Institutional Investing When Shareholders Are Not Supreme

69 Pages Posted: 26 Mar 2015 Last revised: 26 May 2015

See all articles by Christopher Geczy

Christopher Geczy

University of Pennsylvania - The Wharton School, Finance Department

Jessica Jeffers

University of Chicago - Booth School of Business

David K. Musto

University of Pennsylvania - Finance Department

Anne M. Tucker

Georgia State University College of Law

Date Written: March 24, 2015

Abstract

Institutional investors, with trillions in assets under management, hold increasingly important stakes in public companies and fund individual retirement for many Americans, making institutional investors’ behaviors and preferences paramount determinants of capital allocations and the economy. In this paper, we examine high fiduciary duty institutions' (HFDIs') response to decreased profit maximization pressure as measured by the effect of constituency statutes on HFDI investment. We ask this question, in part, to anticipate HFDIs’ response to alternative purpose firms, like benefit corporations. Only with access to institutional investors’ capital can alternative purpose firms gain economic significance to rival the purely for-profit corporation.

In our empirical study, we ask whether decreased profit maximization pressure, as evidenced by expanded director discretion to pursue non-shareholder interests, affected HFDIs’ decision to invest (or remain invested) in firms incorporated in constituency statute states (constituency firms) because of a conflict, or perceived conflict, of fiduciary duties owed to beneficiaries and shareholders. HFDIs, as agency investors for their shareholders and beneficiaries, are subject to strict fiduciary duties, which among other things explicitly disallow, everything else equal, sacrificing monetary returns for other goals. We focus on HFDIs for our statistical analysis under the theory that any impact of fiduciary duties on investment behavior would be strongest among those subject to the strictest duties. In other words, if we were to see an effect at all between expanded duties and investment behavior, it would be most easily observable in HDFI.

Constituency statutes expand directors’ ability to consider non-profit maximizing goals similar to, although smaller than, the expansion of director prerogatives under alternative purpose firm legislation. Moreover, constituency statutes are particularly well-suited to an empirical study because 1) institutional holdings of public firms are public and easily observable unlike investment levels in alternative purpose firms, which are all private; 2) the sample is large, as it comprises all public firms in all states; and 3) the timespan over which states passed constituency statutes, three decades, makes it unlikely that any effect observed would be confounded empirically by some other concurrent event. Before testing changes in HFDI investment, we review 30 years of court decisions to verify that constituency statutes, once enacted, were enforced by courts and therefore changed directors’ duties in practice.

Our findings answer questions raised in early constituency statute scholarship regarding the scope and impact of constituency statutes. Our findings also connect constituency statutes to the current academic debate on alternative purpose firms by identifying potential litigants and theories of recovery under the new statutes. Finally, as to our empirical inquiry, we observe that HDFIs did not meaningfully change investment behavior in response to constituency statutes’ expansion of director duties. Extrapolating our empirical observation to the current question of alternative purpose firms, we do not foresee expanded director duties under these new hybrid entities to, by itself, be a barrier to HFDI investment.

Keywords: institutional investing, institutional investors, high fiduciary duty institution, fiduciary duty, corporate law, constituency statutes, empirical legal research, boards of directors, director duties, alternative purpose firms, benefit corporations

JEL Classification: K20, K22, L22

Suggested Citation

Geczy, Christopher Charles and Jeffers, Jessica and Musto, David K. and Tucker, Anne M., Institutional Investing When Shareholders Are Not Supreme (March 24, 2015). Harvard Business Law Review, Vol. 5, 2015; Georgia State University College of Law, Legal Studies Research Paper No. 2015-08. Available at SSRN: https://ssrn.com/abstract=2584674

Christopher Charles Geczy

University of Pennsylvania - The Wharton School, Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
(215) 898-1698 (Phone)
(215) 898-6200 (Fax)

Jessica Jeffers

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

David K. Musto

University of Pennsylvania - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

Anne M. Tucker (Contact Author)

Georgia State University College of Law ( email )

P.O. Box 4037
Atlanta, GA 30302-4037
United States
(404) 413- 9179 (Phone)

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