One mechanism designed to ensure that ESG considerations are implemented through a company’s operations is that shareholders have influence over the management of companies. As shareholders, they appoint agents – the management team – to run the company. If those agents don’t run it effectively, new agents can be appointed.
However, a new report from MSCI ESG Research suggests this process may not work as smoothly as it seems.
The report shows that the ownership of the world’s largest companies is increasingly concentrated, which threatens to undermine the influence of smaller shareholders. Its research shows that 46% (1,317 of 2,870 companies) of the MSCI ACWI Index constituents were ‘controlled’ as of 1 February 2022.
This represents a considerable increase from the 32% in 2015. A company is considered ‘controlled’ by MSCI if one or more shareholders or shareholder blocks holds 30% or more of the company’s voting shares. The group uses the 30% cut off, believing it to be the most accurate reflection of effective control.
Only 40% of companies are diversely held
Does this matter? Probably. If a company has a large controlling shareholder, it is more difficult for other shareholders to get their voices heard. That controlling shareholder can block change and implement their own agenda. The same survey found that only 40% of companies are diversely held.
This ‘principal’ risk is generally less explored by shareholders than ‘agent’ risk – ie most focus more on the skill of the management team rather the views of a controlling shareholder.
The reasons for this concentration are myriad. The increased presence of emerging market companies in the index, many of which are owned by the state or by a single powerful family, has contributed to the phenomenon. In India, for example, 92 of 106 MSCI ACWI Index constituents (86.9%) were controlled companies, and 34 of those (32.1%) were considered by MSCI to be family controlled.
The percentages for Brazil were similar. In China, the overall percentage of controlled companies was somewhat lower at 73.6%. However, given that Chinese companies only form 4% of the MSCI ACWI index – and it is far lower for the other emerging markets – this is far from the only factor.
Overhauling listing rules
The technology sector must also take some responsibility. Jonathan Ponder, co-author of the report, says: “The communications and information technology industries serve as strong case studies for the complexity and lingering questions regarding ownership concentration trends in the past five years.
“On the back of significant financial growth, some founders of newer companies in these sectors have maintained their control on company management and structure. Other companies in these sectors have attracted significant institutional investor interest due to strong stock performance, tipping the principal shareholder scales.”
On the one hand, this trend looks like it may be starting to reverse. The technology giants are coming under increasing pressures over their governance structures, which often leaves control in the hands of the founder. This may have made sense when they were dynamic young companies but is more problematic when they are the largest companies in the world.
Equally, shareholders may have been willing to overlook governance problems when share prices were soaring, but may be more circumspect as they weaken.
On the other hand, as the competition to attract tech IPOs hots up, in the UK, there have been discussions of a relaxation of shareholder structures to encourage more companies to list in the UK. The FCA published a discussion paper in May proposing an overhaul of the listing rules, including a two-tier system of continuing obligations. The EU looks likely to follow suit. This may increase the prevalence of controlling shareholders rather than restrain it.
Ponder adds: “It’s too early to tell if those founders will retain their influence over the long term, for example, or how potential changes in investor allocations in bear market scenarios could influence the owner mix.”
Listening to minority shareholders
Ric Marshall, executive director at MSCI ESG Research, says that the concentration in the hands of certain institutional investors and large asset managers has also increased. Blackrock held 5% or more of 638 index constituents, 458 of which were US listed, and Vanguard held 5% or more of 424 index constituents, 395 of which were US listed.
Between them, Blackrock, Vanguard and Berkshire Hathaway own 20% of Apple, while Vanguard and Blackrock own 15% of Microsoft.
Marshall says this is more neutral in its influence: “From a corporate governance perspective, that’s neither good nor bad. These investors are typically not the ultimate beneficial owners of publicly-traded companies. They are complex intermediaries that have and can take steps to encourage their many institutional, and in some cases individual, clients to exercise their shareholder rights.”
However, this increasing concentration is still a concern for those who want to see management teams held accountable for their decision-making and the voices of minority shareholders heard. It may be that the controlling shareholders are benign and capable stewards of the company, but less accountability may make that less likely.
Marshall says: “The investing community will continue to examine and better understand the push-and-pull forces that influence corporations’ management decisions.”