The interconnection between shareholder value and financialisation concepts.
As defined by Van der Zwan (2014, p. 99), Financialization refers to an accumulation pattern whereby profit making occurs increasingly in all the financial channels rather than through commodity production and trade. On the other hand, shareholder value may be described as a theory of corporate performance which prioritizes the shareholder over other stakeholders of the organization.
Financialization and shareholder value maximization are two concepts that are closely interconnected. This is because, the financial gains realized from financialization activities are not re-invested into the organization's productive facilities but are redistributed to the respective shareholders in the form of dividend payouts and share buybacks, (Van der Zwan, 2014, p. 105).
Shareholder value maximization concept can be explained using the agency theory. It is associated with some activities such as the introduction of financial performance metrics like the return on equity, short-term business outlook and adoption of international accounting standards, (Hein, 2012, p. 478). These activities are accompanied by management concentration on the business’ core competencies. Managers are, therefore, forced to retrench underperforming projects in an attempt to raise the organization’s net worth, (Van der Zwan, 2014, p. 108). Other financialization activities may also include acquisitions, leveraged buyouts, and hostile takeovers. The financial gains from these operations are always paid back to the shareholders as dividends or share buybacks, hence increasing the shareholder value.
Implications of the institutional investor behavior on corporate strategy and performance
Institutional investors are entities which pool funds to purchase real property, security and investment assets. They include insurance companies, hedge funds, banks and mutual funds, (Aggarwal et al., 2011, p. 154). There are three broad types of strategies that can be adopted by firms; growth, stability and renewal strategies. The growth strategies are plans aimed at expanding the organization into some markets served, (Elyasiani & Jia, 2010, p. 608). In stability, the firm maintains the status quo, while the renewal strategies are always implemented whenever there is a decline in business performance, (Elyasiani & Jia, 2010, p. 608). Institutional investors can exert enormous impacts on the success of the organization in implementing the above strategies. The institutional investor behavior can adopt two approaches- activism and passive approach.
The activism approach.
These are investors who take a monitoring approach. They always play an active part in monitoring the performance of the organization, attending and voting at the general meetings and monitoring the management activities and strategies implemented, (McCahery et al., 2016, p. 2906). The monitoring aspect of the investors may be influenced by several factors; investment horizon, the liquidity of the firm’s portfolio stock and the size of institutional investors.
Investment horizon:
Under this aspect, investor behavior can be classified into two- those interested in the short-term success of the business, and those interested in long-term performance, (Kaniel et al., 2012, p. 640). The investors who are interested in the long run profitability will be dedicated to monitoring the business. They will not sell their shares until the company accomplishes its long-term objectives, (Kaniel et al., 2012, p. 640). These investors are essential to the performance of the firm, as they invest significant funds to the business. The company could easily use such funds to execute growth and expansion strategies, so as to improve profitability in the long-run.
The short-term investors like hedge funds are interested in short-term profits and not on the firm’s value. Such investors may not contribute so much to the growth strategies of the enterprise, as they may not be able to finance long-term projects of the firm, (Gunnoe & Gellert, 2011, p. 270). The management may, therefore, opt for short-term and faster-maturing projects that would enable it to pay back the profits demanded by the investors. This may lead to liquidity problems, making the firm unable to execute the growth strategies efficiently.
The size of an institutional investor:
This element may determine the propensity of an investor to be an active owner. Investors may have bigger stakes or smaller stakes in the investee organization. Those with more significant stakes tend to have higher monitoring incentives so as to improve their influence and resulting benefits, (Bushee et al., 2013, p. 132). Therefore, if a firm has one particular investor who controls a bigger stake in the enterprise, that investor would closely monitor the company's strategies so as to ensure that they are executed fairly.
The smaller stake investors tend to be passive in monitoring the activities of the firm. Active institutional investors ensure that competitive managers and independent auditors are elected, (Aggarwal et al., 2011, p. 170). This in return, provides that the firm can implement its strategies appropriately, as the funds will be adequately accounted for.
Liquidity of the portfolio holdings:
The liquidity of portfolio holdings may escalate the intensity of investor monitoring as it encourages the shareholders to divest rather than intervene. Higher liquidity may increase the tendency of follow-up, as the institutional investors would be able to reap from their companies in case they sell their shares prematurely, (Gunnoe & Gellert, 2011, p. 275). Investors would always need to benefit from their investment, (Kaniel et al., 2012, p. 650). Therefore, if they suspect that the firm may have future liquidity problems, they may sell their shares prematurely to avoid losses. This may make the business to lose its primary investors, making it unable to access funds for implementing future corporate strategies.
Passive institutional investors.
These are institutional investors who do not take an active role in monitoring the organization’s governance and performance. These institutional investors may have several reasons for being passive. These may include:
Short-term investment horizons:
Most investors with short-term investment horizons tend to be passive, (Elyasiani & Jia, 2010, p. 608). This is because they are only interested in short-term liquidity. They are not interested in the long-term survival of the firm. Such situations may encourage mismanagement of the enterprise by the managers, leading to the financial crisis such as those which were experienced in Enron. The corporate strategies may not be implemented successfully, as the managers may be reluctant and compromised. This may lead to poor strategic performance.
Preference for exit over voice:
Some institutional investors may prefer not to confront the management, but to sell their shares whenever they suspect that the organization may experience gearing issues, (McCahery et al., 2016, p. 134). Such investors do not contribute to improving the firm’s management process. As such, they may encourage mismanagement and poor implementation of corporate strategies, which may lead to business failure.
In a nutshell, institutional investors’ behaviors significantly dictate corporate strategy and performance of organizations. Active institutional investors may make attempts to monitor the organization's processes so as to ensure the policies are implemented effectively, while the passive institutional investors may encourage laxity of the management in implementing strategic objectives.
References
Aggarwal, R., Erel, I., Ferreira, M. & Matos, P., 2011. Does Governance Travel Around the World? Evidence from Institutional Investors. Journal of Financial Economics, 100(1), Pp.154-181.
Bushee, B.J., Carter, M.E. & Gerakos, J., 2013. Institutional Investor Preferences for Corporate Governance Mechanisms. Journal of Management Accounting Research, 26(2), Pp.123-149.
Elyasiani, E. & Jia, J., 2010. Distribution of Institutional Ownership and Corporate Firm Performance. Journal of Banking & Finance, 34(3), Pp.606-620.
Gunnoe, A. & Gellert, P.K., 2011. Financialization, Shareholder Value, and the Transformation of Timberland Ownership in the US. Critical Sociology, 37(3), Pp.265-284.
Hein, E., 2012. "Financialization," Distribution, Capital Accumulation, and Productivity Growth in a Post-Kaleckian Model. Journal of Post Keynesian Economics, 34(3), Pp.475-496.
Kaniel, R. et al., 2012. Individual Investor Trading and Return Patterns around Earnings Announcements. The Journal of Finance, 67(2), Pp.639-680.
Mccahery, J.A., Sautner, Z. & Starks, L.T., 2016. Behind the Scenes: The Corporate Governance Preferences of Institutional Investors. The Journal of Finance, 71(6), Pp.2905-2932.
Van Der Zwan, N., 2014. Making Sense of Financialization. Socio-Economic Review, 12(1), Pp.99-129.
