oversee cross-border compliance frameworks, but the smaller ones often grapple with this problem.
5. Agency Conflicts : In case the institutional investors put their interests first, over those of other stakeholders, a situation of conflict of interest would arise. Such misalignment would potentially affect the long-term shareholder value negatively. Accountability and transparency can go a long way.

Conclusion

Institutional investors play a vital role in developing corporate governance practices in India. They must however be more actively involved in raising questions and ensuring shareholder democracy.