Getting to Know You: The
Case for Significant Shareholder Engagement
Posted by F. William McNabb III,
Vanguard, on Wednesday, June 24, 2015
F. William McNabb III is Chairman and CEO of Vanguard. This
post is based on Mr. McNabb’s recent keynote address at Lazard’s
2015 Director Event, “Shareholder Expectations: The New Paradigm
I’ll begin my remarks with a premise. It’s
a simple belief that I have. And that is: Corporate governance should
not be a mystery. For corporate boards, the way large investors vote
their shares should not be a mystery. And for investors, the way
corporate boards govern their companies should not be a mystery. I
believe we’re moving in a direction where there is less mystery on
both sides, but each side still has some work to do in how it tells
its respective stories.
So let me start by telling you a little
bit about Vanguard’s story and our perspective. I’ll start with an
anecdote that I believe is illustrative of some of the headwinds that
we all face in our efforts to improve governance: “We didn’t think you
cared.” A couple of years ago, we engaged with a very large firm on
the West Coast. We had some specific concerns about a proposal that
was coming to a vote, and we told them so.
The proposal failed, and it was
embarrassing for the firm. They responded by reaching out for feedback
from all of their largest shareholders—or so they said. They didn’t
call their largest independent shareholder—Vanguard—nor did they
apparently take into account the very specific feedback we had already
In conversations afterward with them (once
we finally got to the board), they told us, essentially, “You guys run
index funds. We didn’t think that you cared.”
Well, we do care. A lot! Interesting
postscript: Now that this company knows we care, they’ve taken
substantive action in response to input from us and others.
A word about Vanguard
Let me pause for a moment to give you some
additional context for Vanguard’s point of view. Today we are the
largest mutual fund firm in the world. We have $3.3 trillion in global
assets under management. We have 159 funds in the U.S., and an
additional 123 in markets outside the U.S. In the U.S., we have nearly
$1.7 trillion in index equities and an additional $356B in actively
managed equity funds.
What that all means is that Vanguard
investors collectively own about 5% of every publicly traded company
in the United States and about 1% of nearly every public company
outside of the U.S.
And, remember, when it comes to our
indexed offerings, we are permanent shareholders. To
borrow a phrase from Warren Buffet: Our favorite holding period is
forever. We’re going to hold your stock when you hit your quarterly
earnings target. And we’ll hold it when you don’t. We’re going to hold
your stock if we like you. And if we don’t. We’re going to hold your
stock when everyone else is piling in. And when everyone else is
running for the exits.
In other words, we’re big, we don’t make a
lot of noise, and we’re focused on the long term.
That is precisely why we care so
much about good governance. Vanguard funds hold companies in
perpetuity. We want to see our investments grow over the long-term.
We’re not interested in managing the companies that we invest in. But
we do want to provide oversight and input to the board of directors.
And we count on boards to oversee management.
That perspective informs our approach to
corporate governance. So let me share, at the very highest level, our
six principles on governance. These are some of the same ideas that
the panelists discussed earlier this evening:
Independent oversight and, more
broadly, appropriate board composition. It is the single
most important factor in good governance. If you think about it,
we’re in a representative democracy. We empower a group of people to
oversee our interests as shareholders, to hire and fire the CEO, and
to have a say in strategy, risk oversight, compensation, and so
forth. We as shareholders are not there, and that group of
representatives needs to be our eyes and ears. Who they are, how
they interact, and the skills they bring to the table are critical
from a long-term value standpoint.
Management should be accountable to the board. The board should be
accountable to shareholders.
Shareholder voting rights that
are consistent with economic interests. This means one
share, one vote. No special share classes for added voting power.
Annual director elections and
minimal anti-takeover devices. We believe that shareholders
benefit when the market for corporate control functions freely.
Sensible compensation tied to
performance. The majority of executive pay should be tied
to long-term shareholder value.
Engagement. I’d like to
place my greatest emphasis on engagement tonight, because it serves
as a touchstone for all of our other core principles.
At Vanguard, we’ve been on a journey
toward increased engagement over the past decade or so. Our peers in
the mutual fund industry have as well. Proxy voting is not poker. Our
votes should not come as a surprise to companies and their boards.
Our outreach efforts began many years ago
by simply posting our proxy voting guidelines on our website, then
having ad hoc, issue-driven conversations with companies. A few years
later, we began writing letters to companies from our CEO (my
predecessor in the role, Jack Brennan, started this practice). We
wanted them to know that we were a significant shareholder, and we
wanted them to be aware of our guidelines.
As we’ve gone along, we’ve become more
targeted in whom we mailed letters to and more prescriptive in our
In March, we sent out 500 letters to
independent chairs and lead directors at companies across the U.S. In
the letter, we talked about our six principles for corporate
governance and the importance of engaging with shareholders. In just
two months, we’ve received 164 responses, and they were almost all
uniformly positive, thanking us for reaching out. Directors shared the
various formats they use for engagement:
Sometimes the lead director is in charge
of shareholder engagement.
Sometimes it’s a committee of directors.
Some companies have board members
involved in “investor days” for their industry, where they’re
hearing from shareholders.
And at other companies, the general
counsel meets with different investor groups and reports back to the
What we’re always advocating for,
essentially, is thoughtful engagement. It’s really “quality over
quantity”: knowing your shareholder base, knowing what they care
about, and knowing how often they want to engage with you.
Engagement is bilateral and comes in many forms.
Engagement is a two-way street. It’s not
just about publishing proxy guidelines or investors voicing concerns.
There are some great examples of boards being proactive and getting
their messages out to investors. Two examples from recent years:
Microsoft, in a number
of instances, has used videos from their directors to communicate
the board’s perspective on issues. Whether it’s the lead independent
director describing the board’s role in overseeing strategy or the
chair of the audit committee describing the board’s perspective on
risk management, these insights into the board’s thinking provide
helpful context for investors. This is a great example of one form
of “one-to-many” engagement that is simple, underutilized, and very
much appreciated by us as investors.
Another example: When Dell
announced its intention to go private, we met with the
special committee of the Dell board that had to make the decision on
shareholders’ behalf to sell at a specific price. We listened to
their perspective, their decision-making process. and the things
that they took into account. It put us in a better position to
decide whether this was a good deal. The more opportunities we have
to interact with directors in the normal course, the more we have an
increased level of insight.
An example that was resolved only a few
hours ago, of course: DuPont and Trian. It’s a
cautionary tale of how no company is truly immune to activist
investors. DuPont is well-known and highly regarded, and, most
relevant to our discussion here, has been reaching out to investors
and acting on their feedback for years. The board gets feedback
early, and feedback influences strategy at the company. DuPont and
Trian engaged with each other for two years beforehand. But a proxy
struggle ensued nonetheless.
Practical engagement around board composition
Sometimes engagement can mean just being
crystal clear about your expectations—and about how you think through
certain issues. This applies to boards and to investors. For example:
Do you have a set of written guidelines
that spell out the type of expertise or perspectives that you want
in your board members (i.e., these are the types of things we’re
looking for, and these are the people we believe embody them)? We’re
seeing an increasing number of companies offering this kind of
perspective, and it’s very helpful to investors.
Do you have a way to assess appropriate
board tenure, both at the aggregate and individual level? Investors
might have questions about why, for example, a particular board
member has served for 30 years and whether he or she is sufficiently
independent of management.
There’s a need to have a framework to
raise important questions and have meaningful discussions between
boards and investors to help facilitate a level of self-awareness for
boards. A framework allows them to say, in essence: We realize that
our board is comprised differently (or operates differently) than
other firms in our business—and here’s why.
There may be a good reason for a board to
be an outlier. There may not be. But let’s provide as much context as
we can and invite the discussion. Because investors are going have
these questions anyway. In the absence of additional context, they may
draw their own conclusions.
Thinking like an activist
The outlier concept extends beyond board
composition and gets into matters of business oversight and strategy.
The best boards work to understand where their companies might be
different or might be perceived as different.
Are those differences strengths or
vulnerabilities? Some of this is a defensive mindset. Some of this is
the continued evolution of the board’s role in strategy. In many
companies, we’re seeing the board’s role move beyond the historical
perspective of “review and concur” to becoming more engaged in setting
So how does a board inform itself? If you
want to, as a director, you can be fed a steady diet of management’s
perspective on issues. And in many instances, if left to your own
devices, that’s what you get. Management comes in, gives you a
presentation, and tells you why this is the right strategy. If that’s
all you’ve got, shame on you.
As an aside here: I’m continually sounding
the warning about the danger of complacency to employees and
leadership at Vanguard. The firm has been doing very well,
particularly over the past several years, in terms of cash flow,
performance, and large-scale initiatives that we’ve rolled out. It
would be very easy for us to feel like we can take a breath, maybe
relax a bit. Complacency is a temptation. But we can’t succumb to that
temptation. A relentless pursuit of excellence on behalf of our
clients continues to drive everything we do. As Andy Grove, former CEO
of Intel, put it, “Success breeds complacency. Complacency breeds
failure. Only the paranoid survive.” I’d suggest that this is how
boards need to be thinking—functional paranoia. Are you getting enough
Healthy and vibrant boards think like an
activist in the very best sense. They ask:
Where should we be pushing harder or
taking costs out? What are the management team’s blind spots?
What are the board’s blind spots?
And how do we correct that? Some boards
bring in sell-side analysts that have a “sell” on the company to
tell them what they’re missing.
If all the board is listening to is
management’s perspective, they may be surprised when an activist shows
up and says, “Hey, your cost structure is way out of line with your
Glenn Booraem, who heads up Vanguard’s
corporate governance team, was just telling me about a conversation he
had last week with an activist. The activist’s premise was, “As long
as there are unhappy shareholders, activists have a role.”
This particular activist has a theory
about maximization mindset versus sufficiency mindset. An owner is
going to have a maximization mindset: the owner wants to maximize the
value of an investment over time. So as an owner, if you have
significant money on the line, you might make different decisions than
what this activist described as some boards’ sufficiency mindset. If a
board has a sufficiency mindset, then a presentation by the management
team seeking approval for a big initiative might be met with, “Yeah,
that looks good. That looks reasonable. You’ve made a sufficient case
to make this capital investment.”
But if you’re looking at the presentation
with a maximization mindset—you’re spending your own money, in
essence—you might say, “Can you do it for 5% less? 10% less? 15%
This activist’s contention was that some
boards aren’t pushing hard enough because they’re not in the owner’s
seat and aren’t thinking as owners of the organization might think.
Changing nature of activist investors
The nature of activist investing has
changed significantly since the 1980s. Today, we’re seeing a greater
trend toward constructive activists rather than destructive
activists. Activists are not inherently good or bad. They often raise
When activists raise legitimate questions
and tie their business cases to long-term shareholder value, that gets
our attention. I can think of several cases where a board wasn’t
asking the right questions and eventually lost touch with how the
company was being run and being perceived by investors. If the first
time we’re hearing from a company in our role as shareowners is when
the company is under siege by activists, that’s not good. The company
is inherently on the defensive at that point. And they’ve lost control
of the narrative, at least to some degree. Generally speaking,
activism most often happens when something is broken.
I’ll share two instances where Vanguard
has sided with activist campaigns in recent years.
Canadian Pacific Railway:
In 2012, activist Bill Ackman identified some
vulnerabilities in Canadian Pacific Railway. We agreed—as did many
other large investors—that the company had been poorly run and
governed. Ackman brought in an experienced CEO and a number of
directors they thought could make a difference. It’s been an
activist success story by and large.
Another example of us supporting an activist: In 2014, Corvex and
Related Companies waged a successful campaign to replace the entire
board of Commonwealth REIT. This was a company with a track record
of poor performance and poor governance, and they were ultimately
held accountable. Commonwealth was using a third-party management
firm, RMR, that was run by family members of Commonwealth
leadership. RMR extracted value from the public company. They didn’t
operate it well, but they were paid well nonetheless. We supported
wiping the slate clean. In the case of Commonwealth, we were the
largest shareholder. We were important to Corvex’s case, but at the
end of the day, I don’t think they needed us. Eighty-one percent of
Commonwealth shareholders voted to remove the company’s board.
There is a caveat that I want to mention,
and it has to do with backbone. We’re talking about how dangerous it
is for companies to essentially write off any particular group of
shareholders. Part of the board’s role is to listen. If someone’s
going to buy up 5% of the company, you should at least listen.
That said, it doesn’t mean that the board
should capitulate to things that aren’t in the company’s long-term
interest. Boards must have a backbone. To be frank, board members
cannot be more worried about their own seats than they are about the
future of the company they oversee. Boards must take a principled
stand to do the right thing for the long term and not acquiesce to
short-term demands simply to make them go away.
Don’t be dissuaded by common concerns
We do hear concerns from boards who
haven’t fully embraced more significant shareholder involvement. The
most common are:
“Strong shareholder engagement
will disintermediate management.” This is not what large
shareholders want in an engagement program. Boards will often choose
to include management for legal support and to talk about
operational issues. And then there are those matters that are the
exclusive province of the board, such as CEO compensation, which we
believe are appropriate for discussion with the board alone.
“We’ll get tripped up on Reg FD
issues.” Just to be clear, large shareholders are not
looking for inside information on strategy or future expectations.
What they’re looking for is the chance to provide the perspective of
a long-term investor. Companies individually have to decide how to
best manage that risk, but it shouldn’t be by shutting out the
shareholders completely. Firms can train directors, include their
legal counsel in shareholder conversations, and set clear boundaries
“There is no time in our
agenda.” Boards should talk about how much time to allot to
engagement. I would say, of course, that time for engagement with
significant shareholders should be on the board’s agenda. Investors
are an important constituency whom boards represent.
“This would be too difficult to
implement.” Leading companies already have substantive
engagement programs in place. The Shareholder-Director Exchange
Protocol is available online and offers guidance on setting up
If your company doesn’t have an engagement
program already underway, start where you are. Start now. The
landscape has shifted, and companies cannot afford to be insular. The
engagement train has left the station, and the leading companies are
Shareholder engagement establishes common ground
A big part of the engagement process is
establishing common ground, getting to the things that the shareholder
and the board both know to be true, and getting to the things that
they’re both trying to accomplish. There should be an extraordinary
degree of alignment between the interests of the shareowners and the
board, because the board represents the shareowners.
One critical benefit of good relationships
that I’ve seen is being able to provide background on some of the
votes we’ve cast. As you know, shareowners have only two votes: for or
against. But not every “for” vote is “absolutely for.” A good
relationship allows us to fill in those shades of gray between
“absolutely for” and “absolutely against.” We may vote “for” but have
reservations at the margin. If we don’t share those reservations, then
the company has no opportunity to consider addressing those issues and
might be very surprised to find that our vote has changed the next
time. Or if we vote against the company’s recommendation, a good
relationship allows us to share why we voted that way and what the
company would need to do to get our support.
If all we’re doing is simply voting, it
doesn’t give the company the full picture. So the company is flying
blind, in a way.
From Vanguard’s point of view, we’re in
the relationship to maximize the value of the longest of long terms
for our fund investors. We understand that things don’t always go up
in a straight line. So if we have a good relationship with a company,
they have a great opportunity to tell us their story. If there are
performance problems, for example, either own those problems or tell
us what you’re doing to fix them. For example, “We know we’ve got cost
problems. We’ve got this initiative underway to trim $1 billion in
costs for the next three years, and we think that’s going to address
our problems.” Whatever the particular issue might be.
It’s worth noting that in the vast
majority of cases, we’re happy to engage with management, too. Many
times the questions or concerns we have are ones that we’re very
comfortable relaying to management and getting management’s
perspective on. In fact, many companies are including in their proxy
statements more information about the engagement they’ve done with
their investors. We’ve seen tables that show “what we heard” and the
corresponding “what we did.” We think that’s a great trend.
So much of engagement gets back to the
idea of self-awareness and knowing the places in which you’re an
outlier. Unless you know where you stand, both from a competitive
standpoint and with your investors, you’re a sitting duck.
Looking ahead: The future of engagement
I’ll close my remarks with a few thoughts
addressed directly to board members of public companies: We count on
you to oversee the companies that our clients invest in. It’s an
important role. In the U.S. alone, Vanguard invests in some 3,800
publicly traded companies. We place a great deal of trust and
confidence in you. And trust and confidence are built upon open
communication. We want to continue to increase the levels of
engagement we have with boards. We believe that directors—and
investors—are moving in the right direction on that front.
As we look ahead, I believe we can do
One idea: The
Shareholder-Director Exchange that I mentioned. It provides
a protocol and some tools and guidelines for institutional investors
and directors to talk. It’s a wonderful idea, and it has great
promise. There’s an open question on how best to measure the
effectiveness of engagement on a wider scale. But from our
perspective, every positive change that we can help to effect is a
win for our investors.
Another possible channel that I’m
passionate about: The creation of standing Shareholder
Relations Committees on public boards. It could be an
incredibly effective way for boards to gather those outside
perspectives I discussed earlier. Frankly, we’re surprised that more
boards don’t solicit our views on general industry topics. For
example, we have a very successful actively managed Health Care
Fund—the world’s largest health care fund, by a wide margin, at more
than $50 billion in assets. I would think that the directors of
pharmaceutical firms or biotech firms would be interested in talking
to our portfolio manager to hear her opinions and outlook for the
industry. There is a great opportunity for dialogue between investor
and director on that level as well.
You, as directors, have a great
opportunity to tell us how your bring value to investors. We want to
listen. When you post a video to the company’s website, we’ll watch
it! When you give a good explanation of an issue in your proxy
statement, we’re reading it very carefully. When you provide context,
we’re taking it in.
We are listening to your perspective. We
want you to be aware of ours. We are your permanent investors. We care
very deeply about the role that you play for our clients. And we thank
you for doing the job well.
Thank you for listening.
Harvard Law School Forum
on Corporate Governance and Financial Regulation
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