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Have global capital markets shifted?

Sensing a broad change in the capital markets in recent years, the Millstein Center for Corporate Governance and Performance set out to better understand what was happening. Jonathan Koppell describes what he and his colleagues learned from a series of discussions with investors, directors, managers, and regulators around the globe.

Over the past 18 months, Yale SOM’s Millstein Center has sponsored a series of roundtables regarding the state of capital markets. These conversations — co-hosted with partners in New York, London, Berlin, São Paolo, and Dubai — were intended to capture the sense of market participants about recent developments. The project’s premise was that understanding corporate governance requires an appreciation for the dynamics of the environment in which corporations, boards of directors, investors, regulators, and other key actors operate. Meetings were held in multiple locales to capture variation in perspective, but because the conversations were also spread over time, we happened to observe the impact of the mortgage crisis and the collapse of prominent financial institutions in shaping views of capital markets. The general mood at the outset of this project was certainly less gloomy than it is at present.

Across roundtables, several features were identified by participants as hallmarks of contemporary capital markets: new investors, new demands, and new roles for existing players


Many participants pointed to the emergence of unfamiliar players as a marked change. In the New York session, much discussion was devoted to sovereign wealth funds (SWFs). These entities use capital accumulated through state enterprises — frequently resource-based — to invest in a variety of enterprises, sometimes with sizeable stakes. This raises alarms for some because the SWF investment is perceived as an extension of state policy. In political or regulatory circles, and to a lesser extent, among investors, the question is whether SWFs are pursuing a non-profit-oriented agenda that could devalue equity. “Whose capitalism is it?” asked a participant in the New York roundtable. “Very different sovereign nations...have totally different concepts as to the func-tion of a corporation than we might in this country... They are not sensitive to returns... They have other agendas.”

Among managers and some boards, however, the capital offered by SWFs is a lifeline, a desperately needed infusion. And, more importantly, it is investment of the most attractive sort — patient capital that gives the businesses time to generate the expected return.

In the Dubai roundtable, which included representatives of some SWFs and their partners, it was clear that the Western reaction to SWF investment was not only baffling, it suggested a fundamental misunderstanding of SWFs and a heavy dose of xenophobia. According to these participants, SWFs are neither new nor distinctive in their investment objectives. They are managed to create return and not to pursue a political agenda, notwithstanding the occasional influence of the politically powerful on investment decisions. Although such funds have room to improve their own governance (including better transparency), it was argued that more interaction across markets, not less, will benefit everyone.

Hedge funds, the other celebrated new investor, are also seen as angelic or devilish depending on whom is asked. Like SWFs, hedge funds are shrouded in mystery. Even the name is misleading, as these funds are rarely devoted to the hedging transactions from which their name is derived. Rather they are pools of capital, organized with varying structures and charged with varying purposes. Some private equity investors are long-term, value-seeking partners while others seem more rapacious, pursuing takeovers as a prelude to debt loading, liquidation of assets, and re-listing. In some markets, the negative view totally overwhelms the positive. Participants in the Berlin session expressed profound misgivings regarding these new owners following the forced breakdown of a very comfortable relationship among firms, banks, and the state. “Supervisory boards...have trouble understanding foreign investors who want to dictate to them,” said one participant. Any positive effects are outweighed by the risk and uncertainty, particularly from the perspective of the regulators who see these new investors and financial instability traveling under the same passports.

Again, this concern is not universal. In the São Paolo discussion, for example, the entrance of new investors raised more modest questions. There is confidence in the ability of firms to adapt to the demands of new investors and maintain a distinctive system attuned to regional business patterns. Perhaps the wave of investment from abroad has not yet reached levels achieved in other markets.


With both the influx of new players and a shift in the expectations of established actors, there is uncertainty among capital market participants regarding the objectives and demands of investors. This creates particular unease for boards who are responsible for representing the shareholders’ interests and regulators who must be wary of the potential downside to investor engagement.

Participants discussed short-term equity strategies that seem dominant in the marketplace. But the discussions did not overwhelmingly reinforce popularly held images, like the tyranny of the quarterly analyst call. Rather, participants pointed to their own ignorance regarding their investors. Without knowledge of owners and their ambitions, the “market” becomes the mouthpiece of demands and it is dominated by those with a short-term view. The voice of investors who do not share this agenda needs to be raised to counteract any short-term bias. “When boards have strong and healthy relationships with their significant investors, directors can be confident enough to proceed with long-term strategy.”

Socially motivated activists seeking to alter the behavior of corporations are finding a new voice through the capital markets. On issues ranging from climate change to child labor to Darfur, socially motivated investors are using their stakes to bring non-financial demands to bear on corporate decsion-making in the executive suite and the boardroom. This type of investor activism can clash directly with the campaigns launched to force companies to focus on increasing return to shareholders. Participants said this activity adds a political dimension to capital markets and makes the job of management and boards that much more difficult.

The substance of the new demands represents only half the equation. Demands are increasingly expressed in ways previously unknown. Many investors, including some varieties of private equity and hedge funds, are engaging with management at a deep level. Indeed, even large institutional investors (particularly some of the public pension funds) are not content to watch their investments from afar. They are meeting with and pushing management as they see necessary to promote their agenda — sometimes related to economic return but increasingly on social or environmental policies.

Such engagement may be a reaction to the emergence of meaningful proxy voting. Devices that give investors the ability to participate via the ballot (including the UK’s “say on pay”) may promote interaction between shareholders, the board, and management by creating pressure to address shareholder concerns. The reaction to increased participation and influence of owners is varied. Naturally, management and some boards fear the negative manifestations: investors uninterested in the long-term interests of the company promoting a shortsighted agenda and using tools described above to browbeat their targets. But others see the boards playing a pivotal balancing role.

An interesting exchange in São Paolo highlighted the distance between ideal and experience. “The pressure [from investors] to perform or perish” is intense and focused on the short term, observed a CEO participant in the São Paulo roundtable. The discussion leader opined that it should be easy for a board to dismiss “unreasonable requests,” to which the CEO said, “The requests come from the board and I have a hard time seeing any director’s requests as unreasonable.”

Finally, at every roundtable, participants discussed the proliferation of complex financial instruments that elude the understanding of even the most sophisticated players. A New York Times article quoting former Treasury Secretary Robert Rubin’s confession that he didn’t understand some of Citicorp’s mortgage-related transactions was cited several times. If such an individual can sign off on something incomprehensible, how many others are doing the same?

The web of counterparties has turned out to be as inscrutable as any instrument. The complexity of transactions makes it very difficult to peel away the layers of the onion, leaving the true consequences of one failure essentially hidden to other market participants.


The introduction of new investors would not cause unease without the concomitant seismic changes among existing institutions. Previously sharp lines are being blurred and heretofore solid institutions are eroding. In some markets the reshaping of institutions represents an uncomfortable departure from historical ownership patterns. German participants, for example, noted that the adoption of European Union policies requiring bank divestiture had shaken the market (as described above). Cross-holding relationships in Asia are also under attack.

Roundtables in Latin America and the Middle East devoted more attention to the particular challenges related to family-owned enterprises. The entrance of new investors from outside the region is a mixed blessing to such companies. Access to new capital sources is welcome, as it opens doors to growth and expansion, but, again, the preferences and expectations of new investors are unknown and their desire for more transparency and access is unfamiliar and off-putting. Regulators can be uncomfortable confronting politically powerful family firms newly subject to the legal requirements of traded companies. Family-owned firms have been shielded from scrutiny and imposing a different model of investor-investee relations may prove contentious.

“Family companies will not move to corporate governance in a formal way, an institutionalized way, without an event,” said a Dubai participant. “Now, that event may be competition. It could be a private equity company coming in. It could be in preparation for an IPO. Or it could be a generational shift. But, generally speaking, family companies will continue without these shake them out of their comfort zone. We need that event to have corporate governance in a sustainable and material way rather than ticking the boxes.”

State-owned enterprises (SOEs) pose a similar set of challenges. Like family companies, SOEs are accustomed to a closed management style with decision-making confined to the company and the controlling ministry. The historical legacy of SOEs as state instruments makes regulators understandably wary of unleashing the full force of global capital markets even as shares of corporatized SOEs are making their way into the hands of non-state investors.

Regulators’ footing is unsure for other reasons. Proponents of Chinese stock exchanges (in Shanghai and Shenzhen) see corporate governance as a crucial element of a stable capital market; laws and regulations defining the role of directors, for example, have been put in place. But formal rules, like those providing for legal resolution of disputes, only assure investors if implemented meaningfully. Complicating the task of improving regulation is a potential conflict in governmental responsibilities. The state now must also be a promoter of domestic capital markets to ensure domestic economic vitality and global competitiveness. Will capital market regulation enter a race to the bottom as a means of attracting listing companies? This is not yet the case. Given the value placed on quality regulation, more lax control is a dubious comparative advantage. The Dubai International Financial Center, for example, advertises its reliance on British common law (including imported judges) as its dispute resolution mechanism. This suggests a race to the top. London participants, for instance, favored “regulations to require more extensive disclosure [by all investors] of equity relationships.” Still, due diligence now must include not just the potential portfolio company but also the market in which it lists. Board members, similarly, must grasp the consequences of their firms’ choice of listing market as a key strategic decision.

Like Heraclitus’s river, capital markets seem to offer constant change. Across roundtables we observed that each development brings strong and varied responses — greeted by some constituencies with consternation while being cheered by others. To really understand the nature of contemporary developments — and to formulate reasonable responses to them — we must comprehend the multiplicity of perspectives and their origins in the different market roles and different market contexts.

Department: Research