Despite the stalemate on the EU’s corporate governance directives, five developments are increasingly having the effect of reducing the specificities of systems, opening national markets to international competition and augmenting the importance of stock markets: 1. Growing Role of Institutional Investors 2. Integration of Capital Markets 3. Harmonisation of Accounting Standards 4. Shareholder Activism 5. Privatisation.

1. Growing Role of Institutional Investors:

The trend in which institutional investors have increased their share of listed companies over time in several European countries is likely to continue, above all in continental Europe, due to developments in retirement financing and health care. The aging of the European population will lead to increasing dependency on funded schemes in the financing of retirement provisions.

European countries currently rely to a large extent on publicly operated pay-as-you-go financed pension schemes, in which contributions from the active working population pay for the pensions of the retired. Growing pensioner-to-worker ratios and the restraints on public spending will make these schemes more and more untenable, and a larger share of pension contributions will have to be financed by privately managed funded labour-market and/or individual pension schemes.


Similar changes might also occur in the sector of health care, where parts of the tasks that are now carried out by the public sector will be divested and handed over to the private sector.

These developments will lead to an increase in the demand for equity and dis-intermediated finance by institutional investors, acting as the depositors of pension funds. They will push companies to adjust their financing methods and may well result in a reduction of the debt-to-equity ratios of European industry.

The role of purely commercial banks (as opposed to investment or universal banks) might diminish in favour of securities markets. Governments might have to reconsider the preferential tax treatment of debt as compared to equity financing.

The growing importance of institutional investors in the European capital markets will push corporate governance towards the British/ American model. Information to shareholders, the one-share/one- vote principle, dividend policy, executive pay and the assembly of shareholders will all become increasingly important.


Institutional investors will be on the demanding side for equal treatment in take­overs and for restrictions on insider trading and dual classes of shares or capped voting arrangements. They can be expected to introduce a more active form of shareholding and pose a direct threat to lax or incompetent management. The growing competition amongst them will only intensify this process.

American pension funds, which possess in volume terms the most assets of all Western countries, are increasingly investing outside the US and bringing their corporate governance standards with them. Overseas equity holdings of US pension funds increased from $117 billion in 1992 to $202 billion in 1993. In percentage terms, the foreign stock of an average US pension fund portfolio was less than 4% in 1986, but rose to 7% in 1993, and is expected to reach 10% in 1996.

American pension funds are required by law under the Employee Retirement Income Security Act (ERISA) to actively monitor investments and communicate with corporate management. The US Labour Department declared the proxy vote an asset that must be exercised to comply with ERISA legislation and required the companies managing the funds to develop voting guidelines aimed solely at member interests. This requirement applies to foreign stock as well. In the UK, the Cadbury report has called upon institutional investors to make positive use of their voting rights.

The two major British institutional investors’ associations — the Association of British Insurers (ABI) and the National Association of Pension Funds (NAPF) — both stress active corporate governance and adequate information to shareholders.

2. Integration of Capital Markets:


The former should be seen in connection with the developments in the EU to create an integrated capital market. The EU’s third life and non-life insurance directives, which came into force in July 1994, reduce investment restrictions and lift localisation requirements for the investments of insurance companies throughout the EU.

Although a draft directive liberalising restrictions in pension funds investment had to be withdrawn, increasing integration of markets and competition between institutional investors will further liberalise the investment climate for institutional investors. At the moment, Ireland, the Netherlands and the UK, which represent over 80% of all pension funds assets in the EU, have no limits on the portfolio distribution of pension funds, the sole exception being the Dutch civil servant pension fund ABP.

Foreign asset holdings are limited in Germany, Belgium and Denmark. German insurance companies and pension funds may invest 30% of their stock in shares, but the traditionally risk-averse fund managers have up to now not been constrained by this limit. They are on average at a much lower level of 18%.

Globally, the worldwide integration of capital markets will lead to more convergence in portfolio distribution of institutional investors. Institutional investors in continental Europe have traditionally overinvested in bonds, whereas equity holdings are underrepresented. The latter form a much more important part of the portfolio of British and US firms. They are more volatile but give a better return in the long run.

3. Harmonisation of Accounting Standards:


The increasing globalisation of markets and the need for a more liquid capital stock led the German company Daimler to request a listing on the US stock exchange in September 1993. Daimler aimed to achieve an increase in its stock market capitalisation and a boost to its international standing through the Wall Street share offering. In order to obtain this listing, however, Daimler had to comply with US accounting standards (US GAAP).

The move was not greeted with enthusiasm. Some German businessmen described Daimler’s decision as an unconditional surrender to the US side. Seen from a political point of view, Daimler’s move jeoparadised efforts to come to an agreement on international accounting standards within the International Accounting Standards Committee (IASC) and discredited the European aim to achieve mutual recognition of European and American accounting standards.

Daimler’s move has in fact given a strong advance to US accounting standards to become the world’s accounting language. Other companies are considering whether to follow this example or are making preparations to do so.

Accounting systems are a reflection of corporate control systems. Whereas the American and English system, dependent as it is on the provision of capital from outsiders, insists on transparency and information, the German system is more closed.


The accounting adjustments entailed in the case of Daimler illustrate the differences between the two systems. For the first six months of 1993, Daimler posted a profit of DM 168 million according to German accounting methods, but a loss of DM 949 million according to the American system. Other European systems take the form of variants on the English and German systems. In general, it can be stated that the greater the distance between the providers and users of capital, the more demanding are the reporting requirements.

4. Shareholder Activism:

Another development that has opened up the control of corporations is the increased activism of shareholders. The trend is clear in the US and the UK, where shareholders are joining forces to have a stronger position vis-a-vis management. Voting services inform shareholders of their rights and encourage them to exercise their proxy.

They notify shareholders of the issues that will come up for voting at the annual general meeting and give background information on the different resolutions. They advise shareholders on which issues are contentious and which are not.

On 29 July 1994, the US Department of Labour reaffirmed its position in guidelines for responsible ownership by pension funds, which call for proxy vote decisions to enhance the value of the shares and active monitoring and communication with corporate management.


The latter includes not only the selection of candidates for the board, but also consideration of executive compensation, the corporation’s mergers and acquisitions policy, the extent of debt financing and capitalisation, long-term business plans, work force training and practices, and other financial and non-financial measures of corporate performance.

The guidelines read-

The Department believes that, where proxy voting decisions may have an effect on the economic value of the plan’s underlying investment, plan fiduciaries should make proxy voting decisions, with a view to enhancing the value of the shares of stock, taking into account the period over which the plan expects to hold such shares. Similarly in certain situations it may be appropriate for a fiduciary to engage in activities intended to monitor or influence corporate management if the fiduciary expects that such activities are likely to enhance the value of the plan’s investment.

The Cadbury report in the UK has also called upon institutional investors to make positive use of their voting rights and to disclose their policies of voting. The UK pension funds association NAPF and the insurers federation ABI organise a voting issues service to allow their members to exercise their proxy votes.


It monitors the largest UK companies, analyses their annual reports and assesses each company’s position in relation to the corporate governance criteria of the Cadbury Code. The organisation reports on resolutions requiring shareholder approval at general meetings and dispatches reports on issues on the ballot in time for proxies to be lodged.

NAPF feels that these measures can assist fund managers to improve the value of investments. This trend is gradually spreading in continental Europe, not only through the shareholdings of American and British investors, but also through increasing awareness of shareholder rights and the potential benefits of activism.

Shareholder activism has indeed become a strategy of investors. Putting money into poorly performing and badly governed, but potentially strong companies, and then agitating for changes in corporate governance, has proved generally to be a rewarding line of action for some investors. Most companies in the US that have been subject to shareholder-influenced restructuring have shown a measurably enhanced performance.

Wiltshire Associates, an American consultancy, analysed the results of 42 shareholder proposals of the California pension fund CalPERS affecting 27 companies during the 1988 to 1991 proxy seasons. Compared to the S&P 500 index total return, the targeted companies realised a positive excess return of 3% over the six months following the announcement, while they experienced a negative excess return of 9.3% over the six months preceding the shareholder proposal announcement.

When the date of negotiated settlement with the management is taken as reference, which precedes the announcement date, the excess return is twice as high. The Wiltshire report, however, adds that only large funds can afford the cost of shareholder activism, while most of the potential gains are distributed to free- riders.

It is sometimes argued that most activist pension funds are also ‘short-termist’ in outlook, thereby increasing the volatility of the stock market. Shareholder activism under ERISA rules tends to be more long-term oriented, considering the issues involved in the monitoring activities.


The Cadbury report also calls upon institutional investors ‘to bring about changes, rather than selling their shares’. Short-termism is nevertheless often considered a problem both in the US and the UK. In his report for the US Council on Competitiveness, Michael Porter (1992) considered the short-term orientation of the US market a competitive disadvantage vis-a-vis Germany and Japan, and called on institutional investors to take a more long-term orientation.

Recent cases have demonstrated the negative effects of exaggerated shareholder activism, in which the owners do not limit their role versus management, but rather become managers themselves, with dramatic consequences for all shareholders and employees.

5. Privatisation:

Several continental European countries have launched important privatisation rounds of state assets. Banks, telecommunications, energy and other enterprises are up for sale to the public in Belgium, France, Germany, Italy, the Netherlands and Spain. These moves will increase the importance of stock markets and augment their capitalisation.

The prime example is Italy, where the stock market capitalisation in percentage of GDP is the lowest in the EU and where the share of government ownership of listed companies amounted to 40% in 1991. To having an overall view of the importance of government ownership is difficult, however, since publicly owned corporations in general are not quoted on the stock exchange.

Nevertheless, the member states’ desire to keep privatised corporations nationally ‘anchored’, in order to retain a strong shareholding in the hands of nationals and to control national assets, might as well play a role in preventing corporate governance from becoming harmonised and transparent. In several European member states, privatisations are placed with local companies and investors.

In France, a core shareholding of the privatised companies is in general placed with French institutional investors and corporations (les noyaux durs). Local individual residents came in second place, but not much was left for foreign investors. The same strategy is followed in other European countries, such as Spain and Belgium. Clearly, however, such policies are irreconcilable with membership of an integrated European market.