Can proxy voting help passive investment managers do a better job of expressing the values of their client base?
Published: 07 Jun 2021
Can the largest investment managers truly judge what is in the true shareholders’ best interests?
The ExxonMobil vote demonstrated the power that the passive managers have over the companies they own through proxy voting. Without the passive investment managers coming off the bench to vote for new directors, Engine No. 1 had no real hope of gaining board seats, even with the large public funds on their side. The three passive managers are the largest shareholders of ExxonMobil shares, with approximately 8% (Vanguard), 7% (BlackRock) and 6% (State Street) for a total of 21% of the company. How do we know that the passive managers were the decisive factor? We know because Vanguard and State Street supported two candidates and BlackRock announced support for three. All three won. The passive managers tipped the balance with their proxy votes.
Should passive managers also be referees?
Why should an investment company simply paid to hold shares in companies that comprise an index be representing underlying shareholders’ interests? How can they know the underlying shareholders’ interests? Historically, the passive managers have represented that they vote proxies in line with the concept of maximizing shareholder value, which is why Engine No 1 framed its analysis in terms of shareholder value. The stock currently trades at about $60 a share, down from $103 per share in 2014, and not much above the levels where it was trading in the early 2000s. This observation leads one to ask on what basis the passive managers’ prior votes were being assessed? It does not look like it was based on maximizing long-term shareholder value.
How to handle moral hazard with proxy voting?
The conflict between the passive managers’ core responsibilities, hold the index on behalf of investors, and the responsibilities that the securities rules and regulations foist upon them as the owner of record (but not the true shareholder), creates a fundamental problem and a potential moral hazard. These firms do not necessarily represent or reflect the values or best interests of the true shareholders. The collective views expressed through environment, social and governance (ESG) activism may also not represent the true shareholders values or best interests.
Maybe the ExxonMobil board votes were clear for the owners of record, but there are many topics and issues where the owner of record may be walking a potential litigation plank by having an opinion. Recently, there have been calls for shareholders to weigh in on global tax avoidance under the ESG banner. How do we expect the big three owners of record to manage on the social aspects, such as ensuring no human trafficking in supply chain management?
For sure, the times they are a changing, but crucial questions and issues remain. Should the largest passive managers be the judging what is in the true shareholders’ interests? If yes, on what basis and how should it be disclosed? Is a sudden change in voting an acknowledgement that past votes did not maximize shareholder value? Does this change create a liability for passive managers? Is there a better way to evaluate and align proxy voting to the true shareholders’ best interests? More on these questions and many more in future blog posts.