The Convergence between Sustainability and Conventional Stock Indices. Are We on the Right Track?

The growth of passive and socially responsible (SR) investment makes that sustainability indices play an important role in defining what constitutes a sustainable investment. In order to know the suitability of sustainability indices as benchmarks for SR investors, we used different linear regressions to compare the compositions of sustainability indices and their conventional counterparts and to compare the levels of corporate social responsibility (CSR) of both types of indices. We showed that the composition of sustainability indices gradually converged towards their conventional peers. Moreover, the difference between the CSR levels of both type of indices remained the same or even decreased over time. We concluded that a change in the weighting method of sustainability indices such as the equally weighted criterion would significantly increase the difference from their conventional counterparts. However, due to the relationship between CSR and size, this change would penalize the CSR level of the index. These results raise the question of whether SR passive investors will be able to meet their non-financial expectations as a consequence of the convergence.

Diversification, Common Ownership, and Strategic Incentives

We argue that within-industry investor diversification is directly related to common ownership incentives (profit loads on rival firms by the manager of a firm) in product markets. Because of their respective investment strategies, passive investors are naturally more diversified than active investors. If more money flows from active toward passive investors, then common ownership incentives increase. The opposite occurs if active investors receive more money flows. This pattern is shown in two example US industries for the period 2004-2012.

Active Investors, Passive Investors, and Common Ownership

Recent studies have extensively examined the hypothesis that a higher degree of common ownership relaxes competition. This approach has typically conducted comparative statics analysis based on exogenously given rates of common ownership. This study constructs a simple model in which common ownership emerges as an equilibrium outcome resulting from ownership acquisition. We characterize the equilibrium incentives of institutional owners to acquire common ownership of the firms operating in a duopolistic product market. Further, we explore the effects of common ownership on passive investors, consumer welfare, and total welfare.

Going the Distance

Before the seventeenth century, trade across Eurasia was mostly conducted in short segments along the Silk Route and Indian Ocean. Business was organized in family firms, merchant networks, and state-owned enterprises, and dominated by Chinese, Indian, and Arabic traders. However, around 1600 the first two joint-stock corporations, the English and Dutch East India Companies, were established. This book tells the story of overland and maritime trade without Europeans, of European Cape Route trade without corporations, and of how new, large-scale, and impersonal organizations arose in Europe to control long-distance trade for more than three centuries. It shows that by 1700, the scene and methods for global trade had dramatically changed: Dutch and English merchants shepherded goods directly from China and India to northwestern Europe. To understand this transformation, the book compares the organizational forms used in four major regions: China, India, the Middle East, and Western Europe. The English and Dutch were the last to leap into Eurasian trade, and they innovated in order to compete. They raised capital from passive investors through impersonal stock markets and their joint-stock corporations deployed more capital, ships, and agents to deliver goods from their origins to consumers. The book explores the history behind a cornerstone of the modern economy, and how this organizational revolution contributed to the formation of global trade and the creation of the business corporation as a key factor in Europe's economic rise.

The English East India Company

This chapter focuses on the English East India Company (EIC). In September 1599, a group of London merchants held a number of meetings that turned out to be the founding meetings of the EIC. It describes two parallel tracks—one for obtaining a royal charter that would incorporate the promoters as a corporate entity and permit them to enter trade with new territories, and the other for raising equity capital for voyages to the East Indies from a large number of passive investors. By employing this dual track, the promoters of the EIC coupled the familiar legal structure of the corporation with the less familiar element of joint stock. In contemporary constitutional terms, incorporation was considered an essential component of the monarch's exclusive and voluntary prerogative to create and grant dignities, jurisdictions, liberties, exemptions, and franchises. The chapter covers how EIC was incorporated in its first charter for a period of fifteen years, ending on December 31, 1614.

Institutional Investor Attention and Firm Disclosure

ABSTRACT We study how short-term changes in institutional owner attention affect managers' disclosure choices. Holding institutional ownership constant and controlling for industry-quarter effects, we find that managers respond to attention by increasing the number of forecasts and 8-K filings. Rather than alter the decision of whether to forecast or to provide more informative disclosures, attention causes minor disclosure adjustments. This variation in disclosure is primarily driven by passive investors. Although attention explains significant variation in the quantity of disclosure, we find little change in abnormal volume and volatility, the bid-ask spread, or depth. Overall, our evidence suggests that management responds to temporary institutional investor attention by making disclosures that have little effect on information quality or liquidity. JEL Classifications: G23; G32; G34; G12; G14.

Passive investors: Implications for corporate governance

The key research question of this paper is to explore the major implications for corporate governance from the emergence and perspective of passive investors. Passive investors care more about long-term governance practices than short-term financial metrics. They do not trade shares when accounting balances or stock prices fluctuate since they have a long-term perspective. They desire a new investor relations approach, based upon independent directors discussing key corporate governance topics of board refreshment, sustainability, and compensation with the stewardship officers of passive investors. Thus, financial accounting is moving back to a stewardship purpose of accounting versus an investment valuation model. The corporate governance literature relating to investors has only focused on active, not passive, investors. The emergence and perspective of passive investors are relevant for updating the theory and practice of corporate governance as follows. Passive investors have a long-term sustainability perspective, not a short-term focus to make financial analysts’ quarterly predictions. Passive investors focus upon three board of directors’ committees: nominating, audit, and compensation, with emphasis on a stewardship officer, a lead director, board refreshment, an indefinite investment horizon, and sustainability risks.

Audit committee guidance for strengthened corporate governance

The major research question in this paper is how to provide guidance to board of directors’ audit committees in order to strengthen corporate governance. Audit committees have a direct responsibility to oversee the integrity of a company’s financial statements and to hire, compensate, and oversee the external auditor. Public focus, especially by activist and passive investors, on how audit committees discharge these responsibilities has increased significantly. As analyzed in this paper, indications that this current audit regime is not working are overwhelming. Neither the public interest nor the needs of investors are being served by the auditor-client relationship as it exists. The reforms suggested in this paper represent advances that would help both board of directors’ audit committees and the auditing profession become trusted watchdogs of public companies’ financial information. This paper speaks to the growing research attention to the audit function and maps out the well-developed strategies to advance the audit quality. The major sections of this paper are a century of audit opinions, 21st-century frauds, fraud analysis, auditor assessment tool (created by The Center for Audit Quality), auditor continuing issues, auditor upgrades, discussion, and conclusion