What makes shareholders engage with companies?

As many of my readers know, I think engaging with company management on ESG issues is not only important but probably the only way to change corporate behaviour. However, not all shareholders are created equal. Some are more equal than others, elevated to higher importance by the size of their investment. Do you think the pensioners who sometimes show up at AGMs to vent their anger about company X make any difference?  Do you think if Blackrock or Fidelity complains about the company, managers will pay more attention?

I think we all guess that investors with bigger pockets have more influence on company practices. But why then do some studies show no correlation between the engagement of large shareholders and subsequent changes in corporate metrics like profitability? Does it mean that shareholders engage but the suggested actions don’t have an impact? Or that the suggested measures are ignored by the management, rendering the entire process of engagement irrelevant?

Felix Nockher approached the problem from a slightly different angle. He argues that pension fund X or asset manager Y may have a large stake in a company, but that stake may itself be only a tiny fraction of the portfolio of the investor. Norway’s Government Pension Fund, for example, has a market value of around $1.4tn spread across 9,338 companies. It is one of the largest investors in most large companies. It is among the ten largest investors in Apple, Nestle, AstraZeneca, etc. But even though it owns c.$20bn worth of Apple shares, this is a mere 1.4% of the portfolio of the fund. Nestle and AstraZeneca don’t even break the 0.5% mark for the portfolio.

So, yes, if the Norwegian Government Pension Fund complains about Apple’s business practices, Apple is going to listen. But how forceful is the fund going to be in complaining?

The Norwegian Government Pension Fund may be a poor example because they are one of the prime ESG investors in the world, but you get the point. What matters for effective shareholder engagement is not just how big the investment in a company is, but how much of the investor’s portfolio is at risk if the company’s share price drops.

Felix Nokher thus investigated if investors with a higher portfolio at risk (PAR) in a specific stock engage more with that company’s management and are better able to push through changes that may enhance profitability or valuation.

The top row in the chart below shows that if the PAR of the top five investors in a company is higher, the company’s profitability tends to be higher and the market valuation as well. The bottom row shows that if the top five shareholders have more portfolio holdings profitability and valuation of the company drops (note the portfolio holdings are given in natural logarithms, so 2 means on average 4 holdings, 8 implies on average 256 holdings).

Portfolio at risk and company profitability

Source: Nockher (2022)

This heavily indicates that investors with more concentrated portfolios are more likely to push company management to enact changes that lead to higher profitability and higher valuations. Meanwhile, investors with highly diversified portfolios aren’t as effective in engaging with companies, possibly because they can devote fewer resources to engaging with every one of their holdings or because they simple aren’t as forceful because there is less at stake for them.