Governance Structures of Investment Banks in Mature International Markets

The governance structure of a company is an institutional framework that coordinates and standardizes the distribution of rights and obligations among shareholders (asset owners), the board of directors, the board of supervisors, and senior executives. It also dictates relevant issues such as elections and supervision. Simply put, it determines how to divide power inside the company. Sound corporate governance structures can address issues related to profit distribution among various parties and constitute a deciding factor for the operation efficiency and competitive strength of the company. As previously discussed, almost all investment banks in mature international markets have adopted the joint-stock limited liability company system. Therefore, excellent corporate governance structure is also an indispensable factor in overseas investment banks.

Equity Structure

In order to analyze the governance structure of an investment bank, the first step must be to analyze its equity structure. By studying data from financial reports of top investment banks in mature international market, we find the following features common to their equity structures.

Institutional Investors Make Up a Large Percentage, but the Equity Is Widely Distributed In the equity structures of investment banks listed in the U.S. market, institutional shareholders make up a large proportion of the bank's equity. However, the equity is widely distributed, thanks to the large number of investors. We will review this feature in two steps.

The first step is to look at the shareholding of institutional investors. Table 8.4 shows the holdings of institutional investors in the top five investment banks in terms of market value as of December 1, 2011.

Table 8.4 shows that institutional shareholders account for an average of 55.90 percent, more than half of all shares in the five investment banks. Morgan Stanley has the largest proportion of institutional investors at 75.88 percent, or more than three quarters. The average number of institutional investors is just under 1,000 (991.2). J.P. Morgan has the most institutional investors at 1,583. Despite the large percentage of shares held by these investors, the percentage of shares held by an average institutional investor in the five investment banks is merely 0.0555 percent, due to the large number of investors. The percentage of each investor is less than 1 out of 1,000. Even in Morgan Stanley, the highest among them, the percentage is just over one-thousandth.

The next step is to focus on the equity concentration of investment banks. The indexes used for equity concentration are the percentage of shares held by the largest shareholder and the percentages of shares held by the top five shareholders in the top five investment banks in terms of market value as of December 1, 2011. The percentages are shown in Table 8.5.

As shown in Table 8.5, only one of the five major investment banks has more than 10 percent of its shares held by its largest shareholders. HSBC has only 0.36 percent of its shares held by its largest shareholder. Only one bank has over 20 percent of its shares held by its five largest shareholders. HBC has only 1.08 percent of its shares held by its five largest shareholders. Of the top five investment banks, Morgan Stanley has the largest percentage of its shares (22.4 percent) held by its largest shareholder. Similarly, Morgan Stanley has the highest percentage of its shares (40.30 percent) held by its five largest shareholders. If the percentage of shares held by the five largest shareholders is used as the measuring index,

TABLE 8.4 Shares Held by Institutional Investors in Top Five Investment Banks in Terms of Total Market Value

Shares Held by Institutional Investors in Top Five Investment Banks in Terms of Total Market Value

TABLE 8.5 Equity Concentration Overview of Top Five Investment Banks in Terms of Total Market Value

Equity Concentration Overview of Top Five Investment Banks in Terms of Total Market Value

the average equity concentration ratio of the top five investment banks in the United States is merely 18.09 percent.

There are mainly two reasons behind the decentralized equity of investment banks in mature international markets:

1. In mature international markets, there tend to be legal restrictions on institutional investors holding a large percentage of shares in a certain company (including investment banks). In the United States, for example, extremely unfavorable tax treatment will be imposed on any insurance company holding more than 5 percent of all shares of a specific company, or any mutual fund or pension fund holding more than 10 percent of all the shares in a company. In addition, once the percentage of shares held by any institution in a specific company reaches 10 percent, the institution will be barred from trading the company's shares without permission.

2. Institutional investors in mature international markets are very familiar with risks in the financial market. In order to distribute risks and lower nonsystematic risks as much as possible, they tend to choose the most diversified investment portfolio.

Low Percentage of Internally Held Shares and High Equity Liquidity Most shares issued by U.S. investment banks are active shares, which can be traded freely and publicly. Active shares refers to the shares issued by an investment bank apart from those held by senior executives and employees internally, those held by shareholders holding over 5 percent of the shares each, and those subject to other types of trade restrictions. Trading of such shares is relatively active.

As shown in Table 8.6, internally held shares averaged only 2.41 percent in the top five investment banks, whereas active shares averaged 97.59 percent. The percentage of active shares is about 100 percent in HSBC. Even on the low end, active shares accounted for 92.47 percent in Goldman Sachs.

Obviously, the high liquidity of equity in mature international markets is based on the highly decentralized distribution pattern of equity. Under a widely distributed equity structure, institutional investor shareholders are usually not willing to actively and directly involve themselves in the corporate governance of investment banks. This may be due to their shortsightedness, constraints in information and expertise, costs of participation in governance, or the public nature of the products. They instead tend to express their judgment on the operation efficiency of an investment bank by buying in or selling out shares, which gives high liquidity to the equity of investment banks.

TABLE 8.6 Overview of Internally Held Shares in Top Five Investment Banks in Terms of Total Market Value

Stock Symbol

Name of Stock

Internally Held Shares

Externally Held Shares

JPM

J.P. Morgan

1.88%

98.12%

HBC

HBC

0.00%

100.00%

BAC

Bank of America

0.63%

99.37%

GS

Goldman Sachs

7.53%

92.47%

MS

Morgan Stanley

2.03%

97.97%

Average

2.41%

97.59%

Source: Based on data from nasdaq.com/symbol/jpm/ownership-summary.

 
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