The Systemic Governance Influence of Universal Owners: Evidence from an Expectation Document

Abstract

Universal owners—large institutional investors with highly diversified and long-term portfolios spanning the entire global capital market—have multiple engagement mechanisms to influence their portfolio companies. Given the costly nature of firm-specific interventions, universal owners have also drawn on systemic governance mechanisms with a wide market effect and low cost such as expectation documents. We focus on Norway’s sovereign wealth fund and its release of an unforeseen key expectation Note in 2012 requesting explicit corporate governance practices from all its portfolio companies. We use this early example of an expectation Note as a natural experiment to examine whether expectation documents have impactful governance consequences for the entire market. We develop a new three-step decomposition approach to explore the effectiveness of expectation documents as an activism mechanism. First, we analyze how portfolio firms adapted to the fund’s new governance expectations and explore their heterogeneous response across ownership levels and firm characteristics. We find a stronger reaction by firms for which direct action is more costly to universal owners. Second, we show how the fund also changed its investment policy to meet its newly stated governance preferences, even at the expense of its financial returns. And finally, we illustrate the new correlation between the firms’ changes toward higher governance scores and the fund’s changes in the investment weights. With this study, we contribute to research on shareholder stewardship by examining a novel and effective governance engagement tactic which is becoming popular in an era of raising pressures for corporations to pursue purpose.

Keywords: Corporate Governance; Institutional Ownership; Expectation Document

JEL Classification: F30, G32, G34