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The
Democratization Of Corporate Governance
Quora
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Dec 6, 2023, 04:30pm EST
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Does my index fund vote in shareholder
meetings of its portfolio companies? And do I have a say in it?
originally appeared on Quora: the place to gain and share knowledge,
empowering people to learn from others and better understand the
world.
Answer by Nadya Malenko, Professor
of Finance, Boston College, on Quora:
Imagine you are an average investor who has
some Vanguard shares, and you get an email from Vanguard to vote on
several corporate governance issues. You may be surprised. You knew
that when you invested in Vanguard's S&P 500 Growth Index Fund, you
were buying into the performance of hundreds of companies like Apple,
Microsoft, and Tesla. But you didn't realize that this also meant you
had a say in how these companies were run.
And that's where our story begins.
When you buy an index fund or ETF, you're not just buying a share in
the performance of a collection of companies, you're also buying
voting rights. Traditionally, these rights have been delegated to the
asset managers, like Vanguard or BlackRock, who then vote on behalf of
their investors.
This has resulted in a concentration of voting power in the hands of a
few large institutions, sparking a debate about the implications for
corporate governance, particularly around contentious issues like
environmental. A key debate was triggered when BlackRock expressed a
strong pro-ESG (Environmental, Social, and Governance) stance, which
led to disagreements with policymakers and investors across the United
States, from New York to Florida to Texas. The high-profile dispute
from 2021 between ExxonMobil and activist investor Engine No. 1 is a
prime example. Engine No 1, backed by Exxon’s top investors Vanguard,
BlackRock, and State Street, pushed Exxon towards more environmentally
friendly practices, despite certain groups of investors not being
onboard, demonstrating the potential power of shareholder voting.
The debate has led to the rise of pass-through voting. Instead of
delegating voting power to the fund managers, the power is passed back
to fund investors. Asset managers like BlackRock and Vanguard have
introduced voting choice programs, where investors can choose to
retain their votes. As of September 2022, institutional investors
holding $530 billion, constituting a quarter of BlackRock's eligible
assets, opted to retain their votes.
While originally only available to asset managers’ institutional
investors, this program was soon extended to many individual
investors, further extending the reach of pass-through voting. And on
Capitol Hill, a proposal known as the INDEX Act seeks to legislate
this practice, requiring passive funds to vote in accordance with the
instruction of fund investors.
Pass-through voting is changing the investing landscape in several
ways. On the positive side, it allows investors to express their
preferences and have a direct impact on corporate governance. As these
preferences are aggregated through voting, they can align with or
challenge the agendas of big corporations.
However, the democratization of corporate governance is not without
its costs. While we want investors to express their ideas, we also
need to ensure they understand the implications of their decisions.
The due diligence typically performed by large asset managers might be
beyond the capacity of individual investors, potentially leading to
less informed voting. Additionally, the all-or-nothing nature of
pass-through voting, where investors must pick their preferences on
all issues across all companies, limits flexibility.
Forcing pass-through voting could also increase the transactional
costs of the voting process. Companies may struggle to reach quorum
for proposals, and the process of reaching out to investors and
setting up voting systems can be expensive. And many institutional
fund investors would feel the obligation to vote, thereby contributing
to additional expenses like advisory and processing fees.
As for the Index Act? There's been no movement in the Senate as of
now. But the debate continues.
So, yes, your index fund votes. You may or may not have a direct say
in it (as of now). And if you do, it may come with a cost.
This question originally appeared on Quora - the place to gain and share
knowledge, empowering people to learn from others and better
understand the world.
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