The Seemingly Forgotten Tool of Corporate Governance

Proxy votes matter.

For anyone unfamiliar with the topic, a proxy vote is an annual vote associated with owning stock in a company. Often, owning one share entitles an investor to one vote. Typical ballot items are the election of directors, the appointment of the auditor, and the approval executive compensation and shareholder proposals such as the lobbying or environmental sustainability reports. Of course management still runs the company, but shareholders are entitled to voice their opinions using this mechanism. Proxy voting was historically done at a company’s annual meeting, but now it’s done online or via mail. Generally, only common shareholders (as opposed to preferred shareholders) are entitled to vote their shares.

Certain companies (most notably Alphabet) have dual class common stock with preferential voting rights in one class. Generally, investors pay a slight premium for Alphabet’s class A voting shares (GOOGL) over its class C non voting shares (GOOG). (See this report for greater depth on the GOOGL/GOOG discussion) Any sustained price disparity between voting and nonvoting stock suggests that the “market” assigns value to a proxy vote: having influence has value.

Flows to passively invested products (commonly S&P 500 tracking ETFs/mutual funds, total market funds or target date funds) are capturing much of a market that was once manually selected by a portfolio manager. Morningstar Research shows how money is quickly becoming passive:

There are many benefits to this trend, but the biggest driver is effortless diversification at a low cost. Presently, only “shareholders of record” or investors in individual securities held in “street name” at a brokerage can vote proxies. With such a seismic shift from individual share ownership and actively managed funds to passive products, an important question should be asked: if index fund holders can’t choose how to vote, who does?

Often, the answer rests at one company: Institutional Shareholder Services (ISS), a “proxy advisory” firm. ISS’s website says it delivers “proxy research and vote recommendations while working closely with clients to execute more than 10.2 million ballots representing 4.2 trillion shares.” Put simply, ISS has massive influence. In a 2014 NY Times Article, Distinguished Professor and author of The Shareholder Value Myth, Lynn Stout calls ISS “the most powerful business institution you’ve never heard of.”

My proposal is to let investors of index funds vote the shares owned by the fund. In my opinion, adding this choice would be beneficial to investors, not burdensome. Investing in index funds is not a completely passive activity: investors must choose the index they seek to track, the institution that operates the fund, and the timing at which they invest. They should have some say in how the shares are voted. Giving retail investors the opportunity to vote the shares they literally paid for would make for a more democratic system.

I believe proxy advisors like ISS still should have a place at the table: advising clients on how to vote is a useful task. Portfolio managers make the prudent choice to outsource this role to ISS, because that’s its core competency. However, I strongly believe that investors in indexed products are entitled to a say in the way proxies are voted. Owners of index funds have actively made the choice to avoid portfolio manager bias in security selection; they deserve to have the option to remove any bias in the proxy voting process, too.

I believe the implementation of this idea is reasonably simple. The SEC could create a rule that mandates any index holder with beneficial ownership of more than one share of a company’s stock gets to vote its proxy. This system could even be “opt-in,” so only investors that truly want to vote their shares could be able to.

If legislation is too extreme or slow to implement, an even simpler solution exists: investment companies could poll owners of their funds and vote shares in proportion to these poll results. Given enough pressure to implement this idea, client owned brokerages (like Vanguard) would likely be the first to do so. Even if brokerages don’t step up, funds (especially Environmental, Social & Governance — ESG funds) should give investors a voice. If enough pressure was placed on profit-driven institutions, they’d follow suit.

One institution, the Long-Term Stock Exchange, is already working to improve the democratization of stock ownership. One of its ideas is “tenure voting:” preferential voting rights for long-term investors.

Vanguard’s website says, “We vote proxies on behalf of each of our funds at public company shareholder meetings across the globe. Our voting is based on Vanguard’s specific guidelines and on detailed company research carried out by our team of analysts.” Admirably, Vanguard and other institutions are transparent by publishing their voting history, but this data is still “after-the-fact.” Unless rules can be created to give index holders the right to vote proxies of the shares held in the index, the onus is on them to demand their investment managers give them the voice that they paid for.