Corporate Governance, Corporate Ownership, and the Role of Institutional Investors: A Global Perspective
Gillan, Stuart L., Starks, Laura T., Journal of Applied Finance
We examine the relation between corporate governance and ownership structure, focusing on the role of institutional investors. In many countries, institutional investors have become dominant players in the financial markets. We discuss the theoretical basis for, history of, and empirical evidence on institutional investor involvement in shareholder monitoring. We examine cross-country differences in ownership structures and the implications of these differences for institutional investor involvement in corporate governance. Although there may be some convergence in governance practices across countries over time, the endogenous nature of the interrelation among governance factors suggests that variation in governance structures will persist. [G30, G34]
* The need for corporate governance arises from the potential conflicts of interest among participants (stakeholders) in the corporate structure. These conflicts of interest, often referred to as agency problems, arise from two main sources. First, different participants have different goals and preferences. Second, the participants have imperfect information as to each others' actions, knowledge, and preferences. Berle and Means (1932) address these conflicts by examining the separation of corporate ownership from corporate management-commonly referred to as the separation of ownership and control. They note that this separation, absent other corporate governance mechanisms, provides executives with the ability to act in their own self-interest rather than in the interests of shareholders.1
However, executives' activities are potentially constrained by numerous factors that constitute and influence the governance of the corporations that they manage. These factors include the board of directors (who have the right to hire, fire, and compensate managers), financing agreements, laws and regulations, labor contracts, the market for corporate control, and even the competitive environment. In general terms, these factors can be thought of as either internal control mechanisms (such as the board) or external control mechanisms (such as the market for corporate control). An increasingly important external control mechanism affecting governance worldwide is the emergence of institutional investors as equity owners. Institutional investors have the potential to influence management's activities directly through their ownership, and indirectly by trading their shares. An institution's indirect influence can be quite strong. For instance, institutional investors may act as a group to avoid investing in a particular company, thereby increasing that company's cost of capital. In this paper we consider the role of institutional investors in corporate governance, the motivation for that role, and how the role has changed during the recent past.2
Before assessing the role of institutional investors in corporate governance, we must first define what we mean by the term, corporate governance. Recent research has viewed the concept in different ways. Gillan and Starks (1998) define corporate governance as "the system of laws, rules, and factors that control operations at a company." A firm's governance, they say, comprises the set of structures that provide boundaries for the firm's operations. This set of structures includes participants in corporate activities, such as managers, workers, and suppliers of capital; the returns to those participants; and the constraints under which they operate. Shleifer and Vishny (1997) define corporate governance in terms of the economic interests of the participants. In particular, they refer to corporate governance as dealing "...with the ways in which suppliers of finance to corporations assure themselves of getting a return on their investment." Similarly, Zingales (1998) defines corporate governance as "...the complex set of constraints that shape the ex-post bargaining over the quasi-rents generated by the firm."
As the corporate environment has changed, so too have corporate governance practices. …