The Push towards Corporate Guidelines

In recent years, corporate scholars and policymakers have devoted a great deal of attention to explore how large institutional investors, mainly mutual funds, lack capabilities and incentives to invest in active corporate stewardship—defined as monitoring, voting and engagement—in their portfolio companies. However, little attention (if any at all) has been given to what I term ‘passive stewardship’, a term that reflects institutional investors’ use of corporate guidelines. These guidelines are being published by large institutional investors, such as BlackRock, Vanguard and State Street, and they reflect how these investors vote at shareholder meetings of their portfolio companies regarding various issues;  institutional investors’ guidelines address various matters including board composition, capital structure, mergers and acquisitions, executive compensation, shareholder protections and environmental and social issues. These guidelines also provide insights into investors’ priorities, views and philosophy regarding these corporate issues.

My recent article, ‘The Push Towards Corporate Guidelines’, aims to fill this void by exploring the growing use of corporate guidelines, explained by two main reasons.  First and foremost, they allow institutional investors to strike a balance between their strict fiduciary duties and their need to be cost-effective. On the one hand, it is important to understand that institutional investors are subject to legal and regulatory duties to vote in thousands of shareholder meetings in a way that reflects the best interests of their clients. This is a colossal burden. Relatedly, given their enormous power, institutional investors are expected to act as responsible ‘corporate citizens’. Hence, they cannot disregard their stewardship duties. On the other hand, institutional investors must also act cost-effectively, in the face of both fierce competition and the fact that active stewardship is very costly. Using low-cost measures such as corporate guidelines helps institutions maintain cost-effectiveness.

The second reason for the growing use of corporate guidelines is that the guidelines are considered a ‘soft’ device that does not seek to dictate specific governance structures. Guidelines designed by institutional investors typically reserve some degree of flexibility for the portfolio companies by allowing them to take into account their individual characteristics when complying with the guidelines, as long as they execute the holistic attitude stipulated by the guidelines. Put differently, institutional investors’ guidelines do not seek to dictate specific governance structures but rather defer to the structures chosen by corporations’ boards of directors, as long as they align with the investors’ philosophy. Consequently, corporate guidelines allow institutional investors to reduce the potential for confrontation with the managements of their portfolio companies and, thereby, reduce the risk of losing business ties with those companies or provoking a political backlash.

My paper also provides new empirical evidence showing the patterns of the use of corporate guidelines as a passive stewardship mechanism. Thus, companies that constitute the S&P 500 refer to corporate guidelines in their proxy statements. Such a reference to investors' corporate guidelines is made by corporations to communicate with their shareholders and other constituencies and to express their commitment to their largest investors and to good corporate governance. Corporations also make the same reference when they respond to shareholder proposals submitted for voting at the annual shareholder meeting. In addition, leading law firms that advise corporations refer to institutional investors' corporate guidelines and urge corporations to review and pay close attention to those guidelines. Lastly, even proxy advisory firms, which have become a major force in the corporate arena during the past two decades, rely upon institutional investors' guidelines when they assist investors in fulfilling their voting tasks.

Moreover, beyond the stand-alone and explicit use of institutional investors' guidelines, corporate guidelines may shape corporations’ governance regimes without being mentioned by companies in their proxy statements. When a corporation designs its own guidelines or adopts a certain governance arrangement, it might say it did so in line with industry best practices, rather than explicitly referring to specific institutional investors’ guidelines. Since corporate guidelines may initiate, accelerate and maintain an industry best practice, those guidelines may have influenced a corporation's governance regime although they were never explicitly mentioned. Empirical evidence supports this possibility where many corporations now declare that their board reviews the corporation's policies, frameworks and guidelines according to current and evolving best practices or emphasize that corporation's governance guidelines are aligned with best practices or that they are committed to best practices.

To sum up, my paper sheds new light on the guidelines' effectiveness as a governance tool that supplements institutional investors' traditional tools, such as voting and engaging with portfolio company managers.

Asaf Eckstein is an associate professor of corporate law at the Hebrew University of Jerusalem.