Introduction
Corporate governance involves the rules and processes by which companies are directed, ensuring transparency, accountability, and ethical conduct. It aims to balance the interests of stakeholders, including shareholders, employees, and customers. In India, institutional investors have gained significant influence over corporates as their investments in companies have grown. With this power, institutional investors have a fiduciary duty to actively monitor and influence corporate governance, ensuring long-term growth, sustainability, and ethical practices in their investee companies. They must manage investments for the benefit of all shareholders, balancing short-term returns with the long-term health of the company.
In addition to having significant stakes, institutional investors play a key role in voting at general meetings and raising important questions at board meetings (if they have a Board seat), ensuring that decisions align with the best interests of the company and its stakeholders.
Who are Institutional Investors?
Institutional investors are organizations such as mutual funds, pension funds, insurance companies, and foreign institutional investors (‘FIIs’), that pool large sums of money to invest in various assets. Owing to their significant stakes, they can inter alia influence corporate governance practices.
Role of Institutional Investors in Corporate Governance
Institutional investors have a significant role in shaping corporate governance by actively engaging with companies beyond just holding shares. Leveraging their substantial financial resources, expertise, and long-term investment horizons, they can influence company strategies and advocate for practices that foster sustainable value creation.
- Enhancing Board Accountability and Independence: A key responsibility of institutional investors is to enhance Board accountability and independence. They can advocate for transparent Board nominations and a diverse set of skills to ensure that Boards are competent, responsive, and act in the best interest of shareholders.
- Promoting Ethical Practices and Addressing ESG Issues: Institutional investors play a key role in encouraging ethical business practices and integrating Environmental, Social, and Governance (‘ESG’) factors into corporate strategies. By engaging with companies, they can promote strong corporate cultures, effective risk management, and sustainability, helping mitigate reputational risks and ensuring long-term value creation that aligns with global standards and societal expectations.
- Facilitating Shareholder Engagement: Institutional investors play an active role in shareholder engagement, participating in Annual General Meetings (AGMs) and other fore. They can raise critical questions, advocate for shareholders’ rights, and hold management accountable. Their engagement fosters a culture of transparency and responsiveness, ensuring that the interests of shareholders are effectively represented and addressed.
- Encouraging Long-Term Value Creation: Unlike short-term investors, institutional investors normally prioritize long-term value creation by advocating for sustainable growth strategies, focusing on capital allocation, executive compensation, and corporate planning. With their reasonably long-term investment horizons, they can engage with corporate boards to shape decisions that maximize shareholder value while emphasizing responsible growth.
- Balancing Power and Aligning Interests: Institutional investors play a crucial role in balancing power between management and shareholders. They monitor executive compensation and performance metrics to ensure that management’s interests align with those of shareholders. By advocating for transparent and fair governance structures, they help reduce agency conflicts and promote an equitable distribution of wealth.
- Shareholder Activism and the Role of Proxy Advisors: Shareholder activism has become an important strategy for institutional investors seeking to influence corporate governance. Activist investors often push for changes in strategy, leadership, and capital allocation to improve company performance. Proxy advisors play a significant role in this process, as they provide institutional investors with voting recommendations. This however should not lead to non-application of mind, and going by the Proxy advisories recommendations mechanically.
Institutional investors are also encouraged to be active participants in general meetings. Their involvement not only helps shape company decisions, but also sets an example for retail shareholders, who may look to institutional investors as role models when determining how to vote. By voting responsibly and asking the right questions at such meetings, they can signal to retail shareholders the types of issues to focus on, fostering a culture of informed and active participation in corporate governance.
- Monitoring Corporate Management: Institutional investors play a vital role in monitoring corporate management to ensure ethical practices, regulatory compliance, and long-term value creation. Their oversight includes evaluating company performance, industry impact, management quality, corporate governance, and ESG risks. Investors should establish a monitoring policy that varies based on investment size, with more active oversight for larger investments and limited involvement for smaller ones. Adherence to insider trading regulations is essential when seeking information for monitoring purposes.
- Promoting Transparency and Accountability: Institutional investors advocate for transparency in financial reporting and governance. They can pressure companies to meet regulatory disclosure requirements and hold them accountable for issues like related-party transactions, executive pay, and mismanagement. They can also engage with companies through investor and analyst calls, where they can seek clarifications, ask questions about financial performance, governance practices, and strategic decisions, and in the process, promote greater transparency. Their vigilance helps enhance corporate accountability, protect shareholder interests, and encourage more responsible and open business practices.
In addition to the roles mentioned above, institutional investors may, in some cases, secure a Board seat, granting them a more direct and influential role in governance. As a Director, the nominee can help actively shape corporate policies, oversee management, and hold management accountable. This level of involvement amplifies their ability to drive change.
The Stewardship Code: A Key Instrument for Institutional Investors
One of the most important frameworks that guides the role of institutional investors in corporate governance in India is the Stewardship Code. The Stewardship Code refers to a set of principles designed to encourage institutional investors to act in the best interests of the companies in which they invest, and by extension, in the best interests of all stakeholders.
In India, the Securities and Exchange Board of India (‘SEBI’) introduced the Stewardship Code in 2020, to enhance institutional investors’ roles in improving corporate governance and aligning their actions with sustainable, long-term value creation. The Code emphasizes transparency, active engagement with companies, and continuous monitoring of investments.
In addition to SEBI’s Code, other regulatory bodies in India, such as the Insurance Regulatory and Development Authority of India (‘IRDAI’) and the Pension Fund Regulatory and Development Authority (‘PFRDA’) have also introduced stewardship-related guidelines for their respective sectors. These guidelines aim to ensure that institutional investors in insurance, pension funds, and other segments take a responsible, long-term approach to governance. Together, these frameworks promote a culture of ethical investing, greater accountability, and alignment with the interests of stakeholders and society at large.
Impact of the Stewardship Code
The Stewardship Code in India promotes active engagement by institutional investors with companies. It encourages responsible voting rights and requires transparency through the disclosure of voting practices and investment policies. The Code also stresses continuous monitoring of portfolio companies’ financial and governance standards. Institutional investors are now required to disclose their engagement activities, enhancing transparency in their role as stewards of capital.
Challenges and the Road Ahead
Institutional investors encounter various challenges in their role as influential players in corporate governance. Some of these are
- Implementation of the Stewardship Code: The Stewardship Code is mandated by Regulators in India, but its full implementation is still evolving. Many institutional investors are still in the process of adopting and adhering to the Code, which has led to some inconsistencies in practice.
- Balancing ESG and Financial Goals: Integrating ESG factors into investment strategies may require balancing with financial returns. Some investors struggle to assess long-term ESG risks and opportunities, especially when facing resistance from companies reluctant to adopt ESG practices. Engagement with companies, to explain to them the importance of ESG, is a likely way forward.
- Lack of Transparency: Institutional investors may face challenges in obtaining accurate, timely information from the companies they invest in, which can hinder their ability to monitor performance, governance, and risk factors effectively. To combat this, they can push for improved disclosures and greater transparency from companies.
- Complex Global Regulations: Institutional investors with a diverse, global portfolio, may encounter challenges in navigating different regulatory environments and varying standards for corporate governance and reporting across countries. The bigger investors can set up teams that monitor cross-border governance and compliance frameworks to navigate diverse regulations.
- Agency Conflicts: Agency capitalism, where institutional investors may prioritize their interests over those of other stakeholders, creates potential conflicts of interest. Misalignment of incentives can lead to short-term thinking, potentially undermining long-term shareholder value.
To address agency conflicts, institutional investors can implement performance-based compensation, align strategies with beneficiaries’ long-term goals, and foster accountability and transparency within their organizations.
Conclusion
Institutional investors play a critical role in shaping corporate governance in India, driving positive change. While obstacles remain, the growing emphasis on governance, transparency, ESG, sustainable investing and stakeholder interests presents an opportunity for them to continue influencing corporate behaviour.
Muskan Saxena