Determinants of institutional investor activism: a test of the Ryan-Schneider model

Journal of Managerial Issues, Summer, 2009 by Michael J. Rubach, Terrence C. Sebora

Ryan and Schneider (2002), following Brickley et al. (1988), propose that pressure-resistant funds will most likely practice shareholder activism because they will not be influenced by the governance of corporations in their portfolios. Following the proposition of Ryan and Schneider (2002), it is hypothesized that:

H4: Shareholder activism will be positively associated with pressure-resistant institutional investors.

Legal Restraints

Ryan and Schneider (2002) point out that all institutional investors, as financial intermediaries, exist under different types of legal restraints, whether fiduciary duties under trust laws or responsibilities and duties under federal and state securities laws. They note that federal pension laws, especially the Employee Retirement Income Security Act of 1974 (ERISA), restrict the shareholder activism of corporate or private pension plans (see Blair, 1995; Brancato, 1997; Schelberg and Bitman, 1999). Further, they suggest that insurance companies, due to their unique nature as holders of both equity and debt, could damage their priority rights in bankruptcy cases by engaging in activism (Brancato, 1997; Ryan and Schneider, 2002). They propose that institutional investors affected by ERISA and/or bankruptcy law conflicts will not engage in shareholder activism. Following the proposition of Ryan and Schneider (2002), it is hypothesized that:

H5: Shareholder activism will be negatively associated with institutional investors directly regulated by ERISA and bankruptcy, laws.

Portfolio Management

In the typical approach to institutional fund management, the fund administrator outsources the investment functions to external money managers. The fund administrator selects, directs, and monitors the asset management services supplied by the money managers, banks, and insurance companies (Crowell and Mainet, 1980). An alternative portfolio management technique locates all investment functions "in-house." A number of institutional investors manage all or a portion of their assets in this manner (McConville, 1995). The focus of this study is not on whether institutions should manage their portfolios, but whether internal/external management affects institutional shareholder activism.

Ryan and Schneider (2002) argue that institutional investors who have more assets externally managed would more likely be activists, that the outsourcing of their portfolio management enabled activism. Following their arguments, we hypothesize that:

H6a: External fund management will be positively associated with institutional investor activism.

We would argue that external fund management involves the delegation to outsiders of the responsibility for investment decisions. This delegation of responsibilities to outsiders would lead to passivity by the delegating institutional shareholder/investor. Institutional investors with internally managed portfolios have already allocated assets to monitor the activities of the firms in their portfolios. Contrary to the proposition of Ryan and Schneider (2002), those institutional investors that already invested resources in monitoring will likely use those allocated resources to also practice activism in order to improve their portfolio returns. This leads to an alternative hypothesis: