The Role Of Institutional Investors In Shaping Corporate Governance

Author: LawSphereX

Category: Corporate & Insolvency

Published: 2026-08-23T21:30:18.639136+00:00

Updated: 2026-08-26T17:05:22.262+00:00

THE ROLE OF INSTITUTIONAL INVESTORS IN SHAPING

CORPORATE GOVERNANCE

Kritika Krishna Srivastava, Christ University, Pune Lavasa "Searching for companies is like looking for grubs under rocks: if you turn over 10 rocks you'll likely find one grub; if you turn over 20 rocks you'll find two." - Peter Lynch.1

ABSTRACT

This research paper throws light on the significant impact of institutional investors on corporate governance. It particularly describes the influence of institutional investors on corporate policies, accountability and transparency. Their large capital base compels businesses to adopt sustainable and ethical practices. The research details the evolution from passive investing to active involvement through strategies like shareholder proposals and proxy voting. However, institutional investors face challenges, including conflicts of interest, legal hurdles, and ethical issues arising from their dual role as financial stewards and activists. The study also highlights how ownership concentration and market scrutiny levels affect their ability to influence corporate governance.

While there is a movement toward global convergence in governance practices, significant differences persist due to cultural, legal, and market contexts, revealing the complexity of their influence and the nuanced nature of their role in corporate governance. Keywords: Institutional Investors, Corporate governance, compliance, Investment 1 Beating the Street by Peter Lynch, https://www. ryandelaney. co/book-notes/beating-the-street-peter-lynch (last visited Oct 22, 2024)

1. INTRODUCTION

1.1 Background of Corporate Governance

There is always a dilemma under which it is discussed what role can an institutional investor play in a firm’s corporate governance framework. It is believed that the institutional investors should meddle with companies' corporate governance structure, where as others believes that they have other investment goals to pursue in the company. Whereas, some argue that institutional investors should not get engaged in the corporate governance due to the conflicting investment goals and compensation structure. ESG focus and global market complexities further underscore governance's importance for economic growth and stability. According to Wharton, Lorsch, and Hanson (1991), institutional investors have a primary fiduciary responsibility to their own investors and beneficiaries, which may create a conflict of interest when acting as owners.

As a result, they are not required to actively participate in a company's corporate governance. 2 It is their responsibility to allocate the beneficiaries' funds to the most lucrative venture, as Drucker (1976) once stated. They have no right to attempt management. It is their responsibility to sell the company's stock if they disagree with the management. The Kumar Manglam Birla Committee Report (1999) chaired by Mr. Kumar also gave suggestions with respect to role of institutional investors in regulating corporate governance in the Indian framework. Some of the suggestions given were: “Take active interest in the composition of the Board of Directors • Be vigilant • Maintain regular and systematic contact at senior level for exchange of views on management, strategy, performance and the quality of management.

• Ensure that voting intentions are translated into practice 2 Advice and Dissent: Rating the Corporate Governance Compact Harvard Business Review. (1991). Advice and Dissent: Rating the Corporate Governance Compact. [online] Available at: https://hbr. org/1991/11/advice-anddissent-rating-the-corporategovernance-compact

Evaluate the corporate governance performance of the company”3

1.2 Description of The Role of Institutional Investors

The major institutional player in the global finance markets such as insurance firms, sovereign wealth fund, hedge funds, pension and mutual funds have grown to contribute into the corporate governance. Their substantial ownership stakes in publicly traded corporations provide them significant sway over corporate governance and decision-making. Institutional investors possess the means, knowhow, and financial clout to actively follow and interact with the businesses they invest in, in contrast to individual retail investors. 4 Overtime the dominant position has affirmed the importance of role played by institutional investors in monitoring the corporate governance in the investee companies and the biggest reason contributing to this is the high percentage of voting powers that lie with such investors.

5 These investors can further act as a guiding factor to ordinary retail investors who usually don’t possess the expertise to analyse the market situation in a correct manner.

3 Birla, K., 1999. Report of The Kumar Mangalam Birla Committee On Corporate Governance. SEBI.

4 Gaur, V.Gaur, V. (2018). Shareholders reject re-appointment of Apollo Tyres MD. [Online] The Economic Times. Available at: https://economictimes.indiatimes.com/markets/stocks/news/shareholdersreject-reappointment-of-apollo-tyres-md/articleshow/65988382.cms 5 Campbell, T.L. and P.Y. Keys, 2002, “Corporate Governance in South Korea: The Chaebol Experience,” Journal of Corporate Finance

1.3 Purpose and Scope of the Research

This study aims to explore how institutional investors influence corporate governance practices. While their impact is recognized, the mechanisms behind it and the challenges they face remain underexplored. It examines strategies like proxy voting and activism, as well as cross-country variations in ownership structures and regulations affecting their involvement.

1.4 Statement of Problem

In the past years decade, the growth of institutional investors in the global finance market has impacted the corporate governance of companies at its peak. Corporate governance procedures have been profoundly impacted by the increasing power of institutional investors in the international finance market. Nevertheless, despite their crucial significance little is known about the ways institutional investors affect corporate governance, particularly in various sectors and geographical areas. Moreover, it is the strategies employed by the institutional investors to promote corporate governance reform vary widely and their effectiveness is not fully understood.

1.5 Analysis of Literature Review

The article, Behind the Scenes: The Corporate Governance Preference of Institutional Investors6, is a crucial article as it explores the dual strategies for intervention and exit of employees by the institution investors, highlighting their influence on the corporate governance practice. It provides empirical evidence and insight into their influence on the corporate governance practices. The article reviews of The Real Effect of Proxy Advisor on the Firm7 and the Proxy Advisory Firm: The Economic of Selling Information to Voter8 provided a piece of detailed 6 McCAHERY, Joseph A., et al. “Behind the Scenes: The Corporate Governance Preferences of Institutional Investors.” The Journal of Finance, vol. 71, no. 6, 2016, pp.

2905–32. JSTOR,

https://www.jstor.org/stable/44155408.

7 Malenko, Andrey, and Nadya Malenko. “Proxy Advisory Firms: The Economics of Selling Information to

Voters.” The Journal of Finance, vol. 74, no. 5, 2019, pp. 2441–90.

JSTOR,

https://www.jstor.org/stable/45213960. 8 Calluzzo, Paul, and Evan Dudley. “The Real Effects of Proxy Advisors on the Firm.” Financial Management, vol. 48, no. 3, 2019, pp. 917–43. JSTOR, https://www.jstor.org/stable/45213511.

information on how proxy advisors influence voting behaviour and firm policies which also showcases that the significance, albeit complex and effects on the governance. Furthermore, there are articles such as The Role of Hedge Fund Activism in Corporate Governance9 and Institutional Investors and Corporate Monitoring: A Demand Side Perspective10, which delve into the activism and monitoring practices, illustrating how different investors are involved in using the hedge fund, mutual fund and pension fund to engage with the firm to mitigate with the agency’s problem and improve the performance. The article Corporate Governance Reform as Institutional Innovation: The Case of Japan11, provides a regional adaptation to explain how the local context shapes government practices.

The article, Institutional Investors on Board: Does their Behaviour Influence Corporate Finances12, is an article which explores a board dynamic and financial leverage impacts on the institutions. Meanwhile the article, Institutional Investors and Mutual Fund Governance: Evidence from Retail- Institutional Fund Twin13 Is an article which reveals how an institutional investor's oversight enhances the fund of corporate governance and later impacts the outcome. If we draw a collective conclusion from all the article reviews, we could collectively determine that the literature underscores that institutional investors are crucial for fostering transparency, accountability and governance innovation with their impact on a corporate body.

Their actions from proxy voting to direct intervention, shape the firm's strategies and policies, reinforcing their roles as stewards of corporate integrity and sustainability in an increasingly global finance environment. 9 Bebchuk, Lucian A. , et al. “The Agency Problems of Institutional Investors. ” The Journal of Economic Perspectives, vol. 31, no. 3, 2017, pp. 89–112. JSTOR, https://www. jstor. org/stable/44321281. Macey, Jonathan R.

“Institutional Investors and Corporate Monitoring:

A

Demand-Side Perspective.” Managerial and Decision Economics, vol. 18, no. 7/8, 1997, pp. 601–10. JSTOR, https://www.jstor.org/stable/3108222.’

11 Yoshikawa, Toru, et al. “Corporate Governance Reform as Institutional Innovation: The Case of

Japan.” Organization Science, vol. 18, no. 6, 2007, pp. 973–88. JSTOR, https://www.jstor.org/stable/25146153. 12 García-Meca, Emma, et al. “Institutional Investors on Boards: Does Their Behavior Influence Corporate Finance?” Journal of Business Ethics, vol. 146, no. 2, 2017, pp.

365–82. JSTOR,

https://www.jstor.org/stable/45022324. 13 Evans, Richard B., and Rüdiger Fahlenbrach. “Institutional Investors and Mutual Fund Governance: Evidence from Retail-Institutional Fund Twins.” The Review of Financial Studies, vol. 25, no. 12, 2012, pp. 3530–71. JSTOR, https://www.jstor.org/stable/41678625.

2. THE RISE OF INSTITUTIONAL INVESTORS

In the middle of the 20th century, institutional investors began to amass a substantial interest in the corporation. 14 It began with their interest in the mutual funds and the pension funds. However the approach that was adopted by the institutional investors were was a passive stance which was following the Wall Street Rule Philosophy, under which they would call for selling the stocks in the underperforming businesses rather than taking an active role in the goverance of business. 15An example of this could be of Vangaurd mutual funds delegates voting authorities to its investment stewardships Oversight Committee, although Vangaurd has announced that the portfolio managers have actively managed funds, they have been responsible for casting the votes on certain issues which affect the shares they manage.

16As most investors were afraid of getting involved with the management decisions, the corporate board and managers also had a high level of autonomy. The role of Institutional investors in the corporate concern ace underwent a significant change in the year 1990s when the financial market started to grow in many countries and transnational financial flow developed rapidly which led to the real rise of institutional investors to become pivotal financial actors they are today. 17 The Pension Fund, California Public Employees Retirement System (CalPERS) was the first one to get targeted abruptly, large institutional investors started aggressively interacting with the companies’ board and management. 18Institutional Investors shifted from their previous passive stance and began pushing for change in the corporate governance of the companies with a focus on improving the 14 Stuart L.

Gillan & Laura T. Starks, Corporate Governance Proposals and Shareholder Activism: The Role of Institutional Investors,

57 Journal

of Financial Economics 275 (2000), https://linkinghub.elsevier.com/retrieve/pii/S0304405X00000581 (last visited Oct 22, 2024).

15 Fisch, Jill, et al. “THE NEW TITANS OF WALL STREET: A THEORETICAL FRAMEWORK FOR

PASSIVE INVESTORS.” University of Pennsylvania Law Review, vol. 168, no. 1, 2019, pp. 17–72. JSTOR, http://www.jstor.org/stable/45389496. Accessed 7 Nov. 2024.

16 The committee is composed of senior officers at Vanguard without external client duties.

Vanguard, Proxy Voting Guidelines for U.S. Portfolio Companies 2 (2019), https://about.vanguard.com/investment-stewardship/portfolio-companyresources/proxy_voting_guidelines.pdf [https://perma.cc/9WR2-L28M]

17 SEC.gov | Institutional Investors: Power and Responsibility (no date) www.sec.gov. Available at:

https://www.sec.gov/newsroom/speeches-statements/2013-spch041913laahtm. 18California

PERS

(A)

Case - Faculty & Research - Harvard Business School, https://www.hbs.edu/faculty/Pages/item.aspx?num=6877 (last visited Oct 22, 2024).

accountability, transparency and long-term performance. CalPER is given the credit for the leading charge for better corporate governance practices. In the past year, CalPERS was targeted poorly by the governed corporation and later made its attempt to strengthen corporate governance publicly known through its Corporate Governance program which was established in the year 1990. After this, CalPERS shifted the norms for institutional investors, demonstrating that they could use their considerable power and influence to push for improvement in the governance without using a hostile takeover. 19 In the Year 2020, the role of the Institutional Investor in the corporate governance of the companies has been significantly expanded by the advancement of the technology.

Investors now have a closer eye on the vast amount of real-time information at their fingertips regarding their corporate performance and governance standards. The data-driven approach allows the institutional investors to make more informed decisions and to engage with the companies in a more targeted and effective manner. 20 With the rise of proxy advisor firms such as the Institutional Share Services(ISS)21 and Glass Lewis,22 had also facilitated greater institutional investors participation in governance. These firms provide institutional investor advice on how to vote on business issues, increasing their ability to governance reforms.

3. RATIONALE FOR INSTITUTIONAL INVESTOR INVOLVEMENT IN

CORPORATE GOVERNANCE

Institutional Investors are involved in the corporate governance of the companies because of their fiduciary duty to maximise returns for their clients. Hence this fiduciary duty compels them to actively engage in the governance procedure to

19 California PERS (A) - Case - Faculty & Research - Harvard Business School,

https://www.hbs.edu/faculty/Pages/item.aspx?num=6877 20 Directors’ Institute, The Role of Institutional Investors in Corporate Governance: How Large Investors Influence Governance Practices, Directors Institute (2024), https://www.directors-institute.com/post/the-role-ofinstitutional-investors-in-corporate-governance-how-large-investors-influence-governanc (last visited Oct 23, 2024).

21 Home, ISS, https://www.issgovernance.com/ (last visited Oct 23, 2024).

22 Martin Lion, Glass Lewis - Proxy Voting, Glass Lewis, https://www.glasslewis.com/ (last visited Oct 23, 2024).

protect their investment and foster value generations. 23 The present example for this is LIC( Life Insurance Corporation of India) which stands as the largest institutional investor in India, which frequently appoints directors to the board to guarantee compliance with corporate governance guidelines. 24 Such acts demonstrate the significance of the role of investors have over corporate practices, increasing accountability and improving transparency. 25This level of engagement is consistent with their duties to act as a steward of the capital. Influencing corporate behaviour in the ways which would be of an advantage to shareholders and other stakeholders. While institutional investors possess the potential to drive governance reforms, the extent of their involvement can vary.

Fund managers often face short-term performance pressures, prompting them to sell shares of poorly governed companies rather than attempt to instigate change. However, influential investors like LIC have shown that proactive engagement, such as board representation, can bolster governance practices effectively. 26 Institutional Investors exert their rights through active involvement in the shareholder meetings, casting votes on crucial resolutions and with regular interaction with the company management and boards. 27 The approach adopted by the institutional investors is referred as the “active ownership” or “stewardship” which gives the institutional investors an opportunity to influence the strategic decision-making and advocate for the better corporate governance practices.

One of the leverage strategies which institutional investors are engaging into with the company boards and management so that, they can address the corporate governance concerns with the management of the company using a constructive dialogue

23 Enriques, L. and Romano, A. (2018) ‘Institutional Investor Voting Behavior: A Network Theory

Perspective’, SSRN Electronic Journal [Preprint]. Available at: https://doi.org/10.2139/ssrn.3157708.

24 Paul Sanderson, REGULATING THE CORPORATION: THE ROLE OF THE INSTITUTIONAL

INVESTOR, 3 Corp. Ownership & Control 1 (2005), http://www.virtusinterpress.org/IMG/pdf/10- 22495_cocv3i1c1p1.pdf. 25 meena, sarita (2014) Corporate Governance and The Role Institutional Investors Legal Aspects of Business Assignment Contents, Academia.edu. Available at: https://www.academia.edu/6780789/Corporate_Governance_and_The_Role_Institutional_Investors_Legal_Asp ects_of_Business_Assignment_Contents (Accessed: 8 November 2024).

26 Supra Note 25

27 27 Tahir Ahmad Wani & Arunima Haldar & Irfan Rashid Ganie, 2023. "In What Contexts Institutional Investors Can Be Catalyst? The Moderating Role of Corporate Governance," International Journal of Global Business and Competitiveness, Springer, vol. 18(1), pages 70-79, June. https://ideas.repec.org/a/ids/ijicbm/v17y2018i2p139- 150.html

between them. 28 In reality, the institutional investors are the champions of the transparency because they advance the cause of clear and comprehensive disclosure of both financial as well as the non-financial information such as Environment Social and Governance. By these processes, they encourage the companies to communicate effectively with their investors in a manner that ensures correct and relevant information for the effective decision making which leads to a strong disclosure practices, which later leads to growing investor confidence and well-governed business.29

4. EVOLUTION

OF

STEWARDSHIP

CODES

AND

RESPONSIBLE

INVESTMENT GUIDELINES

The Stewardship Code introduced by SEBI in 2019 marked a significant step in strengthening the role of institutional investors in India’s corporate governance landscape. Institutional investors, given their substantial stakes in companies, are positioned to drive governance practices that align with the interests of both organizations and stakeholders. However, concerns over their direct involvement in managerial decisions often arise, with critics citing potential gaps in expertise and time due to their portfolio management responsibilities. 30 By introducing the Stewardship Code, the regulator's main objective is to compel the institutional investors to carry out a crucial role in the corporate governance of corporations they invest their money in.

However, one main issue that remains in India is that concentrated shareholding remains an essential feature of the corporate setup in India. Promoters/ promoter groups stay in the majority, whereas, in comparison, the institutional investors remain in the minority. 31

“ESG

Regulations and Compliance Monitoring.” Acuity Knowledge Partners, https://www.acuitykp.com/blog/esg-regulations-and-compliance-monitoring/. Accessed 6 Nov. 2024. 29 I. Sridhar, 2018. "Corporate governance and institutional investors - law in India," International Journal of Indian Culture and Business Management, Inderscience Enterprises Ltd, vol. 17(2), pages 139-150. 30 Varottil, U. (2014) Shareholder Stewardship in India: The Desiderata Shareholder Stewardship in India: The Desiderata. Available at: https://law.nus.edu.sg/cals/wpcontent/uploads/sites/4/2020/10/005_2020_Umakanth.pdf (Accessed: 13 December 2022).

31 Singh Khurana, K. et al. (2021) ‘“WITH GREAT POWER, COMES GREAT RESPONSIBILITY”:

DECODING SEBI’S STEWARDSHIP CODE FOR INSTITUTIONAL INVESTORS’, Antardrishti IUD Journal of Interdisciplinary Research, 1(2), pp. 98–106. Available at: https://www.iudehradun.edu.in/assets/pdf/Volume-Issue/Paper-9-(98-106).pdf

Acknowledging these challenges, the Stewardship Code mandates institutional investors to actively monitor and engage with investee companies, ensuring alignment with governance standards. It requires institutional investors to develop a public stewardship policy and periodically update it to reflect current governance demands. Key elements include regular monitoring of companies and policies for necessary intervention, establishing a framework to act as stewards of good governance. For effective implementation, however, cooperation from corporations is essential. While companies might perceive institutional involvement as intrusive, embracing such engagement can benefit corporate longevity, enhance investor sentiment, and improve governance frameworks.

32 Although corporate governance has evolved substantially, the dynamic business landscape continues to highlight the critical role of institutional investors, making their proactive involvement ever more essential for sustainable growth. In countries such as India, controlling shareholders are either business families or the state. When it comes to business families, the concept of stewardship applies squarely to those companies given the multigenerational considerations involved. 33 Family owners’ stewardship is a measure of their need for the company’s continued success in the long term. 34 Some attribute the performance of family firms to the fact that ‘the family understands the business and that involved family members view themselves as the stewards of the firm’. 35 In addition, such an approach ‘is conducive to corporate longevity and favourable relations with stakeholders’.

36 The expansive stewardship approach that encompasses family owners is consistent with the broader outlook towards stakeholders and not limited to protecting the interests of beneficiaries of institutional investors under the narrow conception of the UK-style stewardship. 32 Varottil, U. (2014) Shareholder Stewardship in India: The Desiderata Shareholder Stewardship in India: The Desiderata. Available at: https://law. nus. edu. sg/cals/wpcontent/uploads/sites/4/2020/10/005_2020_Umakanth. pdf (Accessed: 13 December 2022). 33 Tarun Khanna & Yishay Yafeh, ‘Business Groups and Risk Sharing around the World’, (2005) 78 The Journal of Business 301, at 340. 34 Danny Miller, Isabelle Le Breton-Miller & Barry Scholnick, ‘Stewardship vs.

Stagnation: An Empirical Comparison of Small Family and Non-Family Business’, (2008) 45 Journal of Management Studies 51, at 51; Loraine M Uhlaner, Roberto H Floren & Jurgen R Geerlings, ‘Owner Commitment and Relational Governance in the Privately-Held Firm: An Empirical Study’, (2007) 29 Small Business Economics 275, at 275. 35 Ronald C Anderson & David M Reeb, ‘Founding-Family Ownership and Firm Performance: Evidence from the S&P 500’, (2003) 58 The Journal of Finance 1301, at 1324

36 Miller, Le Breton-Miller & Scholnick, ‘Stewardship vs. Stagnation’, at 73.

5. CONCLUSION

As the study reveals, these investors have transitioned from passive stakeholders to active participants, significantly impacting corporate policies, accountability, and transparency. Their substantial capital base and expertise enable them to advocate for sustainable and ethical practices within the companies they invest in. Despite their potential to drive positive change, institutional investors face numerous challenges, including conflicts of interest and varying levels of market scrutiny. The findings indicate that while there is a trend towards greater global convergence in governance practices, significant differences remain due to cultural, legal, and market contexts. This complexity underscores the nuanced role institutional investors play in corporate governance.

Moreover, the introduction of frameworks like the Stewardship Code in India emphasizes the need for institutional investors to engage actively with companies to ensure adherence to governance standards. This proactive approach not only enhances corporate accountability but also fosters a culture of transparency that benefits all stakeholders. Institutional investors are pivotal in shaping corporate governance landscapes. Their ability to influence decision-making processes through mechanisms such as proxy voting and direct engagement positions them as crucial stewards of corporate integrity. As they navigate the evolving financial landscape, their continued involvement will be essential for promoting sustainable business practices and ensuring long-term value creation for shareholders and society alike.