Lifting The Veil On Voting

Over the last decade, there has been a huge shift from active to passive investment strategies. While a lot of time is spent trying to understand the implications of this on market efficiency and asset class returns, a lesser discussed topic is the influence this has on shareholder voting. Each year, shareholders in public companies vote on matters of corporate governance at the annual general meeting (AGM); topics can range from routine questions such as the election of the board of directors and management compensation, to high-profile questions such as takeover proposals. Asset managers, acting as agents, exercise this right on behalf of their underlying investors.

For a manager, the challenge of deciding how to vote consistently on the resolutions of the hundreds of public companies it owns, could be met by employing John Rawls’ veil-of-ignorance reasoning. This concept, which is aimed at identifying the governing principles of a just society, is premised on the idea of making choices (such as voting decisions) from an “original position” of equality (by applying a one-size-fits-all policy) without knowledge of any biasing information (such as company-specific facts). Despite the lack of academic consensus about what constitutes “good corporate governance”, asset managers have established similar rule-of-thumb principles to define what they believe reflects good governance. These are inevitably reductionist in nature because they turn principles where reasonable minds could differ into binary outcomes. Yet, with these procedures established as best practice, consistency is ensured but suboptimal outcomes can ensue.

In this newsletter we discuss why this is the case, not only as more of the “voting voice” is dominated by a small number of large players, but also because shareholders are being asked to apply these “best practices” to complicated questions; this is especially true as company AGMs are increasingly becoming platforms for deciding complex social and environmental issues.

As an active manager with a long-term mindset, we value being able to take a thoughtful approach to voting each case on its merits. This approach may result in different voting decisions for different companies, but this will always be consistent with our fiduciary duty to drive long-term, risk-adjusted returns for our clients.

Power of the two Ps: passive and proxy

Today, Vanguard, BlackRock and State Street collectively own as much as 20-30 per cent of nearly all US public companies and they constitute the largest investor in 88 per cent of the S&P 500 (up from 25 per cent in 2000).¹ Similarly, the proxy advisory market, which provides research and recommendations to institutional investors on how to vote their shares, is controlled by just two companies, Institutional Shareholder Services Inc. (ISS) and Glass, Lewis & Co. (Glass Lewis).²

Taken together, these five players have become increasingly influential in the corporate governance decision-making of companies. In the case of passive fund managers, the stewardship and voting decisions are typically made by a centralised investment stewardship team, which is responsible for developing policies and guidelines about how they plan to vote on recurring issues and engaging with companies. Relative to the shares they own, these teams are generally quite small in size; for example Vanguard employ around 60 people who analysed and voted on 177,307 proposals for 12,937 companies in the 2021 proxy season.³ Put differently, each member must research, analyse and make governance decisions on around 2,900 proposals for over 200 companies; we consider this to be a gargantuan task which would be very difficult to do with any great specificity.⁴

Applying rule-of-thumb principles, at scale, can result in an automatic, unthinking approach to corporate governance issues, such as voting for resolutions that prima facie improve director independence or blanket voting against dual-voting share structures (serving two masters). In the case of proxy advisors, they develop policies about how to vote on recurring questions and then provide recommendations on how to vote on each particular question for each particular company to the institutional investors who subscribe to their research. Although these investors can then choose how to vote, the reality is that many adopt the practice of “robovoting”, whereby they automatically, and with minimal evaluation, rely on the proxy advisors’ recommendations.⁵ This concentration results in little diversity of advice and these players have the power to  influence voting outcomes. The recent move by some passive managers to allow eligible institutional clients to vote their own shares would seem to ameliorate this problem.⁶ But it could merely be a case of shifting the problem from one corner to another if decisions are not made by people who take the time to understand and contextualise the nuance of specific proposals.

The evolving agenda of the AGM

Over the past decade we have also witnessed a shift away from the notion that the sole responsibility of business is to generate profit for its shareholders, and towards one which requires they consider the interests of all stakeholders. As a result, investors are increasingly being asked to assess complex questions around the environmental and social aspects of companies’ activities. As stewards of our clients’ capital there are a number of considerations we must take into account when deciding how to vote on these, and we believe these illustrate why using rule-of-thumb principles can lead to suboptimal outcomes.

Firstly, we are often confronted with trying to determine whether the proposal is attacking the problem in the right way. Many proposals have progress as their aim but in some cases a specific outcome might be better. There is increasing focus on trying to get  companies to reduce their carbon emissions; supporting a proposal for a company to reduce its carbon emissions by five per cent each year might seem obvious. But is incremental progress the right solution? As investors we should be asking whether becoming carbon neutral, or even carbon negative is a more appropriate goal. Moreover, the answer will differ between a software business and an aluminium smelter. At Seilern, we invest in companies which have established long-term, sustainable business models and which tend to score very well on certain environmental metrics (such as carbon emissions) and so the ability for them to make progress may be limited; the challenge lies in the fact that the investment community often prioritises progress when outcomes (in this case) may be the more relevant thing to target.

The next consideration is how well-suited a particular proposal is to achieving the intended outcome. Some proposals have the effect of oversimplifying the problem; for example, a resolution asking a company to measure and report certain statistics may have the opposite effect of encouraging box-ticking and quota-filling. Put slightly differently, we must consider whether a proposal can be said to achieve the “right outcome” if the unintended consequences have not, or cannot, be fully taken into account; an initiative to promote cleaner energy dependence or reduce carbon emissions may sacrifice well-paying jobs, or make products more expensive for the most vulnerable in society.

Finally, it is relevant to ask whether, as investors, we are even qualified to make these complex calls. Admittedly, the answer is that we are probably less qualified than we would like to be, especially when proposals require technical skills in niche fields in order to make an informed assessment. It is our view that investors should stick to the few, big directional calls that are within their competence and that can impact the long-term sustainability of a company, rather than blindly support proposals that are overly prescriptive or micromanage how a company achieves the outcome.

The concern, in our eyes, is that investors who follow a formulaic, “if-then” approach when considering these complex questions may be more likely to vote for the proposal if it meets some pre-defined or best practice qualifications. Perhaps this explains why support for these proposals is increasing.⁷ Often, these resolutions are non-binding, but voting in a particular way signals to management one’s commitment to the cause being put forward, and that is enough for us to pause for thought.

Conclusion

The one-size-fits-all, veil-of-ignorance reasoning employed by asset managers to vote at company AGMs is a lesser considered consequence of the rise of passive funds. While this approach may seem fair and rational in theory, the risk, we believe, is threefold;  firstly, the “voting voice” has become concentrated in a small number of players who have the potential to influence voting outcomes; secondly, investors are increasingly being asked to consider very complex issues that are being reduced to fewer variables than is required to address the matter, and oversimplifying complex issues can result in the right intention leading to the wrong outcome; finally, these problems are posed to people who are not necessarily in a position to solve them.

As an active manager with a concentrated portfolio we are not bound by rule-of-thumb reasoning. We recognise that nuance is important and that in some cases best practice can lead to undesirable outcomes, both in terms of returns but also the ultimate goal that the proponents of these resolutions are looking to achieve. At Seilern, we invest in companies that have established long-term, sustainable business models and our actions as investors will always be aligned with this; for companies in the Seilern Universe, there may be situations where applying our principles brings different results on similar matters, but this will always be consistent with our fiduciary duty to drive long-term, risk-adjusted returns for our clients.

C. Hoelzl,

30th September, 2022

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