The Role of Institutional Investors in Voting: Evidence from the Securities Lending Market

• DOI: http://doi.org/10.1111/jofi.12284
• Published date: 01 October 2015
• Author: PEDRO A. C. SAFFI,REENA AGGARWAL,JASON STURGESS
• Date: 01 October 2015

THE JOURNAL OF FINANCE •VOL. LXX, NO. 5 •OCTOBER 2015

The Role of Institutional Investors in Voting:

Evidence from the Securities Lending Market

REENA AGGARWAL, PEDRO A. C. SAFFI, and JASON STURGESS∗

ABSTRACT

This paper investigates voting preferences of institutional investors using the unique

setting of the securities lending market. Investors restrict lendable supply and/or

recall loaned shares prior to the proxy record date to exercise voting rights. Recall

is higher for investors with greater incentives to monitor, for firms with poor perfor-

mance or weak governance, and for proposals where returns to governance are likely

higher. At the subsequent vote, recall is associated with less support for management

and more support for shareholder proposals. Our results indicate that institutions

value their vote and use the proxy process to affect corporate governance.

Understanding institutional investors’ preferences regarding governance is

important for firms that are trying to attract new investors and for policy

makers considering the regulation of governance mechanisms. However, the

∗Reena Aggarwal is at the McDonough School of Business, Georgetown University. Pedro A. C.

Saffi is at the Judge School of Business, Cambridge University. Jason Sturgess is at the Driehaus

College of Business, DePaul University. We thank Cam Harvey (the Editor), an anonymous As-

sociate Editor, and two anonymous referees for excellent comments. We thank Alon Brav, Susan

Christoffersen, Isil Erel, Richard Evans, Slava Fos, Stuart Gillan, Mireia Gin´

e, Denis Gromb,

Steve Kaplan, Jose Liberti, Gregor Matvos, David Musto, Lee Pinkowitz, Adam Reed, David Ross,

Astrid Schornick, Laura Starks and David Yermack,as well as seminar participants at the Federal

Reserve Board, U.S. Securities and Exchange Commission, 10th Cambridge–Princeton Meeting,

ICGN 2014 Academic Meeting, 3rd Annual RMA–UNC Academic Forum for Securities Lending Re-

search, American Finance Association 2013, European Finance Association 2011, Western Finance

Association 2011, FMA Asia 2011, Drexel Conference on Corporate Governance 2011, DePaul Uni-

versity, Georgetown University, IESE, Universit`

a Cattolica del Sacro Cuore, Comisi´

on Nacional

del Mercado de Valores,London School of Economics, Temple University, University of Cambridge,

Queen Mary, University of Maryland, University of Texas at Austin, Imperial College, INSEAD,

University of Sydney,UNSW Australia, Singapore Management University, National University of

Singapore, Nanyang Technological University, and HKUST, for helpful comments. Conversations

with several industry participants, in particular, Les Nelson of Goldman Sachs and Judith Polzer

of J.P.Morgan helped us understand the workings of the securities lending market. Doria Xu and

Jiayang Yu provided excellent research assistance. We gratefully acknowledge a grant from the

Q Group. Saffi acknowledges support from the Spanish Ministry of Science and Innovation under

ECO2008-05155 at the Public-Private Sector Research Center at IESE. Aggarwal acknowledges

support from the Robert E. McDonough endowment at Georgetown University’s McDonough School

of Business.

DOI: 10.1111/jofi.12284

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2310 The Journal of Finance R

mechanisms used by institutional investors to influence corporate governance

tend to be private and difficult to study.

One key mechanism through which institutional investors can exert influ-

ence is the proxy voting process. In this paper, we use the unique setting of

the securities lending market to study the conditions that prompt institutional

investors to influence firm-level governance and the extent to which investors

use the proxy voting process to exercise their influence. Most large pension

funds, mutual funds, and other institutional investors have a lending program

and consider it an important source of revenue, with estimates of $800 million

in annual revenue for pension funds.1Equity lending transfers voting rights

to the borrower, typically hedge funds, and hence lenders cannot vote shares

that are on loan on the voting record date.2Institutions must therefore de-

cide whether to recall shares or to make shares available for borrowing for an

associated fee and the transfer of voting rights.

Our study uses a comprehensive daily data set that comprises lendable sup-

ply, shares on loan, and the associated borrowing fee for the period 2007–2009.

Lendable supply measures the shares made available for lending by investors

with long positions in the stock, and shares on loan measures borrowing de-

mand, which is the quantity actually lent out. We find a marked reduction in

the lendable supply prior to the proxy record date and an increase in borrowing

demand and the borrowing fee around the record date. Lendable supply returns

to normal levels immediately after the record date. These patterns are consis-

tent with institutions restricting and/or recalling their loaned shares to exercise

their voting rights and resuming lending immediately after the record date.

Our main findings are as follows. First, analyzing the lendable supply

dynamics of the equity lending market around voting record dates reveals

that institutional investors recall shares to retain voting rights.3This finding

suggests that institutional investors value the right to vote and use the

proxy process as an important channel for affecting corporate governance.

In addition, we show that borrowing demand and the borrowing fee increase

around the record day.Second, we find that not all institutional investors value

their voting rights in the same way, with considerable heterogeneity in their

preferences. Third, we show that the decision to recall shares on the voting

record date varies with firm and proposal characteristics, which typically

affect the value of control rights. Fourth, we find that lenders of shares place a

higher value on their vote than borrowers. Finally, we show that share recall is

associated with less support for management in the subsequent voting outcome.

1See http://www.ft.com/cms/s/0/5da3c26c-bd04-11df-954b-00144feab49a,dwp_uuid=571fa9ea-

b6a7-11db-8bc2-0000779e2340.html.

2The record date determines the ownership date for voting purposes. The record date is set prior

to the date of the shareholder meeting, when the voting takes place. Most states (for example,

California and Delaware) require that the record date be set at a maximum of 60 days and a

minimum of 10 days prior to the meeting; New York sets the maximum at 50 days.

3We use the terms “recall” and “restrict” interchangeably, capturing both the recall of shares

actually on loan, and a restriction on shares available to lend that have not been borrowed.

The Role of Institutional Investors in Voting 2311

The heterogeneity in share recalls suggests that institutional investors

systematically differ in their desire to exert governance via proxy voting.

Shleifer and Vishny (1986) model the blockholder’s free-rider problem and

show that the willingness of a shareholder to intervene increases with the size

of their stake and the value creation stemming from such intervention, but de-

creases with the cost of monitoring.4Thus, in the present context, institutional

investors should not be expected to recall shares en masse on all record dates.

Rather, the recall by institutional investors should differ along several di-

mensions including their ownership stake, investment philosophy, investment

time horizon, fiduciary responsibility, and ability or incentives to engage with

management and/or invest in the private information necessary to effectively

monitor (e.g., Maug (1998), Kahn and Winton (1998), and Edmans (2009)).

While we do not know the identity of the lenders and the borrowers, we

study the heterogeneity in investors’ voting preferences by observing the dif-

ferences in recall between firms that have a higher proportion of ownership

by certain types of investors. Based on institutional ownership categories used

previously in the literature (e.g., Bushee (1998,2001), Bushee and Goodman

(2007), and Chen, Harford, and Li (2007)), we examine aggregate blockhold-

ings (Maug (1998)) as well as the holdings of four types of investors: mutual

funds, banks and insurance companies, pensions and endowments, and long-

term investors. For aggregate blockholdings and each of the four institutional

investor categories, we find that the recall/restriction in lendable supply is

significantly higher for firms with higher ownership than for firms with low

ownership. When examining borrowing demand, the difference is never sta-

tistically significant. These results suggest that not all institutional investors

have the same motivation to be active in corporate governance.

We next examine asymmetric changes in lendable supply and borrowing

demand based on underlying firm characteristics and types of proposal on

the ballot. Firms with poor performance, weaker governance, and smaller size

exhibit a higher recall of shares on the record date. Additionally,recall is higher

for record dates associated with meetings that have important proposals on the

ballot related to nonroutine items, compensation, antitakeover, and corporate

control. For example, the recall effect is almost 40% higher for record dates with

corporate control–related proposals than those without. These results support

the hypothesis that shareholders value their vote and are keener to vote when

it is more “important” to do so.

When we examine the subsequent vote outcome, we find that higher recall

of lendable supply is associated with less support for management proposals,

such as those related to compensation and corporate control, and more support

for shareholder proposals. In additional tests, we focus on the voting behavior

of mutual funds, since these institutional investors provide a large fraction

of lendable supply. Mutual funds are significantly less likely to vote in favor

of contentious proposals where recall in lendable supply is greater and the

4Edmans (2014) surveys the literature on blockholders and discusses the different incentives

and costs faced by blockholders when deciding how to exert governance.