Scott + Scott Stresses Shareholder Activism to Investors to Achieve Corporate Sustainability

COLCHESTER, CT, Jun. 2006 -- In his keynote speech before the well-attended 2006 Scandinavian Institutional Investors Summit in Stockholm, Sweden, Scott + Scott partner David R. Scott spoke of the rising need for institutional investor shareholder activism to combat corporate corruption in an effort to achieve long-term sustainability for institutional investors.  This topic served as the framework for this year’s Scandinavian summit.

The Institutional Investor As the Universal Shareholder

The institutional investor is uniquely impacted by corporate fraud.  The growth of large institutional investors in recent decades has concentrated a substantial amount of corporate equity and debt in the hands of a relatively small number of fiduciary institutions. Consequently, institutional investors, in essence, are universal owners whose holdings are highly diversified and, typically, held long term. Most importantly, a universal owner’s cumulative long-term return is determined not merely by the performance of each individual firm it owns, but by the performance of the economy as a whole. The concept of long-term sustainability shares much in common with the idea of the fiduciary responsibility of universal owners.  One result has been the emergence of institutional investor activists engaged in vigorous corporate governance programs aimed at increasing the long-term value and return of their ownership assets by using a variety of techniques to pressure corporate managers to improve performance.  Thus, in seeking maximized returns, the institutional investor plays an important role in restoring confidence and trust in today’s corporations by demanding stronger corporate governance and investing in a socially responsible manner. 

Good Corporate Governance Correlates With Better Financial Performance

An increasing body of evidence suggests that enhanced corporate governance – mostly achieved through shareholder activism – equals enhanced financial performance.  A 2005 study by the U.S.-based Institutional Shareholder Services concludes that companies with better corporate governance have lower risk, better profitability and higher valuation.  Specifically, well-run companies outperform poorly governed firms in return on investment, annual dividend yield, net profit margin and P/E ratio. 

Socially Responsible Investing  Becoming Mainstream

Moreover, socially responsible investing (SRI) has become, in the past decade, a force in the US financial marketplace.  According to the U.S. Social Investment Forum (SIF):  2005 Report on SRI Trends in the US – Ten Review (Jan. 24, 2006), in the last ten years, SRI assets under management (AUM) grew four percent faster than the entire universe of managed assets in the U.S.  Additionally, SRI no longer is considered to be contrary to fiduciary obligations according to an analysis written by Freshfields Bruckhaus Deringer, one of the world's largest law firms with a highly regarded environmental and regulatory practice.

Finally, SRI does not lead to lower financial returns.  Academic studies continue to explode the myth that social screening inevitably leads to lower financial returns or constrains investing options beyond the acceptable threshold of a prudent fiduciary.  Far from compromising fiduciary responsibility, the incorporation of environmental, social and governance factors into the investment process is increasingly becoming recognized as an emerging element of fiduciary duty. Recent research has found statistically significant correlations between corporate financial performance and social and environmental performance. 

Scandinavia Promotes Shareholder Activism

Scandinavia, with a long history of and commitment to social consciousness is ideally situated to promote shareholder activism through corporate governance mandates and responsible investing. To date, all the Scandinavian countries have comprehensive national corporate governance codes.  In addition, the Scandinavian public pension funds are already strong proponents of SRI.  For example, Sweden’s National Pension Funds Act (2000:192) requires that the national pension plans must include guidelines for the exercise of voting rights in listed companies.  Moreover, the act mandates that each pension fund shall carry out a yearly review to establish how ethical and environmental considerations are taken into account in investment options.  To that end, each pension fund publishes a corporate governance policy which explains its consideration of ethical and environmental issues.

Institutional Investor Trustee’s Fiduciary Obligations Require Action

Evidence clearly shows that institutional investor commitment to SRI and requiring adoption of strong corporation governance principles by those corporations in which they invest increases both long-term sustainability and return on investment.  In keeping with institutional investor trustees’ fiduciary obligations to the ultimate beneficiaries of institutional investment funds, careful consideration of and, indeed, action in accordance therewith of each of these activist principles is required.

Relevant questions institutional investors should consider in portfolio building, include:

• Can return maximization be merged with promoting corporate governance and responsible investment?
•  Will economies be better off with universal shareholder activism and incorporation of economic, social and governance principles into investment analysis?
• Can institutional investors change the cost-benefit analysis of companies by being active shareholders to institutionalize values into value?
• Is the institutional investor, as the universal shareowner, the means to the end in moving corporations toward long-term sustainability?