The Role Of Institutional Investors In Coporarate Governance Of China’s Listed Companies

China’s concentrated ownership structure has long been criticized by academics at home and abroad.According to the classical Agency Theory,highly concentrated ownership structure will easily lead to majority shareholders’ tunneling,in which majority shareholders direct company assets or future business to them for personal gain at the expense of company and minority shareholders.So far,mountains of empirical research on the correlation between concentrated ownership structure and company value have been conducted,but researchers have not come to the unified conclusion.Many anecdote evidences also prove that there is a non-monotonic relation between ownership structure and corporate value.For example,Singapore ranks high in corporate governance though its ownership structure is relatively concentrated.As recognized,the shareholding structure in Japan is dispersed but there have been so many corporate scandals in recent years.All these indicate that corporate governance is an inclusive notion in which ownership structure,internal monitoring mechanisms,incentive compensation,regulation,judicial protection and etc.,are closely interactive.It is true that there is a high risk of tunneling activities in a company with concentrated shareholding structure,but if other corporate governance mechanism can work well,such as strong legal protection,the company can still achieve to a high level of corporate governance.It is well recognized that highly concentrated ownership structure is a root cause of China’s bad corporate governance,but this paper cannot completely agree with it.In fact,China’s concentrated ownership turns into a big problem because other corporate governance mechanisms are too weak,such as independent director and supervisor.In turn,concentrated ownership further weakens those corporate mechnism.The judicial protection,as a last resort,cannot effectively protect minority shareholders due to its dependence on governments which are key majority shareholders in China.While occasional institutional activism in China sheds a light on another monitoring mechanism to counterbalance majority shareholders and to improve China’s corporate governance.Though no unified conclusion has been achieved among academics about the effectiveness of institutional activism in China,a rising of institutional activism in China,such as 48 Fund Managers Against China Merchant Bank’s Proposal of 10 Billion Convertible Bond Issuance,Dacheng Fund Management Pushing for the Dismissal of the Chongqing Brewer’s Chairman,Yale Endowment Fund in collaboration with Penghua Fund to Nominate A Director Candidate for GREE,and etc.,and an increasingly significant role institutional investors are playing in China in an era of asset management suggest that institutional investors are able to and should play a positive role in China’s corporate governance.We need to rethink what kind of role institutional shareholders can play and how to facilitate and strengthen institutional engagement in corporate governance.In comparison to independent directors,supervisors and other shareholders,institutional shareholders are more capable and motivated to improve China’s corporate governance.First,unlike independent directors and supervisors,institutional shareholders are directly affected by the level of corporate governance.By expropriating the benefits of minority shareholders,majority extract control premiums for private benefits.Second,the cost of corporate engagement for institutions is not as high as known due to diversification and types of corporate issues they deal with.For institutions,especially those index fund,“vote by foot” is not always an ideal choice.Sometimes it can incur high cost.In addition,selling share,sometimes,can be restricted by policies in China.Diversification can enhance incentives to monitor by creating the potential of economics of scale in monitoring.Many process and structural issues arise in similar form at many companies.A shareholder who offer the same proposal at a number of companies can reduce her per-company solicitation cost,while preserving the per-company benefit from success.Third,the importance of institutional investors in the society assures their voice can be heard by the public,media,corporate management and regulator.In the era of asset management,institutional investors are able to pool huge amounts of public wealth together through all kinds of collective investment schemes and then distribute those fund to portfolio companies.It is actually a process of re-allocating social wealth.Fourth,frequent and closely communications between intuitions and regulators can not only help regulators make regulations in pragmatic way but also help enhance the enforcement of corporate governance rules.Theoretically,institutional investors are well motivated to and able to counterbalance the power of majority shareholders,but China’s institutional investors are often labeled “Institutional passivity”.This paper suggests that this label is not accurate because the model and characteristics of institutional engagement in China are not as well understood.Much of institutional oversight occur in an informal way.They usually make private dialogues with managers and majority shareholders to question them and voice concerns or suggestion rather than fight against them directly.They rarely vote against proposals without informing management in advance.In practice,when institutional investors are not satisfied with corporate proposals,they approach to management and majority shareholders first and negotiate with them to seek for their explanations or amended proposals or alternative solutions.Only when all these informal pressures fail,will they fight against management and majority shareholders.Such informal action is out of public view.That’s why institutional shareholders are often viewed by public as passive shareholders.Institutions prefer informal action not only because it is less costly and less confronting but also due to the highly-concentrated ownership structure in China.Due to the concentrated shareholding structure,institutions in China are limited to voice their opinions and monitor management and majority shareholders in an informal way.They cannot rely on independent directors,supervisors,market for corporate control and other corporate governance mechanism.They also need avoid confronting majority shareholders to protect themselves.Second,intuitions rarely put forward shareholder proposals,which is closely related to the rule which prescribes that shareholders who own or collectively own 3% shares can put forward proposals.Third,intuitional coalition is not often seen in China.On one hand,less concentrated institutional shareholdings due to legal restrictions on the percentage of institutional shareholdings makes institutional coalition costly;on the other hand,there are a lot of obstacles for institutions to coordinate in the absence of trade associations and proxy advisory firms in China.Fourth,it is rare for institutions to nominate director candidates.In fact,cumulative voting policy,which intends to help minority shareholders win a board seat,does not function well in China.Out of consideration of avoiding conflicts of interest and insider trading risk,institutional shareholders are less willing to nominate director candidates.Based on analysis aforementioned,this paper make some suggestions which may not be perfect.First,regulator can relax restrictions on institutional shareholding in a gradual and proper way.Second,it may be beneficial to set up trade associations and to grow proxy advisory market.China either independently establish its own proxy advisory firm or import foreign proxy advisory firm which can help China to establish its own ones.In this part,this paper also introduces Stewardship.Stewardship is a new mechanism to promote institutional engagement which was firstly established by UK then are followed by many countries,such as Japan,Canada,Italy and etc.This paper highly recommend that China should learn from UK Stewardship.The ideal of Stewardship is to bring responsible ownership into equity market,which are extremely important to be understood and performed by institutional investors in China.Additionally,“Comply or Explain” model in the execution of Stewardship Code is a more enlightened approach for Chinese regulators.In the era of asset management,China is advancing into the third stage of capitalism,an era of financial intermediaries,which has been articulated by Professor Robert Charles Clark in his insightful paper titled The Four Stages of Capitalism: Reflections on Investment Management Treaties.It is important for institutional investors to actively and responsibly engage in corporate governance.It will not only improve China’s corporate governance but also promote social wealth growth.