“Patient” pension funds prove beneficial for innovation strategies in Europe

By Stéphanie Lavigne

Quite unexpectedly, those European companies which invest the most in Research & Development (R&D) are also those whose majority shareholders are institutional investors (and particularly pension funds located in English-speaking countries) whereas we expected to find so-called ‘strategic’ investors (the State or families) that are generally believed to support a company’s growth policy and therefore also its innovation policy.

The advent of institutional investors in the 1990s led to a radical change in equity breakdown in European companies. Today, 50 to 60% of the capital of European groups listed on the stock exchange is held by pension funds and mutual funds (which manage other peoples’ money). Now, as leading shareholders, they have imposed their own governance principles and value creation strategies, demanding about 15% return on investment for the households whose savings they manage.

To achieve this level of return, companies are implementing financially-driven strategies with shorter investment periods, so that they can deliver ever-increasing dividends to their shareholders on a yearly or even a six-monthly basis. But is this short period of time compatible with a given company’s growth and with its R&D policy in particular?

Relationship between share ownership and R&D policies

In this study, we have tried to establish a relationship between the equity breakdown and innovation policies of major European companies.

A review of empirical studies undertaken so far reveals that they relate almost entirely to the North American market and yield contradictory results. Two opposing theories have emerged regarding the influence of institutional investors: one of the theories asserts that these investors believe in short-term profitability only and do not encourage high-risk innovation policies; the second theory, on the other hand, acknowledges the control exercised by these investors and their positive influence on innovation policy, which ensures the company’s long-term profitability.

Our study shows that in Europe, the more companies’ shares are held by institutional investors the more they spend on R&D whereas we were expecting to find strategic investors such as governments or families that are known to support companies with patient growth policies. It seems that the crucial factor is the investment period of these institutional investors: the longer the period, the greater the likelihood of the company committing to an innovation policy. This may seem insignificant, but the findings have never before been demonstrated in a multinational context (a sample of 324 European companies) over such an extended period of time (tests between 2002 and 2009).

“Patient” investors versus “impatient” investors

One of the major conclusions of our study highlights the detrimental effect of short-term investor attitudes on the innovation strategies of companies, which actually need the support of long-term investors in order to carry out their R&D policies.

When analyzing how the investment period influences the innovation strategies of European companies, we compared companies having short-term or “impatient” investors (with an investment period of less than 18 months) as majority shareholders with companies where long-term or “patient” investors are the majority shareholders. Our findings show that R&D spending is higher when the majority shareholders are patient investors and lower when most of the company’s capital lies in the hands of impatient investors.

This article was written by Stephanie Lavigne and the article “Ownership structures and R&D in Europe: the good institutional investors, the bad, ugly and impatient shareholder”, co-authored by Olivier Brossard and Mustafa Erdem Sakinc, published in Industrial and Corporate Change (Volume 22, Number 4) – Oxford University Press, 5 July 2013.

Practical applications

Our study of equity breakdown and the innovation strategies of European companies shows that we should not be disparaging about institutional investors but focus on the crucial issue of how long they leave their investments in companies.
With this in mind, companies must learn to identify the investment period of any new institutional investors promptly in order to build a privileged relationship with them and attempt to offset any short-term investors.

Methodology

In our research, we conducted an empirical study of the relationship between the equity breakdown and innovation policies of leading European companies. We analysed a sample consisting of the 324 most innovative European companies (as listed on the EU Industrial R&D Investment Scoreboard between 2002 and 2009) and compared their R&D expenditure against financial and shareholding data obtained from the Thomson Financial data base.