What Is Active Ownership?
Active ownership is a strategy within the realm of corporate governance and investment management where investors actively engage with the companies in which they hold stakes. Rather than simply buying and selling securities, active owners use their shareholder rights to influence a company's policies, practices, and strategic direction. This approach is rooted in the belief that engagement can enhance long-term shareholder value and improve a company's overall performance, including its environmental, social, and governance (ESG) factors. Active ownership aims to align the interests of management with those of shareholders and can encompass a range of activities from direct dialogue with management to submitting shareholder proposals and voting on board elections.
History and Origin
The concept of active ownership has evolved alongside the increasing prominence of institutional investors in public markets. Historically, individual shareholders dominated equity markets, and their influence was often diffused. However, as large institutional investors like pension funds, mutual funds, and endowments grew in size and holdings, their potential to influence corporate behavior became more apparent.
The rise of institutional ownership, particularly since the late 20th century, has been accompanied by an enhanced role in monitoring companies' corporate governance behavior. Activist hedge funds and private equity firms, in particular, have achieved success in actively shaping the business plans of target firms. These firms often pursue the goal of increasing the market value of their pooled capital through active engagement with public companies, which can involve demands for changes in management, board composition, dividend policies, company strategy, and capital structure.24
Regulators have also played a role in shaping active ownership. For instance, the U.S. Securities and Exchange Commission (SEC) has provided guidance on investment advisers' proxy voting responsibilities, emphasizing their fiduciary duty to clients.23,22 This guidance underscores the importance of investment advisers exercising their voting authority in the best interest of their clients, even when relying on proxy advisory firms.21,20 Large asset managers like BlackRock have also published their own investment stewardship principles, outlining their approach to engaging with companies on governance and sustainability matters.19,18
Key Takeaways
- Active ownership involves investors using their shareholder rights to influence company behavior and strategy.
- It is a core component of responsible investment, particularly concerning ESG issues.
- Engagement can range from private dialogues with management to public shareholder proposals and proxy voting.
- The goal of active ownership is typically to enhance long-term shareholder value and mitigate risks.
- Institutional investors, such as pension funds and asset managers, are key proponents of active ownership.
Interpreting Active Ownership
Active ownership is interpreted as a proactive stance by investors to safeguard and enhance their investments rather than merely reacting to market fluctuations. It signifies a shift from passive investment, where shareholders might simply buy and hold, to a more involved approach where ownership implies a degree of responsibility and oversight.
When institutional investors engage in active ownership, they are often seeking to influence areas such as a company's financial performance, executive compensation, board independence, and its approach to environmental and social challenges. The effectiveness of active ownership is often measured by the degree to which it leads to positive changes within the company, such as improved governance practices or better risk management.17 For example, if an active owner successfully advocates for a company to adopt more robust climate change disclosure practices, it is seen as a positive outcome of their engagement.16 The focus is on the long-term sustainability and value creation of the investee company, benefiting all shareholders.15
Hypothetical Example
Imagine "GreenFuture Investments," an asset manager committed to sustainable investing. GreenFuture holds a significant stake in "GlobalTech Corp," a large technology company. GlobalTech has been criticized for its energy consumption and electronic waste. Instead of divesting, GreenFuture decides to engage in active ownership.
GreenFuture's portfolio manager initiates dialogue with GlobalTech's management and board of directors. During these discussions, GreenFuture presents research on the financial benefits of reducing energy consumption and implementing a circular economy model for electronics. They suggest specific targets for renewable energy adoption and propose an independent audit of the company's waste management practices.
Initially, GlobalTech's management is hesitant, citing short-term costs. However, GreenFuture, leveraging its influence as a major shareholder, explains how these changes could lead to long-term cost savings, improved brand reputation, and reduced regulatory risk. They also indicate their intention to vote against certain board members in the upcoming annual general meeting if their concerns are not adequately addressed.
Facing this pressure and presented with a compelling business case, GlobalTech agrees to develop a plan to increase its renewable energy usage and invest in product recycling initiatives. This engagement demonstrates active ownership in practice, where a shareholder actively influences corporate strategy for mutual long-term benefit.
Practical Applications
Active ownership manifests in various ways across the financial landscape:
- Institutional Investors: Large institutional investors like mutual funds, pension funds, and endowments routinely engage in active ownership. They have dedicated stewardship teams that monitor portfolio companies, vote on proxy statements, and engage in direct dialogue with management and boards on topics ranging from executive compensation to climate strategy. BlackRock, for example, has a comprehensive investment stewardship program that includes engaging with companies and proxy voting on behalf of its clients.14
- Shareholder Activism: Hedge funds and other activist investors employ active ownership to push for more significant and often rapid changes, such as management shake-ups, asset sales, or strategic overhauls. Their tactics can be more aggressive, including public campaigns and proxy contests.13
- ESG Integration: Active ownership is a critical tool for investors focused on ESG factors. By engaging with companies, investors can encourage improvements in environmental performance, labor practices, diversity, and corporate governance. Research suggests that institutional ownership can positively influence firm ESG scores.12 However, the focus of institutional investors on ESG tends to be more concentrated on environmental and governance aspects, with social factors often being less emphasized.11
- Regulatory Compliance: Investment advisers, in particular, have regulatory obligations regarding their proxy voting responsibilities. The SEC has issued guidance to ensure that advisers fulfill their fiduciary duties when voting on behalf of their clients, whether they manage the votes internally or rely on proxy advisory firms.10,9
Limitations and Criticisms
While active ownership is often touted for its potential to improve corporate behavior and drive long-term value, it faces several limitations and criticisms:
- Free-Riding Problem: A significant challenge is the "free-rider problem." The benefits derived from successful active ownership, such as improved governance or increased shareholder value, accrue to all shareholders, regardless of whether they participated in the engagement efforts. This can disincentivize individual shareholders from expending resources on active ownership, as they can benefit from the efforts of others without contributing.8
- Short-Termism vs. Long-Termism: Critics sometimes argue that certain forms of active ownership, particularly those associated with activist hedge funds, can lead to short-term decision-making by companies focused on immediate financial gains rather than sustainable long-term growth.7
- Cost and Resource Intensive: Engaging effectively with companies requires significant resources, including research, legal expertise, and dedicated personnel. This can be a barrier for smaller investors or those with diversified portfolios across many companies.
- Effectiveness and Impact Measurement: It can be challenging to definitively measure the direct impact of active ownership on a company's performance or ESG outcomes, as numerous factors influence corporate results. While some studies suggest a positive link between institutional ownership and ESG performance, the specific mechanisms and extent of influence can be complex.6,5
- Conflicts of Interest: Investment managers engaged in active ownership may face potential conflicts of interest, especially if they have business relationships with the companies they are trying to influence. Regulatory bodies like the SEC provide guidance to help investment advisers manage these conflicts in proxy voting.4,3
Active Ownership vs. Shareholder Activism
While often used interchangeably, "active ownership" and "shareholder activism" represent different facets of shareholder engagement:
| Feature | Active Ownership | Shareholder Activism |
|---|---|---|
| Primary Goal | Long-term value creation, risk mitigation, ESG integration | Driving specific, often rapid, strategic or financial changes |
| Approach | Collaborative dialogue, behind-the-scenes engagement | More confrontational, public campaigns, proxy fights |
| Investor Type | Large institutional investors (pension funds, mutual funds) | Hedge funds, private equity firms, individual activists |
| Time Horizon | Long-term | Often shorter-term, though can have long-term goals |
| Examples | Voting proxies, regular board engagement, ESG dialogue | Pushing for management changes, asset sales, M&A |
Active ownership is a broader term encompassing all forms of proactive engagement by shareholders to influence a company. Shareholder activism, on the other hand, is a more specific and often more aggressive form of active ownership, typically initiated by investors seeking to compel significant and sometimes rapid changes within a company, often in response to perceived underperformance or mismanagement.2
FAQs
Why do investors engage in active ownership?
Investors engage in active ownership to protect and enhance the value of their investments. By influencing corporate governance, strategy, and ESG practices, they aim to mitigate risks, improve long-term financial performance, and ensure companies operate sustainably and responsibly.
What are common activities in active ownership?
Common activities include engaging in private dialogues with company management and boards, voting on proxy proposals at shareholder meetings, submitting shareholder proposals, and advocating for changes in executive compensation, board composition, or environmental and social policies.
How does active ownership relate to ESG?
Active ownership is a fundamental mechanism for integrating ESG considerations into investment decisions. Investors use their influence to encourage companies to improve their environmental footprint, social practices (like labor relations and diversity), and governance structures.1
Is active ownership only for large investors?
While large institutional investors have the resources and scale to engage extensively, the principles of active ownership apply to any shareholder. Individual investors can participate by voting their proxies, staying informed about company issues, and even joining shareholder advocacy groups.
What is the difference between active ownership and passive ownership?
Passive ownership typically involves investing in a company's shares with little or no direct engagement in its management or governance. The investor relies on market forces and management's decisions for returns. Active ownership, conversely, involves direct intervention and influence to drive specific outcomes.