I am in favor of the idea put forward in this article which recently ran in the Wall Street Journal. The article’s premise is that index funds should not be allowed to vote in corporate proxy elections.
Funds and Voting
Currently, if you invest in any type of fund – mutual fund, ETF, UIT, whatever – the manager of your fund gets to vote the shares that the fund owns. The individual investors in the fund don’t get a vote.
Active vs. Passive
If you invest in an actively-managed fund, that means that the fund manager picks and chooses which individual stocks to invest in. Presumably, these fund managers, therefore, want to have a say as to how the companies are managed. That makes complete sense. Active managers, by all means, should be able to vote their proxies.
However, passive fund management is completely different. All a passive manager is trying to do is to mimic some index of companies. A passive manager doesn’t have an interest in how each company that makes up the index is managed – only that their allocation to each company is in line with the index that the fund follows.
If a manager of an index fund doesn’t care how an individual company is managed, why then should that manager be allowed to vote their proxy? Just because we have one person one vote standards in other areas of society doesn’t mean we should have that same standard in corporate governance.
As index funds have grown, they have become major shareholders. In the recently-concluded proxy battle over Procter & Gamble, ETF’s through Vanguard were the largest single shareholder, with 7.2% of the company, and ETF’s through BlackRock were another large shareholder, with 4.5% of the company, according to an article on the CNN website. Both parties in the proxy battle, which pitted P&G against activist investor Nelson Peltz, heavily lobbied Vanguard, BlackRock, and all of the other ETF owners of P&G stock. This gave the Vanguard and BlackRock fund managers an outsized amount of corporate power that they didn’t want. Vanguard and BlackRock, as index ETF managers, shouldn’t have had a dog in this fight. They were not seeking to improve the management of P&G, only to own P&G stock as part of an index. Vanguard, BlackRock and any other ETF fund owner/managers should not have been able to vote in the P&G vs. Peltz battle.
One of the major problems with the growth of the Index ETF phenomenon is that, the more people own stocks through Index ETF’s, the less they have an interest in keeping watch over the individual companies that comprise the Index. Only direct shareholders have the true best interest of the company as their own. In finance academia, this is called a Free Rider problem. The proposal in the Wall Street Journal article that I am promoting here would greatly help to solve this Free Rider problem because the proxy vote, and therefore corporate governance, would be left only to those who have an actual interest in improving each company. If 20% of a company is owned by Index ETF’s, for instance, management of the company should rest with the 80% of shareholders who actually care how the company is run, and not with the 20% that doesn’t care.
When you invest in an individual stock, you are acting as an allocator of capital: You are deciding to invest in that company’s stock and not in other companies. When you are an allocator of capital, you rightfully should have a vote as to how your investment is managed. When you invest in an index fund, you are not allocating capital: You are investing in a basket of companies and hoping that the tide rises for all of them. You are not interested in the management of any single company. As such, I believe Index investors should not have a say as to how those companies are managed. That task should be left to individual stock investors.