Few institutional investors embrace the concept of securities that provide differentiated rewards to shareholders based on the tenure of their shareholding, according to a new study by Mercer LLC and two other organizations.
But the study — “Building a Long-Term Shareholder Base: Assessing the Potential of Loyalty-Driven Securities” — found “broad consensus” that short-term behavior of investors “is driving non-optimal behavior by companies.”
Mercer, Stikeman Elliott LLP law firm and Generation Foundation, an advocacy arm of Generation Investment Management LLP whose chairman is Al Gore, collaborated on the study, released Dec. 18.
Loyalty-driven rewards could include use of extra dividends, warrants or additional voting rights granted to investors who hold shares for a long term, such as a minimum of three years.
Loyalty-driven securities “were, in general, not seen as a measure that would contribute significantly (and positively) to the perceived problems or address what were viewed as the root sources of short-term pressures (misaligned incentives throughout the investment chain), even if adopted on a widespread basis,” wrote the co-authors of the study, Jane Ambachtsheer, partner and global head of responsible investment, and Ryan Pollice, senior associate-responsible investment, both in Mercer's Toronto office, and Edward J. Waitzer and Sean Vanderpol, both Toronto-based partners of Stikeman Elliott.
“With the exception of a small number of participants (surveyed for the study), issuers and investors consulted did not view loyalty-driven securities (and the commensurate differential rights for shareholders of a certain holding period) as an attractive proposition.”
Among key findings, the study found, “The endorsement of the principle of 'one class, one share, one vote” as corporate governance best practice represents a significant barrier to the widespread introduction and acceptance of loyalty-driven securities by both issuers and investors.”
Other findings include unintended consequences. “Investors raised concerns that eligibility criteria based solely on holding period … would favor certain types of investors and may produce outcomes that may not be consistent with the objectives of loyalty-driven securities.”
Index investors “may be a long-term holder of shares” and “while some passive managers will exhibit active ownership-type behavior, others put much less focus” on share voting and “do not represent an engaged shareholder,” the study said.
In addition, some long-term holders that would receive loyalty rewards could use derivatives to hedge their exposure.
The study found a general consensus for creation of more constructive relationships between investors and companies “as a central means of strengthening the focus on long-term value creation.”
“We propose that if a greater proportion of investors on quarterly investor calls posed the question — 'What is your plan to build wealth over a five- to seven-year time horizon? — then a fundamental shift in narrative would result,” the authors write in the study.
The study identified three areas of building such relationships that are “longer time horizons for investment analysis, aligned frameworks for performance measurement and reward” and “stronger relationships between companies and investors.”
For the study, interviews were conducted with a total of some 120 chief investment officers, portfolio managers, corporate directors and others at asset owner organizations, investment management companies and corporations.
