1. Pension Reform, Ownership Structure, and Corporate Governance Mariassunta Giannetti Stockholm School of Economics, CEPR and ECGI Luc Laeven IMF, CEPR and ECGI Presented at the Joint Discussion Forum hosted by ICPM / Netspar / Maastricht University October 2007

2. Motivation Aging populations are pushing for pension reforms Research has so far focused on analyzing the effects of pension reforms on individual savings  Attanasio and Brugiavini, 2003, and Attanasio and Rohwedder, 2003 Any effects on the financial system? Pension reforms to fully funded systems increase institutional investment in the stock markets Which effects?

3. The common wisdom Increase in institutionalized saving due to pension reforms (Khorana, Servaes and Tufano, 2005) More investor activism? More market oriented financial system? Decrease in private benefits of control and ownership concentration; increase in firm valuation and stock market development

4. Research design Swedish experience Detailed ownership data are available Semi-annual information on the top 200 owners Nice quasi-natural experiment Exogenous reshuffling of institutional ownership Institutional saving and financial markets Effects of changes in pension funds’ ownership on ownership concentration, firm valuation, corporate governance

5. Related literature Investor activism effects on firm performance and corporate governance Mixed results, probably due to identification problems In clinical studies, activism is not always observable as it is done with private negotiations with management more often than with proxy proposals  Carleton, Nelson and Weisbach, 1998; Becht, Franks, Mayer and Rossi, 2006 In larger scale studies, institutional ownership is endogenous  Karpoff, 2001; Woidke, 2002 Focus on the US and UK

6. Our contribution: Large scale study of the arrival and exit of potentially active investors Swedish pension reform  Exogenous change in ownership Is there room for pension funds’ activism in financial systems with concentrated ownership? Which investors become active?

7. Data Ownership data Starting from December 2000 to June 2005, we have biannual information of the top 200 owners of Swedish companies Price data and balance sheet data Six trust and market manager Board nominating committees Hand-collected from company reports

8. Swedish pension reform Two quasi-natural experiments First phase of the pension reform AP4, a public pension fund, has to dismiss most of its participations between December 2000 and June 2001 Second phase of the pension reform Six public pension funds, known as AP Funds, were recapitalized and allowed to invest in stocks starting from January 2001. 500 private mutual/pension funds, selected by the government after negotiation of the fees, were allowed to receive compulsory and discretional pension savings  Saving in these selected mutual funds is tax advantaged Starting from January 2001 pension funds expanded their portfolio of Swedish stocks  We look at the expansion of their assets from June 2001

9. Pension reform and identification Causality vs. selection Pension funds may improve performance or may select companies that are going to perform better Differences of firms with and without pension funds ownership in 2000 No systematic differences in operating performance, some differences in market to book Pension funds systematically select large companies, companies that are part of the index

10. First experiment A public pension fund (forced) ownership dismissal between December 2000 and June 2001 AP4 Independent Large stakes in the Swedish market Traditionally, active in corporate governance Sells participations equivalent to 2.5 percent of the votes in 51 companies All companies in which AP4 had participation are affected

11. First experiment: empirical implementation D&D Instrument: Dummy equal to 1 for firms AP4 was invested in December 2000 Both in OLS and IV specifications industry dummies capture different exposure to the index

12. Equity Market Shares of Different Classes of Pension Funds (Table 1)

13. First stage Capturing the exogenous change in AP4 ownership

14. Second experiment The subsequent expansion of public and private pension funds holdings Timing exogenous But stock picking may be endogenous Expectations on future performance Exogenous preferences for certain types of stocks  Pension funds invest similarly to other mutual funds, in large companies, companies that are part of the index What is the strategy of pension funds if one abstracts from expectations on future performance? We proxy the strategy of pension funds using the above firms characteristics before the reform

15. First stage

16. Equity Market Shares of Different Classes of Pension Funds (Table 1)

17. Heterogeneous funds

18. Pension funds and performance Control includes industry fixed effects or time dummies, time effects, stock turnover, number of employees, leverage

19. More on private pension funds and performance Only large and independent pension funds appear to become active

20. Which is the mechanism? Liquidity or corporate governance? Liquidity unlikely over a six month period Also, we control for liquidity and find a similar effect on operating performance If (all) private pension funds increase their shareholdings by a large amount no positive effect on firm performance

21. Reaction of the principal shareholder Large increase in public pension funds ownership only

22. Change in the control premium

23. Effects on the value of a vote Control premium=value of a marginal vote Value of marginal vote=f(private benefits of control, probability that the vote is pivotal) Pension funds that are active in corporate governance may increase the probability that a marginal vote is pivotal Expected more difference in opinion in corporate policies

24. Are pension funds really active in corporate governance? Evidence from board nominating committees Hand-collected from 2005 companies’ reports

25. Conclusions An increase in institutionalized saving does not necessarily lead to more disperse ownership and market oriented financial systems Ownership concentration may even increase if private benefits of control are large Pension funds’ incentives matter What happens within the firm? Board composition and turnover CEO compensation