The Role of Institutional Investors within Public Limited Companies in the UK - Coursework Example

The Role of Institutional Investors within Public Limited Companies in the UK Name Professor City and State Date The Role of Institutional Investors within Public Limited Companies in the UK Within the public limited companies in the UK, there has been an increasingly imperative external control means influencing their governance-the materialization of institutional investors as owners of equity in the company. For the last twenty years, institutional investors play an integral part in monitoring the corporate governance of public limited companies; they have the capacity to control the management activities openly via their company share as well as indirectly through shares trading. Such an indirect control is relatively strong, for example, the investors may act collectively to pass up investing in a certain corporation, and this may raise the cost of capital for the company. The institutional investors also play a major in floatation’s and take-over mergers. The institutional investors have thus become an important, if not majority, constituent of equity markets. The Assets that institutional investors hold in the UK have increased and this means that although the institutional investors might not a very major role in markets, their plans have managed to control the financial investments of companies and consequently the capital markets in the economies. Institutional have the ability to influence the action of companies because of their very size. According to Hampel Report (1997), 60% of UK companies, listed shares belong to UK institutions and thus is apparent from this that discussions of the shareholders role in corporate control mostly concern these institutions. Institutional investors are accountable for the owners of the funds in which they invest. The institutional investing arrangement, which exist in the UK, means that fund managers rather than the beneficial owners invest funds. The institutional investors thus have a duty to maximize their investment returns. They are the major actors in the financial markets and they have grown in size and importance. Pension funds as well as insurance companies form the largest segment of the institutional market with about 90 percent in the UK (Mallin 2006). These two major types of investors are of particular importance because they offer a potential source of large funds. Moreover, the institutional investors provide a more stable source of finance than other non-bank private sources of funds because their investment is mostly in longer-term assets. The pension funds and life insurance companies which households increasingly use as a means for saving more willingly than as a vehicle for transferring risk, have long-term liabilities. These investors thus usually tend to hold long-term assets to match these liabilities. Institutional investors clearly serve a significant role in mobilizing resources in the UK. The assets of the UK institutional investors have increased as a fast rate. Pension funds and insurance company assets have increased by over 300 percent during the last ten tears (Mallin 2006). The institutional investors pool the funds of the market participants and use the funds to buy a portfolio of financial assets. Institutional investors are a source of funds for public limited companies. They invest their capital through private equity funds indirectly. They provide such capital to the companies with the intention of realizing risk-adjusted returns, which surpass the ones possible in the stock markets. The public companied surrender a part venture in the company in return for investment and the transaction generally include one or more positions as a board of director(s) (Noe 2002). Since they are a major source of fund in the company, the institutional investors have a lot of influence in the public companies management as they are entitled to exercise their voting rights. They can choose to take part in the corporate governance actively and they have the freedom to buy and sell shares. Influencing the conduct of the public companies and offering them capital are all part of the institutional investors. The investors play a major role in UK capital market, as they own approximately 70 per cent of the equity in Britain large companies (Mallin 2006). Critics of the current situation in the UK usually identify the stock market as an important culprit and often single out organisational investors like funds from pension, unit trusts as well as insurance frims for particular blame (Mullin, 2006). The stock market is a major feature of the UK economy; largely than in the case of Japan and Germany, shares in Britain are larger, companies are publicly quoted (Mallin 1995). Pension funds and unit funds suffer from a short-term myopia, which is evident in various ways (Cheffins 1997). There is for instance, a lack of patience, illustrated by a tendency to look at a company’s newly announced financial results and then hurries to buy or sell shares accordingly by the institutional investors. The second manifestation of institutional investor short-terminism is the lack of a sufficient sense of responsibility or commitment to companies. The approach, which institutional investors allegedly take in response to a takeover bid, further reinforces the impression that they do not take responsibility for companies. With such transactions, a bidder offers to purchase shares in a target company at a substantial premium to the existing market price. Apparently, institutional investors are keen to accept such offers and often make a quick profit- they fail to give much thought to the possibility that such plans with a bidder may have to bring in a new management team or orchestrate a re-organization of the target operations. This short-termist short-sightedness seems to afflict unit trust, pension funds, and similar investors. Executives in UK public companies are usually under pressure contemplating entering into a commercial relationship, which is likely to be highly beneficial for all involved. The existing viewpoint in the market is that the temporary view by the institutional investors is usually related to negative upshots whereas long-term view is considered to lead to positive upshots. Gaspar et al. (2004) demonstrated that short-term investors are more commonly allied to acquisitions and mergers, which enable executives to carry on with value-reducing attainments or to negotiate for personal gains such as empire building and job security at the expense of shareholders return. Companies with numerous short-term investors are increasingly apt to obtain acquisition bit although attain lower payments. This comes about as executives are poorly monitored by funds that have short-term frames. The timeframe given by the owners influence the activities of the bidder companies’. Various constrains limit capital availability for long term investing in public companies (World Economic Forum 2011). These constrains include the need for the investors to trust in a long-standing investment plan. Secondly, the objective and goal of the decision makers may not be in line with the one related to the investment fund beneficiaries partly because of skewed compensation schemes, career considerations, and measures which fine executives who support long-term ventures. The third constrain lies in the fact that behaviour biases favouring short-term decisions are stronger; the long-term shareholder may be resource light when it comes to budget as well as professional in relation to other shareholders. According to Haldane & Davies (2011), the meaning of long-term investor outlook has considerably become shorter in capital markets. The two further argued that short-terminism is equally economically and statistically important in “capital markets” and it appeared to be increasing in the United Kingdom. Five years and old cash flows are discounted at rates more suitable for over eight years and as a result, ten year ahead cash flows are charged as if over sixteen years forward and the ones that are over thirty years ahead are rarely valued in any way. This means that long is short. The preference for investment by the institutional investors is returning to a shorter period. Haldane & Davies (2011) hypothesize that this marks a market failure as it results in too low investments and suffering of long duration projects. This shows that the fact that institutional investors are the major source of funds for the public limited companies in the UK influences the companies’ investment decisions. The short terminism by institutional investor limit the companies’ investments. The Institutional investors within public limited companies affect the management structure. As noted earlier, institutional investors have a relatively larger share in the company and thus they are given the right to take part decision making within the company. The institutional investors influence the management activities through this ownership and indirectly by trading their shares. Institutional investors are dominant shareholders in public company and thus have various rights, including the right to take part in election of Board of Directors. The Board is usually the shareholders’ representative and thus has the duty of monitoring executives as well as their activities. In case the institutional investors-as shareholders- become discontented with the performance of the board as well as of the company, they can choose to trade their shares, hold them or air their discontent or preserve their shares and remain passive. Hirschman (1971) (cited in Mallin 2006) referred to the three decisions by institutional investors as exit, voice, and loyalty. Most institutional investors choose to exercise their voice and engage in the company monitoring relative to simply exiting or remaining loyal to management decisions. In this case, the institutional investor plays an active role in monitoring the activities of the company. Shareholder activism particularly the function of dynamic institutional investors is at the heart of enforcing and redefining superior corporate governance. Their suggestions bring about economic welfare and entrepreneurship. By pressurizing for improved corporate governance, a vast increase in profits is feasible for the public companies. In most public companies, large institutional investors dominate the ownership structures and thus they are involved in control and monitoring activities, which limits corporate problems (Noe 2002). The minor shareholders gain from the acts of a monitoring institutional investor without sustaining any expenses; just large investors who hold significant motivations to watch over the management and company activities. Kaplan and Minton (1994) noted the presence of a larger shareholder is allied to elevated organization turnover and the shareholders offer a supervision purpose. In addition, Bertrand and Mullainathan (2001) also observed that such a shareholder on a company board is connected to better management of compensation of executives. Hutchinson (1995) argued that investor pitch their ten with specific policies which suite them-the clientele effect of dividend policy. UK has relatively good corporate governance with institutional investors as prominent block holders, such as pension funds. The investment institutions have realized that passive shareholding is not the route to shareholder wealth maximization. The actions of Hernes and Governance for Owners in the UK have shown that active shareholding and involvement in the investee company can be financially rewarding (Mallin 2006). Through portfolio investment, they are discharging accountability primarily to their own clients and the society as a whole. In terms of voting, the institutional investors vote in favour or against the incumbent management. A signal of strong disapproval is evidenced when institutional investors vote against the incumbent management. Most of the incidences of voting against tend to relate to executive remuneration. For instance the shareholders of United Business Media (UBM) voted against an ex gratia payment for an outgoing CEO after a successful handover to a new CEO as his successor. The remuneration committee of UBM had agreed to pay Lord Hollick, the outgoing CEO 250,000 pounds in recognition of a successful handover to his successor. However, a number of institutional investors felt that the amount was not appropriate. Seventy seven percent of shareholders including numerous large institution investors voted against the Remuneration Committee Report, thus showing their dissatisfaction with the proposed payment. Lord Hollick decided not to accept the payment because of the message sent by the institutional investors and other shareholders. By doing this, the institutional investors proved that they could exert power and influence through the advisory vote on the committee report. The relationship between the institutional investors and control techniques present a bilateral aspect, as there are techniques for acquisition and cession of control that can be hostile or friendly and since the institutional investors can be passive or active subjects of corporate control and can exercise their control directly and indirectly. The intervention of institutional investors in the company governance creates a gap in the relationship between property and control The second example of institutional control over company decisions was reflected in the Royal Dutch Shell where the institutional investors and other shareholder voted against the proposed payment of discretionary awards to the executive directors as the company failed to meet its targets. The growth of institutional investors and the significant power and influence, which they can exert on the public companies, shows that institutional investors engage fully to ensure that best practice corporate governance is followed. The institutional investors also play a major role in mergers and acquisitions. Mergers and acquisitions are relatively important in reallocating corporate control. The institutional investors in public companies have also been playing an important role in determining takeover outcomes. Their votes are credited with determining the high stake contests outcomes. For instance, during the largest ever-takeover battle between Vodafone (UK) for Mannesmann (DE) - Mannesmann was reported to have been held by a large number of institutional investors and the battle for shareholder support by the bidder and management was mostly focused on this investor group: foreign investors held Over 60 percent of Mannesmann (Hopner & Gregory 2004). Some of the major acquisitions and mergers in history with all industry and field major players contesting for another in an endeavour at global supremacy took place between 2000 and 2009. The start of the decade witnessed some of the major agreements on paper still amid “American Online Inc (AOL) and Time Warner.” AOL publicized its takeover of Time Warner in a $164 billion transaction. At the time the merger was announced, a number of institutional investors held significant shares of stock in the two companies. The merger was completed with an exchange of stock in which one AOL share would be exchanged for one AOL Time Warner Share and one Time Warner share exchanged for 1.5 new shares in the merged companies (Verma, 2006). The companies expected the news shares to climb in the continuing bull market and therefore maintain the premium paid for the old shares. The institutional investors were only interested in the holdings rise in price and were not concerned with any write-off as far as the share price did not fall. The investors expected that the merger would produce a major player in a new economy, in which the use of the internet and digital technology would produce productivity gains and earnings without end. However, this was not the case and the company shares fell to the lowest level possible. The AOL-Time Warner stock was less 70% by 2001(Verma 2006). The institutional investors were concerned with sound financial results and failed to look at the structural and indirect influenced in context. The executives of the two parties annoyed big organisational investors through mission development targets as well as turning financial accounts to present their performance improved than it was. Adding to these tension were new questions about AOL accounting practices. The merger between the two suffered from a defective tactical foundation by the institutional investors as well as post-merger integration failures (Verma 2006). The second merger in 2003 was between Pfizer Inc and Pharmacia Corporation. Pfizer made a formal announcement concerning the attainment of Pharmacia Corporation at a price of $55 billion in an enhanced trial to enlarge the base for its product and come up with new medicines. As a team, they made the globe’s quickest developing as well as most worthy firms. Currently, Pfizer is the global leader in research-founded pharmaceutical firm. This merger is a reflection that keeping stronger ties with institutional investors who own large numbers of stock is important for most companies. The merger met the investors’ expectations in terms of numbers and candid and frequent communications: the company has nearly two and a half million shareholders, however most of the shares are owned by a small number of institutions through pension funds and mutual funds. The company decisions to buy, sell, or hold larger number of Pfizer shares puts them in a good position to influence the overall direction of the stock prices. The larger institutional shareholder base increases the returns going to the target firm shareholders. The institutional investor presence is positively associated with the merger premiums. The third merger took place between Royal Dutch Petroleum and Shell Transport & Trading. The two firms combined to form the Royal Dutch Shell. The firm requested investors to steer in a period of “one company, one board, and one chief executive.” Following the merge, Shell realised an increase in profits and emerged among the six super majors “(vertically integrated private sector oil exploration, natural gas, and petroleum product marketing companies)” together with Chevron as well as ExxonMobil who were meant to be a super merger. Shell’s operations is currently in 140 nations, it is on the FTSE 100, and was recorded as the globe’s largest corporation in 2009 by Fortune and the globe’s second largest company by Forbes. The merger between the two companies arose after a group crisis resulted from miscalculation of gas and oil reserves. The institutional investors welcomed the idea of the merger and viewed the proposed governance structure positively. The unified board structure would offer more effective communication channels as well as decision-making processes. The simplified structure of the board would allow a more accountable and transparent to both UK and Dutch stock shareholders. The institutional investors accepted the merger as it was better than the earlier arrangement and the structure of the new company would be more aligned to best practice and the shareholders guidelines. The merger has so far yielded fruits for the investors. From the reviewed mergers, it is evident that the most interesting merger formula is absorption. In mergers by absorption, institutional investors are situated in an active-passive double role, for instance, as absorbed companied or as absorbing companies. Institutional investors account for approximately one-half and in most cases more than half, of the equity holdings of the large corporations. Given the significant holdings, they account for together with that a reduced number of institutions may control larger percentage of company stocks, these investors are key success in success before and after a merger. Smaller individual shareholders are naturally apathetic, given their share of ownership in the company; however, larger institution shareholders are increasingly dominating the equity markets and command more than half of outstanding shares of a company. Institutional investors pool the funds of market participant and use the funds to purchase a portfolio of financial assets in public limited companies in the UK. In public companies, the institutional investors influence takeover outcomes because they hold a large percentage of the company assets. Because the investors are a major source of finance and hold majority shares in the public limited companies, they influence their management structure, floatation, takeover mergers, and corporate governance. 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